Environmental corporate social responsibility, firm dynamics and wage inequality

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Abstract

Based on a general-equilibrium framework, this paper examines the income distributional effect of firms which commit to environmental corporate social responsibility (ECSR) investments. In the short run with fixed number of firms, ECSR investment raises capital rental cost and hence widens wage inequality between skilled and unskilled workers via the factor substitution effect, while the increased capital cost causes firms to exit in the long run. This releases capital and hence lowers the capital rental cost. Thus, the wage gap can be mitigated or even narrowed by a rise in unskilled wage and a drop in skilled wage via the firm-exit effect. This theoretical prediction is confirmed by the empirical result.

Introduction

Corporate social responsibility (CSR) is defined by European Commission (2011, p. 4) as “the responsibility of enterprises for their impacts on society”. This suggests that a CSR firm needs to take into account social, environmental and consumer consequences of the actions undertaken to maximize its shareholders’ wealth when conducting its business activities. CSR has become a popular practice in many firms over the last three decades. The recent 2016 UN Global Compact Accenture Strategy CEO study reports that 80 percent of the CEO surveyed believe that showing commitment to societal purposes helps their firm to differentiate themselves from competitors and 89 percent believe that the commitment to sustainability translates into real impact for businesses (Accenture and United Nations Global Compact, 2016).

The strong interest in CSR can be attributable to the general belief that CSR improves a company's long run performance, which then leads to the improvement in social welfare. This is because a rational firm would not engage in a CSR activity that simultaneously reduces its profits and social welfare (Benabou & Tirole, 2010). The relationship between CSR and a firm's economic and financial performance has been well studied in the literature. The first attempt which links these two concepts is the Milton Friedman (1970) argument that “the corporate social responsibility of firms is to maximize its profits”. Subsequent studies investigate whether or not a company has other types of social responsibility apart from profit maximization (D'Alessandro & Fanelli, 2015). By taking non-profit objectives such as social and environmental aspects into business consideration, the objective function of a socially responsible firm hence becomes a weighted average of its profits and other concerns arising from social and environmental impacts to the firm. The modified objective function has been utilized in past studies that examine the behavior of CSR firms and the resulting effects on prices, outputs and profits for firms that incorporate CSR into their objective functions (e.g., Matsumura & Ogawa, 2014; Manasakis, Mitrokostas, & Petrakis, 2014; Lambertini & Tampieri, 2015; Chan, Chou, & Lo, 2017). However, the income distributional effect of CSR firms remains by and large unexplored.

As evident in the mankind history, economic and political instability has often arisen from income inequality. A recent report by Credit Suisse (2017) indicates that income inequality has been worsening lately since the world's richest 1% controls over 50% of global wealth. The widening wage gap between skilled and unskilled labor can cause social conflict, consequently affecting economic growth and regional stability. Many countries, notably France, have imposed taxes on the rich to mitigate the problem. The factors contributing to the increasing wage inequality between skilled and unskilled labor have been well studied in the literature. In advanced countries, skill premium due to skilled-biased technologies contributes to rising skilled wage, while globalization is a main reason for declining unskilled wages since these countries import more unskilled labor-intensive goods or shift unskilled jobs abroad. This suggests that in the counterpart developing countries, globalization may raise unskilled labor wages (c.f., Goldberg & Pavcnik, 2007). Nonetheless, still many other competing factors, such as market distortions, trade barriers and factor movements, have been pointed out as the reasons that cause rising wage inequality in developing countries. For example, Marjit, Beladi, and Chakrabarty (2003) suggest that foreign investment lower unskilled wages, while this wage reduction is attributed to unemployment in Davis (1998) and immigration in Kar and Beladi (2004). In addition, political and economic institutions have been found to be important sources for rising wage inequality in developing economics (e.g., Easaw & Savoia, 2009).

In this paper, focusing on the environmental dimension of CSR, namely, the environmental CSR (ECSR), we study the income distributional effect of firms which takes ECSR investments into account using a general-equilibrium framework. The ECSR is an integral part of CSR (Flammer, 2013; Lambertini & Tampieri, 2015) and is included within the set of core principles in the United Nations Global Impact (Accenture and United Nations Global Compact, 2013). We consider a two-sector economy with agricultural and manufacturing sectors, in which ECSR activities by skilled labor and capital take place in the manufacturing sector. In the economy, capital is mobile between sectors while skilled labor is specific to ECSR activities. In the short run with fixed number of firms, ECSR investments increase the demands for skilled labor and capital, thereby raising skilled wage and capital rental cost. Consequently, wage inequality between skilled and unskilled labor is widened. However, in the long run, the increased capital cost causes firms to exit from the manufacturing industry. This releases capital to other sectors and reallocation of capital lowers the capital rental rate. Hence, the wage gap can be narrowed in the long run by raising unskilled wage and lowering skilled wage partly through the substitution of skilled labor by capital in the manufacturing sector. We then empirically test the aforementioned short-run and long-run theoretical predictions by using a dataset consisting of 57 countries from 2006 to 2014. We use the environmental dimension of Sustainable Society Index as the proxy for ECSR investment. We find that ECSR has a direct positive impact on income inequality in the short run. However, the effect of ECSR becomes weaker when the firm exit effect is taken into consideration in the long run. Our analysis suggests an overestimation of the average economic effect of ECSR on income inequality by approximately 26 percent if the firm exit effect is ignored in the long run.

This study is closely related to the large literature on the economic impacts of ECSR. It is notable that the results of the past studies on the relationship between ECSR and firm performance and welfare is mixed. On the one hand, Lyon and Maxwell (2008) argue that a lower marginal cost of environmental compliance resulting from a firm's ECSR investment may lead to a reduction in regulatory oversight, which may actually reduce welfare. In addition, considering production externality, Jinji (2013) shows that corporate environmentalism may reduce the effectiveness of government policies and domestic welfare in a simple third-market trade model with strategic environmental and trade policies. On the other hand, Crifo and Forget (2015) suggest that social and environmental policy can serve as the regulatory barriers for a firm's competitors which helps increase the firm's profitability. Liu, Wang, and Lee (2015) consider the certification of ECSR and show that the competition structure affects firms' incentives to adopt ECSR and that ECSR benefits both firms and consumers. Lambertini and Tampieri (2015) investigate how socially responsible behavior influences firms' profits and social welfare when production entails an environmental externality in a Cournot oligopoly, and show that with a large enough market, the ECSR firm obtains higher profits than its profit-seeking competitors, and induces a higher level of social welfare. In a linear state differential game describing an asymmetric Cournot duopoly with capacity accumulation and pollution, Lambertini, Palestini, and Tampieri (2016) show that if the market is sufficiently large, the ECSR firm sells more output, accumulates more capital, and earns higher profits than it profit-seeking rival. Our study differs from the afore-mentioned studies by our focus on the impacts of ECSR investment on the wage differential between skilled workers and unskilled workers in an economy.

This paper is organized as follows. Section 2 lays out the general-equilibrium model with manufacturing firms committing to ECSR investments, while section 3 examines the income distributional effect of ECSR investments. Section 4 describes the data and empirical strategy and presents the discussion of results. Section 5 concludes.

Section snippets

Firm ECSR investments

We consider a two-sector economy, in which the manufacturing good X is produced by n firms with ECSR investments, while the agricultural good Y is produced by perfectly competitive firms. Choosing good Y as the numeraire, the domestic relative price of the manufacturing good X is denoted by p.

Letting DX and DY be the domestic demands for these two goods, consumers’ preference can be presented by a quasi-linear utility function: U(DX, DY, z) = u(DX, z) + DY = (A + αz)DX DX2/2 + DY, where z is

ECSR investments and income distribution

Letting “ˆ” over a variable denote its percentage change, by totally differentiating Equation (2) we obtain the change in firm's output in sector X as:-(1+1/n)xˆ=-εδzˆ+nˆ+εbθLXmwˆ+εbθKXmrˆ,where δ = pzz/p expresses the price response to ECSR investments, b = m/p is marginal cost to price ratio, ε = -p/Xpx > 0 is the price elasticity of demand for good X andθjXmrepresents the variable cost share of the jth production factor in producing good x. From Equation (7) for a given capital rental cost r

Empirical analysis

From Propositions 1 and 2 in Section 3 we obtain the following two main testable hypotheses:

  • Increased ECSR investments may increase wage inequality in the short term.

  • With free exit of firms in the manufacturing sector, an increase in ECSR investments can decrease wage inequality via the firm-exit channel in the long run.

In this section, we empirically evaluate the above two hypotheses. We introduce the data sources for our empirical analysis, present the estimation strategy and then discuss the

Conclusion remarks

Utilizing a general-equilibrium framework, we have examined the income distributional effect of ECSR investments in this paper. We find that in the short run with fixed number of firms, ECSR investments raise capital rental cost and hence widen wage inequality between skilled and unskilled workers. Nonetheless, in the long run, the increased capital cost causes firms to exit from the industry. This results in the release of capital to other sectors and hence the reallocation of capital lowers

Acknowledgements

This paper was presented at the Chu Hai Conference, Recent Advances in International Trade and Finance, on December 14–15, 2017 at Hong Kong. The conference was supported by the Hong Kong RGC-IDS project, UGC/IDS13/16. We gratefully acknowledge the financial support of the Hong Kong RGC-FDS project (UGC/FDS13/B01/16). We are indebted to anonymous referee, and thank to Kenneth Chan, Bihong Huang, Jie Li and the workshop participants for the valuable comments and suggestions.

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