The economicsof poIIution control in Japan A unique relationship between government and business has
been a key factor in Japan’s successful pollution control program
Thomas K. Corwin PEDCo Enuironmental, Inc. Cincinnati, Ohio 45246 Japan has undergone a period of remarkable economic growth since World W a r 11. There was a strong commitment to expansion in the 1950s and 1960s, and heavy industry grew up in zones surrounding densely populated areas in the drive for economic recovery. Factory smoke became a symbol of this growth, a source of pride to the Japanese people. As in the United States and other industrialized countries, however, economic growth was accompanied by nationwide and localized environmental problems of increasing diversity and complexity. In response to increasing public pressure, the Japanese government in the late 1960s instituted a complex system of ambient and emission standards based on health effects, and not necessarily on available technology. The result has been a dramatic reduction in levels of some pollutants (see Figure I ) . What the economic effect of this action has been-and how economic and social conditions in Japan facilitated the i n stitution of pollution controls--will be examined here. Spending for pollution abatement by industry increased rapidly after 154
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1965 and reached a peak of nearly 18% of total capital expenditures in 1975. Capital expenditures have decreased in recent years, primarily because most major firms have largely completed their antipollution investment programs, especially with respect to SO2 control. (By October 1975, over 1000 flue gas desulfurization units had been installed.) Operating expenses for pollution control, however. remain high. At many copper smelters they are reported to represent 20-30% of production costs. The reported total investment for pollution control by industrq between
Table 1
Private sector investment in pollution control YO of total prlvate investment
Japan U.S.
4.0 3.4
Netherlands Germany Sweden Norway
2.7 2.3 1.2 0.5
Yo of GNP
1.o 0.4 0.3 0.3 0.1 0.1
Source: Organization for Economic Cooperation and Development, Economic lmplications of Pollution Control, A General Assessment, 1974.
1965 and 1975 was 5.3 trillion yen (at I970 price levels)-about $15 billion. These costs represent a significantly higher proportion of total private capital investment than occurred in other industrialized countries during this period (Table I ) . The annualized costs (opportunity cost of capital, related operating costs, and depreciation expense) were about 2% of the gross national product ( G N P ) ; these costs are also higher than those estimated for other countries. All told, expenditures for pollution control by industry and government at all levels represented about 3% of the G N P by 1975. The significant macroeconomic effects of these expenditures are shown in Figure 2 . Pollution control investment has been concentrated in such industries as iron and steel, petroleum, thermal electric generation, pulp and paper, and chemicals. The effects of this spending have been simulated by Japanese researchers with several econometric models; all have yielded similar results. Modeling by the Environment Agency has shown significant estimated increases in 1975 price indexes resulting from pollution control investments in several key industries, including pulp and paper (5.6%), ceramics (4.0%), chemicals (3.7%), and primary metals (3.3%). Such price
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increases reduce demand for the products of these industries and depress investment in new equipment. The resulting reductions in supply and the negative effect on G N P are offset somewhat by increased demand for control equipment and attendant materials and parts, which stimulates investment, increases production in these industries, and has a positive effect on the G N P . The greatest induced production resulting from pollution abatement expenditures has understandably occurred in metals and machinery, although all segments of the economy appear to have benefitted from the secondary effects of the new investment needed for additional pollution control equipment (Figure 3).
Polluters-and consumers-pay The Japanese approach to pollution control expenditures is based on the “Polluter Pays Principle” (PPP), an economic concept introduced by the Organization for Economic Cooperation and Development (OECD) in 1972. Under the PPP, costs are borne by the polluter rather than the government. The costs are then passed on in increased prices, and so the consumer, not the taxpayer, pays for pollution control. Japan has extended the original PPP to include payment for restoration of polluted environments, administration of monitoring and surveillance programs, and compensation for victims of pollution-even, for example, those who must travel some distance to swim because the waters at nearby beaches are polluted. As one example of the application of the PPP in Japan, all major SO2 emitters (those releasing more than 5000 normal m3/h of exhaust gases) must pay a penalty for each cubic meter of SO2 released, even if the plant is in compliance with the appropriate emission standard. The tax rate is based upon the amount of industrial developnient and pollution in the area. Rates in some specially designated regions are as much as nine times those in less developed areas; the penalty in a designated area could amount to as much as 17% of the cost of a 3% sulfur fuel. Total proceeds from the SO2 penalty in 1976 were 33 billion yen ($1 I O million), about 5 million yen per source taxed. Proceeds are used to reimburse certified victims of certain respiratory ailments and to research these diseases. “Administrative guidance” The unique relationship between government and business in Japan has been a key factor in that country’s re-
sponse to its deteriorating environment. Japanese society emphasizes harmony, cooperation, and group welfare. There is a traditionally close association between government agencies, banks, and industries. Government takes a paternalistic view toward large business firms, which are regarded as the greatest national asset. In turn, there is a tradition of private acceptance of government leadership, as well as a sharing of values and beliefs between business and government leaders. Enforcement of environmental standards in Japan has generally relied on “administrative guidance,” not coercion. Pollution control is part of an overall package negotiated between business and government, a package which may include government loans, grants, subsidies, tax incentives, contracts, and permit and license approvals. The possibility of public criticism is also a strong motivating force behind a company’s compliance with environmental standards. Business feels that its image, and therefore its place in Japanese society, is at stake. A 1976 analysis of 100 000 plant inspections by regulatory agencies
showed no prosecutions and less than 200 official orders for change; administrative guidance had been relied upon to resolve problems in 4700 cases. The cooperative government-business relationship is further illustrated by the regular submission of accident reports when emergency violations of environmental regulations occur: The violation itself is not always punishable, but failure to report it is.
Tax breaks Selective differential taxation has always been a key element in the Japanese economy. The initial depreciation allowance for pollution control equipment was first increased in 1967, and such investments are now stimulated through a range of government fiscal policies. A first-year depreciation write-off of 50% was permitted through 1976 on new pollution-control equipment. In 1977 this rate was reduced to 25%. First-year depreciation of 33’/3% is allowed for nonpolluting production equipment. Small- and medium-sized companies are offered either 50% depreciation of the equipment cost in the first year ur 30% for each of the first three years. Such de-
FIGURE l
Annual concentration of principal air pollutants
‘65
‘66
‘67
‘68
‘69
‘70
‘71
‘72
‘73
‘74
’75
Source: Environment Agency, Tokyo. 1978
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FIGURE 2
Macroeconomic effects of pollution control investment
1965
'66
'67
'68
'69
Source: Environment Agency, Tokyo 1978
'70 '71 Fiscal year
'72
'73
'74
'75
FIGURE 3
Induced production in various industries
Foodstuffs Textiles Paper and pulp Chemicals Petroleum and coal products Ceramics Primary metals Metals and machinery Transportation machinery Other manufacturing Electricity. gas, transportation, and communication Construction Service and miscellaneous (billion yen)
0
100
200
300
400
500
600
Real induced production (at 1970 prices) Source: Environment Agency, Tokyo. 1978
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700
preciation policies result in a reduction in taxable income (a zero-interest loan) and thus effectively reduce the cost of the new equipment. This encourages firms to make continuing investments while the depreciation policy is still in effect. Business firms in Japan are assessed a tax on fixed assets. A 50% reduction in this tax for pollution-free production equipment is permitted in the third year following installation. Additional deductions from income ("special reserve funds") are also permitted for companies with large pollution-control costs or significant reductions in profits because of their investments and expenses in this field. This also reduces a company's tax burden. Fiscal policies are also used to stimulate pollution control spending at the local government level. Tax exemptions and a reduced tax base were permitted for firms with pollution control facilities installed for the three years ending in 1978. The tax base may be reduced to 60% for production facilities equipped with pollution control and wastewater reclamation systems. It may also be reduced to one-sixth of the installation cost for wastewater treatment facilities required by certain regulations. In addition, the local fixed-assets tax on equipment for recycling wastes may be halved for the first three years following installation. T h e national government also subsidizes pollution control activities through special organizations and financial institutions. For example, the Environmental Pollution Service Corporation, founded in 1965, provides assistance for land development, construction of public facilities for pollution prevention, and loans for pollution control equipment. T h e Japan Development Bank makes loans for conversion to nonpolluting processes, pollution control facilities, and improved factory working conditions. The total 1975 lending limit from these and the other institutions that subsidize environmental measures i n industry was nearly 320 billion yen (about $ 1 . I billion). The interest rates for IO-year loans for antipollution investments from several of these institutions i n 1975 ranged from 6.85 to 8.0'30, whereas the market interest rate averaged 9. I '30. By 1976, government appropriations for pollution control had increased to 565.9 billion yen (about $1.9 billion), more than 1% of the total govern ni en t budget . A 1t ho u g h de f i n i tive data are lacking, O E C D has estimated that the subsidy equivalent of the government tax and loan programs
that year represented about 2.6% of the total pollution-control investment. One interesting feature of the Japanese approach to pollution control has been the attempt to share the burden of meeting these costs when more than one industry is responsible. To illustrate, tariff revenues from imports of high-sulfur fuel oil have been assigned to refineries to offset the costs of subsequent desulfurization, but some of the costs have b’een charged directly to the electric power industry, whose flue gas desulfurization costs are lowered by burning the cleaner oil.
Integration eases the burden The ability of Japanese firms to absorb high pollution-control expenditures is also due in part to the unique business structure of that country. Prior to World War 11, the economy was dominated by giant financial conglomerates (zaibatsu), often controlled by single families, whose reach extended to all aspects of modern business. Immediately following the war, strong antimonopoly and restraint-of-trade, laws enacted by the Allied Command broke up the zaibatsu, but enforcement of these laws was relaxed in the early 195Os, and the largest groups re-formed. These modern associations (keiretsu) have grown rapidly in the last 25 years. The three largest keiretsu-Mitsubishi, Mitsui, and Sumitomo-together account for nearly 40% of the capital of all the firms listed in the first section of the Tokyo Stock Exchange. Along with the next three largest associations, they control about 30% of all corporate assets in Japan. At the top of the most modern keiretsu are central banks, which may exercise working control over 20-30 major companies within the group through indirect corporate financing. Each controlled company, in turn, may have minority interests in a hundred or more sister companies, so the total number of firms associated with a single keiretsu may r u n into the thousands. The degree of interlocking ownership is a key to understanding the keiretsu. Financial institutions hold 35% of the total share capital in the Japanese economy, while other corporations hold an additional 23% of the outstanding common stock. Although none of the companies holds much stock in any one of the others within the group, the holdings of all the sister companies in the total keiretsu capital may be 40-50% because of the number of companies involved. Intergroup financing is an even more important source of funds than joint ownership.
Financial institutions hold 7 5 % of all corporate bonds in Japan, and these relationships are frequently within the keiretsu. The individual subgroups in the keiretsu are usually linked vertically with the central bank in the financial phase. Much horizontal activity also occurs among the companies, although these ties vary in strength. Activities a r e coordinated through regular meetings of top management, and consultations normally occur among the group members before important decisions are made by a company. The extent to which group support has eased the burden of pollution control is not known, but all of the groups drew more tightly together during the middle 1970s, consolidating resources and integrating management. A lead bank could conceivably support pollution control expenditures both through direct loans and by arranging loans from other financial institutions. Other potential methods of financial assistance within the keiretsu include accelerated payment from customers, postponed billing by suppliers, and order channeling or discriminatory pricing. The Japanese business style itself also has an effect on pollution control expenditures. The rate of capital ownership is less than half that in the United States. In 1968, only 22% of total Japanese corporate assets were financed by equity; less than 10% of new funds were provided by this means. Rapid economic growth has prevented many firms from accumulating capital from internal sources. Tax laws favor debt financing by allowing interest to be deducted from income, and equity financing is relatively expensive because new stock is usually issued at par value, not market. There is also heavy reliance on trade credit. The importance of debt in Japanese business provides some freedom from short-term stockholder interests; investments can be made more easily without regard for their immediate profitability. The fact that financial institutions and corporations own so many of the outstanding capital shares is also important, for they regard their holdings as part of a long-term relationship, not a short-term investment. Nonproductive investments that do not promise a rapid return on capital, such as pollution control facilities, are therefore more feasible. No major shocks Although there have certainly been adverse effects on individual industries and at specific locations, the available
data indicate that the high costs of pollution control have not caused a major shock to Japan’s economic growth. In spite of the highest rate of pollution control spending in the world, the rate of growth in G N P remained high until the 1974 worldwide recession. Over the past decade, the positive income effects of pollution control spending have surpassed the negative price effects. Japan’s experience, though, is not strictly applicable to other countries. Japan’s long history of relatively authoritarian social and political forms, as well as traditions of group cooperation and self-discipline, have contributed to the orderly changes in social attitudes and industry practices. Pollution control expenditures have been subsidized by government at all levels and directly and indirectly by the unique financial structure of Japanese business. That the majority of capital expenditure programs were initiated during a period of economic growth when funds were relatively available musr also be considered. Still, the success of Japan’s drive for environmental improvement cannot be denied.
Additional reading Environment Agency, Quality o f t h e Encironment in Japan-1977, Tokyo, February 1978. Environment Agency, Recent Countermeasures f o r Air Pollution Control in Japan. Tokyo, 1977. Organization for Economic Cooperation and Development, Encironmental Policies rn Japan, Paris, 1977. PEDCo Environmental, Inc., Pollution Control in the Japanese Primary Nonferrous Metals Industry (Contract No. 68-02-1 375, Task No. 36, U.S. Environmental Protection Agency, Office of Air Quality Planning and Standards), Research Triangle Park, N.C., March 1978. Patrick and Rosovsky, Asia’s N e w Giant: How the Japanese Economy Works, The Brookings Institution. Washington, D.C., 1976.
Thomas K. Corwin manages a variety of studies in pollution assessment and control and energy use at PEDCo Environmental. He has a n undergraduate degree in economics from Miami University, an M.B.A. from Columbia University. and an M.S. from Ohio State’s School of Natural Resources. Volume 14, Number 2, February 1980
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