Environmental policy stringency and CO2 emissions: Evidence from cross-country sector-level data

This paper provides empirical evidence on the short and long-term sectoral effect of environmental policy stringency on CO2 emissions, exploiting longitudinal data covering 30 OECD countries and more than 50 sectors. The analysis relies on the OECD Environmental Policy Stringency (EPS) index, a composite index tracking climate change and air pollution mitigation policies. Estimates obtained from panel regressions suggest that more stringent environmental policies are associated with lower emissions, that the effect builds over time and differs across sectors depending on their fossil fuel intensity. A one unit increase in the EPS index (about one standard deviation), is associated with 4% lower CO2 emissions in the sector with median fossil fuel intensity after two years and by 12% after 10 years. For sectors in the top decile of the fossil fuel intensity distribution, the estimates point to a decline in emissions by 11% after two years and 19% after ten years. Environmental policies targeted at energy, manufacturing and transport sectors have the largest potential impact on emissions. Illustrative policy scenarios based on these results indicate that achieving emission reductions consistent with net-zero targets will require raising the stringency of environmental policies more drastically and rapidly than in the past.