Environmental Regulation and Production Efficiency

The development of the power sector in India has proceeded so far with little attention paid to its environmental implications. Such a course of development, however, seems difficult to continue in the face of growing degradation of environmental quality and increasing public awareness of environmental problems in the country. The share of the thermal-power sector is about two-thirds of India's total electricity production. In the thermal-power sector, coal contributes the largest share of fuel consumption. Shrestha and Acharya (1992) have noted the fairly substantial contribution of thermal power to air pollution in India. Being a negative externality, this pollution adversely affects the welfare of society. Thermal-power plants in India have been asked to make compliance decisions to meet environmental standards that can involve the investment of millions of rupees. How could these pollution control efforts affect the production efficiency of this sector? The objective of this chapter is to study the impact of compliance decisions on the production efficiency of India's thermal-power sector. In recent years, an active debate has emerged on the impact of environmental regulations and pollution abatement on the production efficiency and the competitiveness of the firm. The discussion was initiated by Porter (1990, 1991) and Porter and van der Linde (1995), who hypothesized that environmental regulation improves a firm's overall production efficiency relative to unregulated firms. Moreover, the hypothesis rests heavily on the inference that stiffer environmental regulations result in greater production efficiency. The conventional textbook economic theory contradicts this hypothesis, and economists have tended to be critical of its theoretical and empirical foundations (see, e.g., Jaffe et al., 1995; Jaffe and Palmer, 1997; Simpson and Bradford, 1996; Hetemaki, 1996).