6. Designing and implementing SDG-oriented industrial policies
Building on the results of previous chapters, this chapter provides policy recommendations on the design of industrial policies for the Sustainable Development Goals (SDGs), aimed to increase the private sector’s contribution to the SDGs through firms’ core business activities. It studies the right policy mix between rewards and incentives, government assistance and mandatory compliance instruments, the importance of targeting small firms, new entrants and innovative firms and the design of industrial strategies for the SDGs.
The diversity of policy instruments reflects the multifaceted challenge of the Sustainable Development Goals (SDGs) and requires an integrated approach to articulate them.
Mandatory compliance instruments are a key component of policy packages, but they need to be complemented with other types of policies. They contribute to reducing excessive negative externalities (such as pollution) from firms’ operations and to promoting sustainable behaviours. However, they can increase compliance costs and may fall short of stimulating innovative activities needed to overcome global challenges. The development of new solutions requires a vibrant ecosystem, notably of innovative sustainable start-ups and entrepreneurs, which can be effectively supported through rewards-and-incentives instruments to promote the private sector’s contribution to the SDGs through their core business.
More generally, because the transition to more sustainable business models entails significant costs and risks, more support to firms, and especially to small and medium-sized enterprises (SMEs), is needed to trigger this transition and assist in the process. This can be done through government assistance instruments.
Beyond core industrial policies, adequate business framework conditions are needed. The advent of a sustainable economy will necessitate a significant reallocation of resources towards more sustainable activities and firms. In particular, international trade, when associated with a more level playing field on sustainability issues, can contribute to the SDGs by increasing the market size for sustainable firms. Demand-side instruments may also be useful in some instances to create new markets for sustainable products and services.
Mission-oriented industrial strategies provide an appropriate structure for consistently articulating policy instruments and establishing suitable governance. To limit the risks of policies being unduly influenced by vested interests, as brought to light by previous waves of industrial policies, a particular emphasis should be placed on including all types of firms (but in particular young and small ones), policy evaluation and regular refit.
Based on the evidence gathered in previous chapters, this final chapter underlines five recommendations for the design of SDG-oriented industrial policies to foster the private sector’s contribution to the SDG through core business.
Mandatory compliance instruments – in particular legal and regulatory standards – are a key component of policy packages. They contribute to avoiding inordinate or irreversible negative externalities from firms’ operations. As shown in Chapter 5, many countries are implementing stringent standards regarding gender equality (in terms of positions and wages), workplace health and safety, or pollution. In these cases, deviation from social norms cannot be tolerated, and firms have to comply with regulations, incurring financial or non-financial sanctions if they do not. Combinations of regulations and sanctions have been shown to effectively reduce violations, not only for sanctioned firms, but also for the others.1 The liability of stakeholders also reduces the negative impact of firms on the environment (Annex F).
Information disclosure also promotes virtuous behaviours. For instance, Christensen et al. (2017[1]) show that, in the United States, the mandatory disclosure of mine-safety records in their financial report decreased citations and injuries. In the People’s Republic of China, Chen, Hung and Wang (2018[2]) showed that mandatory disclosure of corporate social responsibility (CSR) activities reduced industrial wastewater and sulphur dioxide emissions.
Other mandatory compliance instruments may also serve as a signal to change behaviours. For instance, carbon pricing, which is now widespread among the countries surveyed in Chapter 5, is considered as an efficient way to reduce greenhouse gas emissions and trigger low-carbon investments. Mandatory compliance measures are effective in fostering innovation in environmental technologies, as measured by patents, favouring the adoption of green technologies, creating markets for green products and reducing emissions (Haščič et al., 2010[3]; Ambec et al., 2013[4]; Blind, 2016[5]; Popp, Newell and Jaffe, 2010[6]). Clear trajectories of gradually increasing carbon prices over the next decades make the business case for a low-carbon transition, and can provide forward guidance to investors and reduce uncertainty (OECD, 2020[7]). The carbon pricing example can be linked to the SDG 7-Affordable and Clean Energy, SDG 9-Industry, Innovation and Infrastructure, SDG 12- Responsible Consumption and Production and SDG 13-Climate Action, which are shown to concern firms’ core business (Figure 3.8).
Mandatory compliance instruments also have the advantage of potentially involving affiliates abroad or arm’s length suppliers, such as the German Act on Corporate Due Diligence in Supply Chains (Sorgfaltspflichtengesetz, passed in June 2021). As discussed in the previous chapters, taking a whole-of-supply chain approach increases the scope for action, and ensures that firms from OECD countries can contribute to the SDGs in developing countries.
However, by increasing production costs and the regulatory burden, mandatory compliance instruments may affect the competitiveness of do (Blind, 2016[5])mestic firms. Building on the above-mentioned examples, Christensen et al. (2017[1]) show that the decrease in mine-related citations and injuries is accompanied by a drop in labour productivity. Chen, Hung and Wang (2018[2]) demonstrate that the decrease in pollution took place at the expense of a decrease in profitability.
The impact of mandatory compliance instruments on competitiveness has been extensively studied with environmental policies, specifically via market instruments (feed-in tariffs, cap-and-trade schemes, carbon levies). Even if environmental regulation fosters innovation and productivity, the net impact on competitiveness remains negative or close to zero in a majority of the studies (Dechezleprêtre and Sato, 2017[8]; Dechezleprêtre et al., 2019[9]; Ambec et al., 2013[4]). OECD research shows that implementing more stringent environmental policies has had little aggregate effect on economic performance over the last three decades, despite achieving significant environmental benefits (OECD, 2021[10]). Yet, small average effects across the economy hide heterogeneous impacts across industries and firms. While more stringent environmental policies may negatively affect the performance of energy-intensive trade-exposed industries, at least in the short run (Aldy and Pizer, 2015[11]) and in least-productive firms, environmental stringency positively affects the productivity of frontrunner industries and firms and the exports of low-pollution industries. Carbon leakage is a possible consequence of unilateral carbon pricing policies and the resulting disparities in the price of carbon across countries, as part of the emissions avoided through domestic environmental regulations are shifted to other locations.
Moreover, stringent standards or price signals are unlikely to be sufficient, as global challenges require the development of new technologies and innovative solutions. These breakthroughs require research and development (R&D) funding, to incentivise and reduce risk for innovators, as a complement to mandatory compliance instruments, which help create a market for these innovations. This has been exemplified in recent years by the new paradigm of green industrial policies. It is now widely acknowledged that carbon pricing policies need to be supplemented by innovation subsidies, in order to foster the development of clean technologies (Altenburg and Rodrik, 2017[12]; Tagliapietra and Veugelers, 2020[13]). A policy portfolio including emission pricing and subsidies for low-carbon technology R&D and deployment can reduce carbon emissions at a significantly lower cost than any single policy alone (Fischer and Newell, 2008[14]).
Finally, the interactions between mandatory compliance instruments and firms’ sustainability actions may not be trivial. While extrinsic motivation may crowd out the intrinsic motivation and reduce voluntary contributions (Gneezy, Meier and Rey-Biel, 2011[15]; Bénabou and Tirole, 2010[16]) or CSR (de Bettignies, Liu and Robinson, 2020[17]) (for instance by reducing reputational benefits of good behaviours), Costello and Kotchen (2020[18]) show that taxing emissions – by reducing the abatement cost – can encourage firms to go beyond expected emission reductions.
Beyond large and established firms, which are often the focus of mandatory compliance instruments, new solutions can also emerge from younger firms, which in many sectors disproportionately contribute to disruptive innovation. The entry and growth of new firms that replace old, unproductive ones is the engine of efficiency-enhancing reallocation and a major driver of aggregate productivity growth (Decker et al., 2017[19]). Moreover, start-ups are often seen as vehicles of radical innovation and, thus, of reallocation and productivity growth (Acemoglu et al., 2018[20]).
Using “rewards and incentives” to foster the creation of innovative sustainable firms, whose core business directly relates to the SDGs, can be an efficient tool to promote the transition towards a sustainable economy. The literature increasingly acknowledges the role of this channel (Terán-Yépez et al., 2020[21]; Keskin, Wever and Brezet, 2020[22]). The analysis in Chapter 3 confirms that a significant share of the economy is linked to the SDGs, showing the potential for sustainable innovation in these sectors. It also demonstrates that, for some SDGs, the corresponding industries remain at an early stage and might benefit from the entry of new firms.
Indeed, studies confirm that the early imprinting of sustainability concerns is key for the subsequent behaviour of firms, be it through sustainable entrepreneurship2 or a more general commitment to the SDGs. Alakent, Goktan and Khoury (2020[23]) show that venture capital (VC)-backed firms are less likely than other comparable firms to adopt CSR practices. Even if the CSR record of VC-backed firms improves over their business life, it does so at a lower rate than for the other firms. However, firms that are backed by VC companies with a responsible investment policy have better CSR records than comparable non-VC backed firms.
Another strand of the literature emphasises the spillovers from sustainable entrepreneurs, and thus the policy rationale to support them. Building on interviews with sustainable entrepreneurs in Berlin and Lagos, Tiba, van Rijnsoever and Hekkert (2020[24]) show the lighthouse role of successful sustainable entrepreneurs, which contribute to attract other entrepreneurs and skills to create an SDG-oriented cluster. Cojoianu et al. (2020[25]) demonstrate how relevant local knowledge positively affects the entry decision of green entrepreneurs in Europe and the United States.
Mandatory compliance instruments, while having a positive impact on available funding for SDGs, do not seem to trigger entrepreneurship (Cojoianu et al., 2020[25]). Therefore, entrepreneurship and start-up policies should be seen as an important component of mission-oriented SDG strategies. Many countries support entrepreneurship, in particular innovative entrepreneurship such as the J-Startup programme (Japan) and the Women Entrepreneurship Strategy (Canada). When designing new entrepreneurship and start-up policies, introducing sustainability considerations into the schemes (e.g. public VC,3 business plan competitions4) should be considered. However, particular attention should be paid to the impact of sustainability considerations on the funds’ financial returns. Barber, Morse and Yasuda (2021[26]) show that the performance of impact-investing VC are two to three percentage points lower than traditional VC.
As shown in Chapter 2, although sustainability constitutes a viable business case in many instances, the transition to a new business model is a sizeable and risky investment.
Larger firms may be better equipped than small firms for such an investment, as part of it can be considered as a fixed cost (e.g. communication on the actions undertaken). SMEs may also face a higher cost of capital, which increases the cost of sustainability efforts, and stronger information asymmetries, which can heighten the perceived level of risk.
In this respect, as for other types of intangible investments (e.g. R&D, software, marketing), small firms may be at a disadvantage compared to large firms in the transition to sustainability (Bajgar, Criscuolo and Timmis, forthcoming[27]).
In this context, countries have opted for more flexible regulation for small businesses. This is confirmed by the policy benchmarking exercise, with a significant share of mandatory compliance instruments focusing on medium and large firms (e.g. non-financial disclosure requirements, gender-balance requirements, carbon trading schemes, etc.).
At the same time, as small firms represent a significant share of economic activity in most OECD countries, policies need also to ensure that these firms have adequate incentives to shift to sustainability. This support is notably provided through government assistance instruments, the objective of which is to reduce the cost or the risk of sustainability investments. For example, the SME Sustainability Roadmap (Canada) provides guidelines and information on the transition to sustainable business models for firms (particularly SMEs). To increase the market size for sustainable firms, governments also implement “matching seeds toneeds” programmes to help small firms find suitable foreign markets for their sustainable products and services.
Support is provided by national governments, but local governments and other intermediaries (e.g. business networks) can also help in this respect (Kundurpi et al., 2021[28]; Cojoianu et al., 2020[25]; McCann and Soete, 2020[29]; Iizuka and Hane, 2021[30]), and complement public initiatives. In some industries, private-sector initiatives are already complementing policy instruments by the government. In the financial services sector, for example, environment, social and governance (ESG) and social impact-investing initiatives (Box 2.4) channel investment into small sustainable enterprises and start-ups. Other intermediaries, such as Global Compact Local Networks and business associations, support firms’ transition into sustainable business by providing toolkits, resource centres, seminars and networks.
The advent of a sustainable economy will necessitate not only the transformation of firms to sustainability, but also a significant reallocation of resources towards more sustainable activities and firms. Chapter 3 shows that SDG-related sectors represent a non-negligible share of the economy, but also that their size significantly differ from one country to another, which suggests a potential for growth in some jurisdictions. This requires a notable amount of reallocation, both between sectors and between firms in the same sector. Framework and demand-side instruments (Figure 5.1) are thus needed to form a coherent and comprehensive industrial strategy.
The reallocation of production factors, including capital, towards sustainable firms will require well-functioning labour and capital markets.5 Moreover, promoting transparency for firms and institutional investors is likely to reinforce the pressure to deliver on SDGs, provided that information is available at a reasonable cost for firms and investors (Annex F). The effect, however, is likely to be muted for smaller firms, and governments need to be mindful about the potential adverse impact on the access to finance or the cost of external funds for these firms when instituting these policies.
More generally, maintaining a sufficient level of competition seems to favour the sustainability of firms. Even though tougher competition could reduce room to manoeuver for sustainability investments and efforts, the literature shows that competition fosters sustainability, because firms try to differentiate from their competitors (Annex F). Competition is also important because the transition to sustainable production could favour large incumbents, at the expense of small and young firms, thereby increasing concentration and leading to entrenchment.
International trade can also contribute to the shift towards sustainability. Chapter 4 illustrates that cross-border contributions to the SDGs are significant and provide opportunities for firms. It creates an additional incentive by increasing the market size for sustainable firms. Trade rules and relevant measures on issues such as removal of barriers to trade and trade facilitation may contribute to this end. Nevertheless, openness to trade must be accompanied by a level playing field for firms. For instance, a recent study has identified the existence of below-market finance in sectors such as heavy industries and high-tech industries (OECD, 2021[31]). Addressing these through trade rules may strengthen the global value chains for SDG-related activities. Furthermore, unilateral climate efforts may increase costs for domestic firms (e.g. heavy industries), damaging their competitiveness and jeopardising emission reductions through carbon leakage. In this example, accompanying measures include the subsidisation of green technology adoption or carbon border adjustments (OECD, 2020[32]).
Finally, beyond supply-side instruments, demand-side instruments may also be useful in some instances to create new markets for sustainable products. For instance, OECD (2021[33]) shows that the definition of regulatory standards (e.g. minimum content requirements, regulation applied to scrap metal) and public procurement may be critical to help create markets for recycled products and synthetic and bio-based feedstock (SDG 12-Responsible Production and Consumption and SDG 13-Climate Action). Some countries have implemented SDG-oriented public procurement tools (e.g. Eruboshi firms and Green public procurement in Japan). However, the impact of this type of instrument on the cost of public consumption and the private sector’s sustainability remain unknown.
More generally, it is also important to nudge and raise the awareness of the SDGs among consumers. This integrative approach (public and private consumption, supply and demand-side instruments) will support the creation of new markets that will be increasingly oriented towards sustainable products and services. Such instruments are important for the providing the basis for a circular economy with responsible consumption.
The complex set of market failures and policy objectives underlying SDG industrial policies calls for a carefully designed strategy relying on a consistent and articulated group of policy instruments, corresponding to the definition of mission-oriented strategies (Box 5.2).
Larrue (2021[34]) and Criscuolo et al. (forthcoming[35]) underline the importance of governance instruments in mission-oriented strategies. This is all the more crucial because, as previous waves of industrial policies attest, mission-oriented strategies also raise a number of questions and pitfalls that need to be closely scrutinised. In particular:
Finding the right level of support can be challenging. As for any other industrial policy, critics have pointed to potential crowding out effects of public investment that might discourage rather than complement private investment. The risk of creating windfall profits to business for activities they would have undertaken anyway is real and needs to be carefully monitored and analysed.
Industrial policies should refrain as much as possible from making bets on specific technologies. Indeed, the a priori techno-neutrality of mission-oriented strategies is one of their major appeals. They are “problem-led” pathways, rather than “solution-led” ones. However, remaining completely technology-neutral may prove difficult in practice. For instance, nobody knows exactly what mix of technologies will be required to reach carbon neutrality, even if informed guesses are possible and desirable.
Finally, as shown by the policy benchmarking exercise, SDG-related industrial policies significantly resort to targeted investment incentives – the effectiveness of which remains largely unknown. Despite renewed interest and a growing number of related publications, the available evidence regarding the effectiveness of these instruments in triggering new investments remains scarce (in particular for targeted investment incentives related to mission-oriented strategies), suffers from severe limitations and points to mixed conclusions (Criscuolo et al., forthcoming[35]). This assessment calls for efforts to evaluate these targeted incentives, rather than refraining from using them.
Moreover, selecting firms and projects to be supported requires gathering a vast amount of information on the expected returns, risks, spillovers and market failures for each option. Some argue that this information is not available (be it for the government or for any other actor), while others claim that it may be easier to access for businesses than for the government. Due to this potential asymmetry in information between public and private actors, there is a risk of capture and lobbying (Romer, 1993[36]). The ability of governments to stop supporting technologies that prove inadequate (Rodrik, 2008[37]) and the risk of lock-in, have also been questioned.
The industrial policy literature, however, points to solutions to overcome these pitfalls. To limit the risk of capture, and attenuate information asymmetries, it is necessary to put an emphasis on the governance of industrial strategies (Paic and Viros, 2019[38]; Romer, 1993[36]; Warwick, 2013[39]). In particular, it is necessary to:
Favour inclusiveness by ensuring that all the relevant firms, including the young and small ones, are solicited to participate.
Allow for failure, and plan a regular refit of the policies. It is even more important when risks or “wickedness” (i.e. complexity) are high (Cantner and Vannuccini, 2018[40]; Wanzenböck et al., 2019[41]).
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Notes
← 1. See for instance Shimshack and Ward (2005[48]) on the impact of fines for water pollutant violations and Johnson (2020[45]) on the impact of a “shaming” policy for workplace safety and health laws violations, both in the United States.
← 2. “Sustainable entrepreneurship is focused on the preservation of nature, life support, and community in the pursuit of perceived opportunities to bring into existence future products, processes, and services for gain, where gain is broadly construed to include economic and non-economic gains to individuals, the economy, and society” (Shepherd and Patzelt, 2011[47]).
← 3. See Bocken (2015[42]) and Vanderhoven et al. (2020[44]) for qualitative discussions on the role, advantages and limitations of public VC in supporting sustainable start-ups.
← 4. See Fichter and Tiemann (2020[46]).
← 5. For instance, Hong, Kubik and Scheinkman (2012[43]) show that the relaxation of financial constraints allow S&P 500 firms to improve their CSR scores.