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Environmental Regulation in Indian Manufacturing Industries:

Production vs. Quality


1
Aditi Jamalpuria
Research Scholar
Centre for Economic Studies and Planning
School of Social Sciences
Jawaharlal Nehru University
New Delhi !!""#$%
Email address& aditi'(amalpuria)yahoo%com
aditi%(amalpuria)gmail%com
Abstract
*n this paper+ we have tried to analy,e the impact of environmental regulation on the
production and the -uality status of manufacturing industries across *ndian states% .his is
done to discern the effect of environmental regulation on the competitiveness of the
industries across *ndian states% Using /rdinary 0east S-uares we chec1 for the impact of
investment in pollution control and status of environmental regulation on the production
of manufacturing across *ndian states+ thereafter+ we chec1 for the impact of these
varia2les on the ac-uisition of -uality status certification 2y the manufacturing units% .he
-uality status certificate considered for the purpose is the *S/3""" certificate which is
given to those factories+ which ta1e up all round measures in their industrial pro(ects for
-uality maintenance% 4e have used the statewise AS* !33$!335 which gives the data
for investment in pollution control as well as the data for *S/3""" certified units for the
*ndian states% Percentage of factories ta1en up pollution a2atement facilities+ percentage
of capital investment of the total capital investment for pollution control and percentage
of running e6pense of the total running e6pense for pollution control is used to construct
a dummy varia2le which indicates the status of environmental regulation in a state% .he
/0S regression results reveal that investment in pollution control negatively affects the
production of manufacturing 2ut positively contri2utes to the ac-uisition of -uality status
certification 2y the manufacturing units in the states% 7oreover+ states with effective
environmental regulation status perform 2etter on 2oth the production and the -uality
!
.his paper is a part of my 7%Phil% Dissertation su2mitted to the Centre for Economic Studies and
Planning+ Jawaharlal Nehru University in July 8""9% * am grateful to my Supervisor Prof% :rishnendu
;hosh Dastidar of Jawaharlal Nehru University+ for his guidance and feed2ac1% * also wish to than1 Prof%
Sarmila <aner(ee of Calcutta University+ Prof% Jayati ;hosh of Jawaharlal Nehru University+ Dr% <
Sengupta 7em2er Secretary at the Central Pollution Control <oard and 7r% :% Narang Advisor at the
7inistry of Environment and =orest+ New Delhi%
!
status front% .hus if there is a demand for high -uality manufacturing product then the
states with effective environmental regulation have a sustaina2le competitive edge over
the states with ineffective environmental regulation%
Keywords& Environmental regulation+ manufacturing+ pollution control investment+
production+ -uality+ sustaina2le competitive advantage%
JEL Classification& C8!> D8?> 0#"> @8"> @85%
8
Environmental Regulation in Indian Manufacturing Industries:
Production vs. Quality
1. Introduction
Past few decades have witnessed an evolution of literature on impact of environmental
regulation on the competitiveness of industries% *t 2rings forth the following two
opposing views% /ne of the views says that an enhanced stringency of regulation
increases the cost of production in the form of investment in pollution control+ which
adversely affects the competitiveness of the industry
8
% 4hile+ the second view+ which
draws heavily on the cele2rated Porter Aypothesis+ says that an enhanced stringency
encourages a cleaner and more efficient mode of production in the form of innovations%
Such innovations result in generating product differentiation in the form of production of
2etter -uality products 2y the firms e6posed to the stringent environmental regulation%
.his leads to a sustainable enhancement in the competitiveness of such firms in contrast
to the firms+ which are competitive through the low cost route+ which is easily duplica2le
and hence unsustaina2le in the long run
B
%
Carious studies since PorterDs E!33"F and Porter G van der 0indeDs E!339F seminal wor1s
have e6plored the two opposing views from 2oth the theoretical and empirical
perspectives% Palmer+ /ates and Portney E!339F critici,e the Porter Aypothesis 2y
theoretically showing that+ in a simple static model of perfect competition there is always
a tradeoff 2etween environmental regulation and competitiveness% 4hile an empirical
wor1 2y 7urty and :umar E8""!F in the conte6t of *ndia supports Porter hypothesis%
Using a distance function approach they show that the technical efficiency of the firms
increases with the intensity of environmental regulation and water conservation effort%
Hepapadeas and de Ieeuw E!333F e6plore the validity of Porter hypothesis 2y
considering firms reactions with respect to 2oth the type and -uantity of e-uipment in
which they respond to invest as a result of changes in environmental ta6es% According to
8
Jaffe et%al% E!339F have presented an e6tensive literature on Environmental regulation and
competitiveness in US%
B
See Porter E!33"F and Porter and van der 0inde E!339F%
B
them the cost of environmental regulation can 2e decomposed into two effects J
downsi,ing and the moderni,ation of capital stoc1 which considera2ly reduces the
sharpness of the tradeoff 2etween stringent environmental regulation and
competitiveness%
*n this paper we try to analy,e the impact of environmental regulations on the production
and the -uality status of manufacturing industries in *ndian states% .his is done to discern
the effect of environmental regulation on the competitiveness of the industries across
*ndian states% 4e first incorporate investment in pollution control and status of
environmental regulation in a state as determinants of production 2esides conventional
inputs li1e capital and la2our% .hereafter we chec1 for the impact of these newly
incorporated varia2les on the production of manufacturing across *ndian states% =inally+
we chec1 for the impact of investment in pollution control and status of environmental
regulation on the ac-uisition of -uality status certification 2y the manufacturing units for
the year !33$!335%
.he focus of our wor1 is industrial pollution for which the Central Pollution Control
<oard ECPC<F has stipulated 2aseline standards 1nown as the 7inimum National
Standards E7*NASF+ however+ the State Pollution Control <oard ESPC<F can prescri2e
more stringent standards depending upon the particular re-uirements% So all over *ndia
standards for industrial pollution are common+ 2ut still the evidences suggest that there is
difference across the states in the compliance status of the industrial units% .his difference
in the compliance status arises possi2ly due to the socioeconomic differences across the
states and also due to the la6ity in enforcement and monitoring on the part of the various
SPC<s% States can have effective regulation only if along with the common industrial
pollution standards specified 2y the CPC<+ the respective SPC<s carry out the tas1 of
enforcement of standards and monitoring of industrial pollution effectively% Against this
2ac1drop we try to chec1 for the issues discussed earlier in the section% .he rest of the
paper is organi,ed as follows% A Production Hypothesis is stated and e6plored in section
8% Section B e6plores a Quality Hypothesis% =inally+ section ? contains the concluding
remar1s and an agenda for future research%
?
2. A Hypotesis for te Inter!"tate Manufacturing Production
#e Hypotesis: Effective environmental regulation in a state and investment in
pollution control by the manufacturing units in a state significantly contribute to the
production of manufacturing units in the state.
.he a2ove hypothesis is e6plored using a crosssection data collected 2y Annual Survey
of *ndustries EAS*F !33$!335
?
which considers the following !5 states for the analysis
Andhra Pradesh+ Assam+ <ihar+ ;u(arat+ Aaryana+ Aimachal Pradesh+ Jammu G :ashmir+
:arnata1a+ :erala+ 7adhya Pradesh+ 7aharashtra+ /rissa+ Pun(a2+ Ra(asthan+ .amil
Nadu+ .ripura+ Uttar Pradesh and 4est <engal% .o analy,e the hypothesis we have used
/rdinary 0east S-uares method where we consider the following varia2les%
$irm "pecific E%planatory &aria'les:
!% (
pur
+ which is defined as the average spending on capital investment 2y the
stateDs manufacturing units Ein Rs% 0a1hsF for categories other than pollution
control%
8% (
pol
+ which is defined as the average spending on capital investment 2y the stateDs
manufacturing units Ein Rs% 0a1hsF for pollution control%
B% ) which is defined as the average num2er of wor1ers involved in the
manufacturing process in the states%

"tate "pecific E%planatory &aria'les:
!% R*+, which is the state level e6penditure on research and development for each
of the states Ein Rs% 0a1hsF for the year !33$!335
9
%
8% +v-Effreg is the dummy varia2le for effective environmental regulation status of
the !5 states%
?
4e are considering year !33$!335+ as it was only in year !335!333 a field wor1 was carried out at the
AS* level to pu2lish the pollution compliance data%
9
.he department of Science and .echnology+ ;overnment of *ndia collects the data%
9
+v-Effreg . 1 if /101 23 of factories ta4en up pollution a'atement facilities5
6 101 23 of capital investment of te total capital investment for pollution
control5 6 101 23 of running e%pense of te total running e%pense for
pollution control57
8
9 :.;1
. < oter=ise
.o o2tain the critical value of 3%9B the average of the weighted sum was
considered for the !5 states+ which came out to 2e !!%9B% .he critical value was
then ta1en as 3%9B
$
%
As stated earlier whether a state has an effective environmental regulation or not
depends upon the performance of its SPC<% So the components of the weighted
sum are due to the initiatives of the SPC<s% Aigher weighted sum would imply
that ade-uate actions are 2eing ta1en 2y the SPC< to render the environmental
regulation effective in a particular state%
=or e6ample& 4est <engal Pollution Control <oard E4<PC<F over the years has
either closed down a num2er of firms not having ade-uate compliance facilities
or have discontinued electricity supply in the industrial units not complying 2y
the standards% Also+ as per the weighted sum calculated for the states the value of
Dv'Effreg is ! for 4est <engal%
<esides 4est <engal the other states which showed the environmental regulation
to 2e effective as per the dummy varia2le are Assam+ <ihar+ Aaryana+ Aimachal
Pradesh+ :arnata1a+ 7aharashtra+ Pun(a2 and Ra(asthan%

4e can further cite the e6amples of ;u(arat Pollution Control <oard E;PC<F and
.amil Nadu Pollution Control <oard E.PC<F% According to the weighted sum
calculated for the states the value of Dv'Effreg for ;u(arat is " and also various
facts over the past few years indicate towards dismal performance of ;PC< on
#
E-ual weights are assigned to all the three components of the dummy varia2le 2ecause a higher
percentage of all the three are e6pected to contri2ute e-ually in rendering the environmental regulation in a
state effective%
$
4e could have ta1en the critical value as !!%9B 2ut that would have rendered some of the states ineffective
even though the weighted sum value for these states was (ust marginally lower than the average value of
!!%9B% So we have ta1en the critical value as 3%9B%
#
the front of industrial pollution regulation% =irst+ in Decem2er !33? 7r% Dilip
<iswas+ the then head of the Central Pollution Control <oard+ pu2licly declared
;u(arat+ with its industrial 2elt 2etween Ahmeda2ad and Capi as the most
polluted state in the country and he specifically critici,ed the state 2oard for
2eing too lenient with industries% *n another incidence in !339 a farmer filed a
petition against largescale pollution of a canal called :haricut% .his 2rought into
notice of Supreme Court the fact that the state of ;u(arat had passed a resolution
in the legislation under the Article 898 to not to introduce the !355 amendments+
which strengthened the implementation provisions of the 4ater Act of !3$?% .he
!355 amendments empowered the state 2oards to close down a defaulting unit
and also raised the penalties% So 2y not adopting the amendments the ;PC<
allowed the industries to pollute land and water 2odies
5
% Similarly+ in !33# .amil
Nadu Pollution Control <oard E.PC<F went to the Supreme Court see1ing a
rela6ation of effluent standards for the .anneries set 2y .PC<
3
% .his is indicative
of the rela6ation in the enforcement tas1 of the .PC<% Also according to the
weighted sum calculated for the states the value of Dv'Effreg for .amil Nadu is
"%
<esides ;u(arat and .amil Nadu the other states which showed the
environmental regulation to 2e ineffective as per the dummy varia2le are Andhra
Pradesh+ Jammu G :ashmir+ :erala+ 7adhya Pradesh+ /rissa+ .ripura and Uttar
Pradesh%

+ependent &aria'le&
Prdn, which is defined as the average output Ein Rs% 0a1hsF of the manufacturing
units in a particular state%
5
See 7andal+ S% and 7%;%Rao E8""9F%
3
See ;upta+ S% E!33#F%
$
4e ne6t specify the general Production function for the analysis which considers
environmental regulation and innovation status of the states 2esides conventional
determinants li1e capital and la2our%
Production function:
Prdn = f (K
pur
, K
pol
, L, R&D, Env
Reg
)
4here+
Env
Reg
: Status of Environmental Regulation in a state%
4e consider a Co22 Douglas production function for the analysis%
Prdn
i
. >
<
(
puri

>1

(
poli

>2

)
i

>1
R*+
i

>?

e
ui

4here iK!LLL!5 is the num2er of states considered for the analysis%
>
<
. .echnological coefficient

K !
!"

u . Stochastic distur2ance term
e K <ase of natural logarithm
11
ln Prdn
i
. >
1
ln (
puri
6 >
2
ln (
poli
6 >
1
ln )
i
6 >
?
ln R*+
i
6 >
;
+v-Effreg
6u
i
.he ta2le EaF 2elow gives the values of the partial regression coefficients and their
corresponding tvalues for the Production model%
!"
4e are ta1ing the technological coefficient to 2e ! as ours is a crosssectional study and not a timeseries
analysis where the role of technological coefficient 2ecomes important in the production function% So there
is no constant term in our model%
!!
Another model in which the states were divided into poor+ mediocre and e6cellent performers with
respect to the status of environmental regulation Ereplacing the dummy varia2le for effective environmental
regulationF was also tried+ so as to avoid the pro2lem of dividing the states into mere good and the 2ad
performers% .he results o2tained were not su2stantially different% .his was done for 2oth the Production and
the @uality Aypotheses%
5
#a'le2a5 Result of te Model
Caria2les
Standardi,ed
Coefficients
!8
tvalue
ln :pur "%B9"M B%$8#
ln :pol "%"93M B%?39
ln 0 "%8?$M 8%8B5
ln RGD "%?!!M 9%3#?
Dv'Effreg "%"98M B%5!9
= K 8B!3%##9M
ad( R
8
K "%335
M Significant at "%"! level
.he result validates our hypothesis that the status of environmental regulation in a state
and investment in pollution control+ along with conventional inputs li1e capital and
la2our contri2ute significantly to the production of manufacturing in the states% .he
regression analysis carried out reveal that the investment in pollution control negatively
affects the production of the manufacturing units in the states thus corro2orating to the
issue of tradeoff 2etween environmental regulation and competition through the route of
loss in productivity% 7oreover+ the 2enefits of RGD wor1s Eour pro6y for innovation
statusF have its spill over effect on manufacturing industries% So as is e6pected the value
of the partial regression coefficient for RGD e6penditure is significantly positive%
Aowever+ the mean output of states with effective environmental regulation is
significantly higher than the states with ineffective environmental regulation 2y 9%B?N
!B
i%e% the states with effective environmental regulation are performing 2etter on the
production front in contrast to the states with ineffective environmental regulation%
A point worth mentioning here is that the value of the standardi,ed coefficient for
investment in pollution control is least in comparison with other -uantitative regressors of
the production model% .his implies that relatively spea1ing investment in pollution
control has less impact on the average output of the manufacturing in the states for the
year !33$!335%
!8
Standardi,ed Coefficients are o2tained 2y standardi,ing the varia2les which renders them directly
compara2le% .his overcomes the interpretational pro2lem associated with the difference in units of the
regressand and the different regressors%
!B
See Aalvorsen and Palm-uist E!35"F for the interpretation of dummy varia2les in a semilogarithmic
model%
3
1. A Hypotesis for te Inter!"tate Quality "tatus of Manufacturing
Process
#e Hypotesis: Effective environmental regulation in a state and investment in
pollution control by the manufacturing units in a state significantly contribute to the
uality status of manufacturing process in the state.
.he 8! states considered for the !rdinary Least "uares regression analysis are Andhra
Pradesh+ Assam+ <ihar+ ;oa+ ;u(arat+ Aaryana+ Aimachal Pradesh+ Jammu G :ashmir+
:arnata1a+ :erala+ 7adhya Pradesh+ 7aharashtra+ 7anipur+ Nagaland+ /rissa+ Pun(a2+
Ra(asthan+ .amil Nadu+ .ripura+ Uttar Pradesh and 4est <engal% .he analysis considers
the year !33$!335%
$irm "pecific E%planatory &aria'les:
1. (
pur
+ as stated in section 8%
2. (
pol
+ as stated in section 8%
"tate "pecific E%planatory &aria'les:
1. +ev, which is the pro6y for development status of the states% =or Dev we have
considered per capita Net State Domestic Product Ein Crore RupeesF for each of the
8! states for the year !33$!335%
2. +v-Effreg is the dummy varia2le for effective environmental regulation status of
the 8! states%
+v-Effreg . 1 if /101 23 of factories ta4en up pollution a'atement facilities5 6
101 23 of capital investment of te total capital investment for
pollution control5 6 101 23 of running e%pense of te total running
e%pense for pollution control57 9 @.A1
. < oter=ise
.he critical value has changed 2ecause the data set now comprises of 8! states%
!"
+ependent &aria'le&
Q
s,
which is defined as the ratio of the num2er of *S/3""" certified
manufacturing factories in a state to the total num2er of manufacturing factories
in the state% *t represents the -uality status of the manufacturing in the 8! states
considered for the analysis% .he data source again is the AS* for the year !33$
!335% *S/3""" certificate is given to those factories+ which ta1e up all round
measures in their industrial pro(ects for -uality maintenance% 4e consider
*S/3""" certification as the pro6y for -uality status for the manufacturing in a
state 2ecause first+ pollution auditing is a must for o2taining the *S/3"""
certification+ so the *S/3""" certified factories are cleaner factories% Second, the
certification is 2ased on 5 2asic principles one of which re-uires the firm opting
for *S/3""" certification to continually improve% .his improvement process is
2ased on the following two preconditions%
o :nowledge of appropriate measures and methodologies for continual
improvement and use as appropriate for their products or services%
o Allocation of appropriate resources for innovative -uality improvements%
So *S/3""" certified factories are not only relatively cleaner in the production
process 2ut are also the ones with innovative capa2ilities which are re-uired for
differentiation and hence for attaining sustaina2le competitive advantage%
4e ne6t specify the general Quality "tatus function and the model in terms of the various
firmspecific and statespecific varia2les%
Quality "tatus function:
Q
s
= f (K
pur
, K
pol
, Dev, Env
Reg
)
4here+
Env
Reg
: Status of Environmental Regulation in a state%
!!
Q
si
. >
<
6 >
1
(
puri
6 >
2
(
poli
6 >
1
+ev
i
6 >
?
+v-Effreg 6 u
i
4here+
i K !LLL%8! is the num2er of states considered for the analysis%
u: the random error term.
.he ta2le E2F 2elow gives the values of the partial regression coefficients and their
corresponding tvalues for the Quality "tatus model%
#a'le2'5: Result of te Model
Caria2les
Standardi,ed
Coefficients tvalue
Constant
!?
8%#"8
:pur "%"5B "%#B9
:pol "%98?M ?%"9!
Dev "%?5?M ?%8#5
Dv'Effreg "%B9#M B%!#8
= K !$%338M
ad( R
8
K "%$$B
M Significant at "%"! level

/ur results in this section validate the hypothesis that -uality status of the manufacturing
in the states is a positive and significant function of capital investment for pollution
control% Also+ effective environmental regulation positively contri2utes to the ac-uisition
of -uality status certification in the states considered for the analysis% .hus effective
environmental regulation and investment in pollution control does lead to differentiation
among the -uality of the manufacturing process in different states+ ma1ing them more
competitive in the long run% 7oreover+ development status of the states also positively
contri2utes to the ac-uisition of -uality status certification across the states indicating that
the development does increase the consumerDs awareness a2out the product -uality%
=inally+ as is evident from the standardi,ed coefficients of regressors+ the standardi,ed
coefficient of investment in pollution control is larger in contrast to the other standardi,ed
!?
4e 1now that intercept K mean value of the dependent varia2le O slope times the mean value of the
regressors + 2ut for the standardi,ed varia2les the mean values of the dependent varia2les and the regressors
is ,ero% Aence the intercept value is ,ero%
!8
regressors% .hus relatively spea1ing investment in pollution control has the ma6imum
impact on the average ac-uisition of *S/3""" certificates 2y the manufacturing units in
the states for the year !33$!335%
?. Bonclusion
Status of environmental regulation in a state can have two effects& one from the firmDs
point of view which is reflected in the investment for pollution control and the other from
the stateDs point of view which is captured 2y the dummy varia2le for effective
environmental regulation% According to the latter+ states with effective environmental
regulation status perform 2etter than the states with ineffective environmental regulation
status 2oth on the production front as well as the -uality status front% So if there is a
demand for high -uality products then the states with effective environmental regulation
have a competitive edge over the states with ineffective environmental regulation in
terms of differentiation% 7oreover+ this gain in competitive advantage is not accompanied
2y a loss in manufacturing production% *t thus seems reasona2le enough for states to
improve the enforcement and monitoring of environmental regulation especially
pertaining to the industrial pollution% <ut investment in pollution control+ gave opposite
direction results for the manufacturing production and ac-uisition of -uality status
certification% .he results revealed that an increase in investment for pollution control was
accompanied 2y a decrease in the manufacturing production 2ut it lead to an increase in
the ac-uisition of -uality status certification among the manufacturing units for the year
!33$!335% 7oreover+ from a comparison of the standardi,ed coefficients in the two
models it is clear that even though investment in pollution control had a negative impact
on the production of manufacturing for the year !33$!335+ it was least in contrast to the
other varia2les of the Production model% 4hereas+ investment in pollution control had
ma6imum positive impact on the ac-uisition of -uality status certificates 2y the
manufacturing in comparison to the other varia2les of the @uality status model%
.his raises the issue of optimum amount of investment in pollution control that would
ameliorate the -uality of manufacturing production with lowest possi2le negative impact
on the manufacturing production% An agenda for future research could thus 2e to
!B
determine the range of cost structure within which this optimum amount of investment in
pollution control would lie so that the -uality of the production might 2e enhanced with a
smaller adverse impact on the production of the manufacturing%
References:
Annual Survey of *ndustries !33$!335+ ;overnment of *ndia%
Annual Reports of Central Pollution Control #oard+ ;overnment of *ndia%
;upta+ S% E!33#F+ PEnvironmental Policy and =ederalism in *ndiaD+ $ational
%nstitute of Public &inance and Policy 'or(ing Paper+ New Delhi%
Aalvorsen+ R% and R% Palm-uist E!35"F+ .he *nterpretation of Dummy Caria2les in
Semi 0ogarithmic E-uations+ )merican Economic *eview+ Colume$"+ No%B + p
?$??$9%
Auman Development Report+ 8""!%
Jaffe+ A% <% et%al% E!339F+ PEnvironmental Regulation and the Competitiveness of
US manufacturing& 4hat Does the Evidence .ell UsQD Journal of Economic
Literature+ ColumeBB+ p !B8!#B%
7andal+ S% and 7% ;ovinda Rao EJanuary 8""9F+ P/verlapping =iscal Domains
and Effectiveness of Environmental Policy in *ndiaD+ $ational %nstitute of Public
&inance and Policy 'or(ing Paper No% 89+ New Delhi%
7urty+ 7% N% and S% :umar E8""!F+ P4in4in /pportunities and Environmental
Regulation& .esting of Porter Aypothesis for *ndian 7anufacturing *ndustriesD+
,iscussion Paper %nstitute of Economic -rowth+ New Delhi%
Palmer+ :%+ 4% E% /ates and P% R% Portney E!339F+ P.ightening Environmental
Standards& .he <enefitCost or the No Cost ParadigmD+ Journal of Economic
Perspectives+ Colume3+ p !!3!B8%
Porter+ 7ichael E% E!33"F+ .he Competitive )dvantage of $ations+ New Ror1&
=ree Press%
!?
Porter+ 7ichael E% and van der 0inde E!339F+ P.owards a New Conception of the
EnvironmentCompetitiveness RelationshipD+ Journal of Economic Perspectives+
Colume3+ p 3$!!5%
Ray+ N% and <% Chaudhuri E8"""F+ PEconomics of Environmental 7anagement
Can *ndian Economy Afford to Shut down Dirty industriesQD Central "tatistical
!rgani/ation 0C"!1 'or(ing Paper+ ;overnment of *ndia%
Hepapadeas+ A% and D% Ieeuw E!333F+ PEnvironmental policy and
Competitiveness& the Porter Aypothesis and the Composition of CapitalD+ Journal
of Environmental Economics and 2anagement+ ColumeB$+ p !#9!58%
!9