Environmental impact on profits and production

16 May 2004

At the seventh session in June 2001, the sub-group on hides of skins requested the FAO secretariat to undertake empirical analysis of the impact of environmental regulations and trade restrictions on the hides and skins and leather sector. This document has been prepared in response to that request and was presented to the eighth session by George Rapsomanikis. The impact of environmental regulations, pollution prevention and pollution abatement costs is examined by means of a partial equilibrium model that provides a stylised picture of hides and skins, light leather and footwear global markets. Rapsomanikis explained that models are simplistic aggregations with huge data requirements. Leather processing is a polluting activity with the tanneries and leather finishing sector being among the most toxic industrial sectors1. An increase in the stringency of environmental regulations is thought of as having implications for the location of the industry as abatement costs may shift leather processing away from countries with stringent regulations. The extent to which environmental regulations across countries determine the location of the processing industry depends on the stringency of the regulations and the corresponding abatement costs. As a generalisation, there is evidence to suggest that developing countries that support their domestic processing sector have environmental standards that are inferior to those prevailing in developed countries, as lower incomes are likely to lead to weak demand for higher standards that improve environmental outcomes. Stringent environmental regulations may have resulted in a relative shift of the leather processing industry from developed to developing countries in the past, as the abatement costs of compliance with the regulations might have exerted pressure on profitability. Analysis was hampered by the lack of hard data. For Europe, only soft estimates were available. It has been calculated that clean-up costs in European plants might be 3-5% of running costs2. An earlier Unido estimate suggested that effluent treatment costs were around 4-6% of final costs3. Technological developments, as well as the operation of large numbers of tanning plants within 'clusters', have resulted in a reduction in treatment costs. In the USA, total expenditure on disposal and recycling in the leather industry for 1999 amounted to US$1 million, while the operating costs for abatement amounted to US$11.8 million4. Based on this data, the only hard figures the FAO secretariat had to work with, it is estimated that the average cost for abating pollution that accrued from processing 1,000 sq ft of light leather in the US amounts to approximately $17.10. Presumably, abatement costs in developing countries, where the same stringent standards are generally not met, would be lower but may rise above 5% of operating costs if an attempt was made to meet developed country standards without the technology available in developed countries. An increase in the stringency of environmental regulations will result in a corresponding increase in abatement costs. Environmental regulations for the leather processing industry often consist of maximum values for air emissions, liquid effluents and solid waste per unit of production. An increase in stringency would reflect a decrease in these maximum values. In the second half of the paper, the discussion focuses on trade liberalisation. Trade policy reform is a priority issue in the WTO negotiations, since trade liberalisation is viewed as encouraging economic welfare and long-term growth. The analysis was again carried out by means of the partial equilibrium model of hides and skins and leather products. Such models are increasingly used to address sensitive policy issues, such as the impact of trade liberalisation on production, consumption and trade, the location of industries, as well as on the distribution of benefits and costs across countries and population groups. Trade measures, such as import tariffs and export taxes, import and export quotas and tariff rate quotas insulate domestic markets by driving a wedge between domestic and international prices and serve to transfer wealth from one population group to another. The objective of import tariffs and import quotas is to protect producers and processors. These policy instruments reduce the degree to which domestic producers or processors are exposed to changes in the international market and provide incentives to increase production by raising the domestic price at the expense of consumers. Such policies are applied for various reasons. The objective could be either to support the income of domestic producers or to protect an infant industry until it becomes sufficiently well established to compete with developed countries. On the other hand, export quotas and export taxes aim at depressing the domestic price relative to the international price and redistribute wealth from producers to consumers. These policies aim at increasing the supply of raw materials to the domestic market, lowering prices to producers and domestic processors. Paul Pearson, representing the UK, said that from the UK point of view, there is concern about export restrictions because of the impact on the competitiveness of the British industry. 'Our raw materials are freely traded but supplies from certain other countries are not available to our industry. We believe that export restrictions have a negative impact on the suppliers of hides and skins. Firstly they reduce prices and secondly they reduce any incentive to improve the quality of hides and skins. 'Overall, our sector has been going through major changes - with the growth and shift in capacity to China being a factor that cannot be ignored in any aspect of the hides, skins, leather and leather products sector. We believe the overall long-term situation in the market is that there is a shortage of hides and skins. 'Quality is a very important and continuing issue. The statistics show a decline in production in countries that have traditionally produced good quality hides and skins and an increase in countries that are considered to produce lower quality. So the long-term position is a growing shortage of good quality raw material - and this is a major challenge for the hides, skins and leather sector.' Table 1 presents the tariff rates for bovine hides, light leather and footwear that are implemented by regions of developing and developed countries. Market access in terms of tariffs is a major issue for both raw materials and processed products in markets of both developing and developed countries. Average import tariffs for raw bovine hides vary between 0% (North America and Oceania) and 11.7% (Africa). The pattern of tariff escalation is evident with the level of protection, expressed in tariff rates for the developing and developed countries, increasing along the processing chain. Average tariffs for finished leather vary between 2.5% (Oceania) to 16.4% (Africa), whilst those for footwear vary between 5.6% (former Soviet Union region) to 37.5% (Oceania). In theory, the elimination of tariff barriers for hides and skins and leather products is likely to increase global economic welfare as it encourages the production of these commodities to take place in regions and countries according to the law of comparative advantage and in line with the availability of resources, such as land, livestock herds, labour and technology. The removal of tariff barriers for raw hides, skins and leather products would be likely to lead to an increase in international prices for raw materials and processed products. Tariff elimination would result in a reduction in prices to consumers in countries that protect their markets, thereby stimulating demand for leather and leather products that in turn would strengthen international prices. Therefore, leather processing is likely to increase and its location is likely to shift following liberalisation. The situation may be different in producing countries which have a large hitherto protected domestic market, where liberalisation would result, at least in the short-term, in lower prices with an inflow of imports competing with domestic producers. In the long-term, liberalisation in these countries may result in increased revenues brought about by an increase in competitiveness and efficiency.

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