Analysis of the Effects of Environmental Regulation on Pulp and Paper Industry Structure

This paper investigates the impact of environmental regulations on market structure using a Markov analysis to quantify relationships among macroeconomic variables, environmental regulation expenditures and firm size distribution in the pulp and paper. Results show that environmental regulation affects the probabilities of capacity moving from one company size category to another and of staying in the same category. Presented Paper at the 1998 American Agricultural Economics Association Annual Meeting in Salt Lake City, Utah. Analysis of the Effects of Environmental Regulation on Pulp and Paper Industry Structure During the past decades many natural resources-based industries have undergone tremendous adjustments as a consequence of environmental regulations and controls. Most of these regulations are a direct result of the Clean Air and Clean Water Acts that were initiated in the early and mid 1970s and subsequent amendments. While ostensively designed to control externalities and increase social welfare, environmental regulations may have indirect effects on market structure resulting from changes in firm behavior as agents adjust to legal mandates. Raising environmental standards may raise plant investment costs, creating potential barriers to entry or fostering mergers and acquisitions because small companies do not have the resources to comply with more stringent regulations. To date, most economic studies of regulatory controls in natural resource markets follow the Pigouvian approach of selecting policy instruments that maximize social welfare. Cropper and Oates review this literature. In general, these studies have investigated the effects of taxes, subsidies, standards, and other regulatory instruments on quantities and prices, while assuming perfect competition and exogenous market structure. However, the assumption of perfect competition may be faulty since many polluting industries are characterized by regionally or nationally concentrated manufacturing sectors. Concentration may augment firms' market power, expanding their ability to pass on cost increases associated with environmental controls (Farber and Martin). More importantly, concentration may enhance firms' abilities to use environmental controls to restrict output supply and input demands, thereby increasing their market power. In this situation, regulatory controls designed to solve pollution problems in markets may change 2 each firm's ability to exert market power, and alter market structure. When policies endogenously alter market structure, standard welfare analyses are no longer appropriate since they presuppose a constant market structure. One natural resource-based industry experiencing high levels of regulation is the U.S. pulp and paper industry. This industry faces stringent environmental restrictions on both water and air emissions. Pulp and paper ranks third after the primary metals and chemical industries in terms of freshwater withdrawal, and ranks fifth among major industries in its contribution to water pollution. Since 1976, many mills have built secondary biological waste treatment plants, and now an estimated 99% of the pulp and paper plants in the U.S. have secondary treatment or its equivalent (Springer). On the air pollution side, the pulp and paper industry is heavily regulated in particulate matter, oxides of sulfur, sulfur compounds and chlorine compounds. The objective of this paper is to investigate the effects of environmental regulations on market structure in the pulp and paper industry. A nonstationary Markov chain analysis is used to investigate the linkages among environmental expenditures, macroeconomic variables and the size distribution of firms. If environmental policies are important in determining industry structure, assuming the relationship of production capacity to market structure is fixed, the atheoretical nature of this analytical technique will reveal that without the bias inherent in structural analyses. Arkansas, Louisiana, and Texas are chosen for this analysis. In 1988, these states accounted for 17.9% of the total capacity of pulpwood, and 15.1% of the total U.S. paper and paperboard capacity. Additionally, plant-specific capacity data are available for these states for the period