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Global Environmental Politics November 2006

Institutional Design for EMS-Based Government Procurement Policies
BYLINE: Matthew Potoski and Aseem Prakash *. * We thank Graeme Auld, Jennifer Clapp, and the anonymous reviewer for their input. Aseem Prakash gratefully acknowledges financial support from the Marc Lindenberg Center for Humanitarian Action, International Development, and Global Citizenship, University of Washington, Seattle. SECTION: CURRENT DEBATES; Pg. 13 LENGTH: 3783 words In recent years scholars have highlighted the public policy potential of using voluntary programs based on environmental management systems (EMS) to improve firms' environmental and regulatory performance. While firms receive some benefits for joining EMS-based voluntary programs, these incentives could be strengthened if governments mandated joining such programs as a precondition for participating in government procurement. While we support Arnold and Whitford's proposal to use public procurement eligibility criteria to induce firms to take environmentally progressive action, we have concerns about using any EMS or EMS-based voluntary program for these purposes. EMS-based programs must impose real requirements on firms and must have in place monitoring systems to ensure that such requirements are met. Only then will EMS-programs likely be effective as well as credible with stakeholders. Introduction Voluntary regulatory programs are promising policy instruments in today's world of technically and politically vexing environmental problems. To proponents, voluntary environmental programs may even seem to be a panacea: if firms voluntarily agree to reduce their environmental harms, governments would no longer need to write detailed policy prescriptions, monitor their compliance, and referee contentious political battles among environmentalists and industry. To the extent that voluntary regulatory programs can effectively improve firms' programs and performance, identifying what governments can do to promote them is worthwhile. In this context, Richard Arnold and Andrew Whitford's article is a welcome addition to the multidisciplinary dialogue on self-regulation via voluntary environmental programs. 1 Their article points to evidence suggesting that firms adopting programs based on environmental management systems (EMS) such as ISO 14001 show superior compliance with public law and superior environmental performance. Arnold and Whitford propose that governments should require firms participating in public procurement to adopt an EMS-based program such as ISO 14001. Because governments across the world tend to be major customers for a wide range of goods and services, participation in government procurement would appear to be a very attractive carrot to induce firms to take progressive environmental action. 2 Further, Arnold and Whitford suggest that an EMS-procurement requirement would insulate firms from changing and conflicting government directives regarding environmental policies. This is important because firms' investments in environmental improvements create benefits in the long run while imposing costs in the short term. Thus, firms would welcome credible government commitments about policy stability before undertaking such

Page 2 Institutional Design for EMS-Based Government Procurement Policies Global Environmental Politics November 2006 investments. Arnold and Whitford suggest that tying public procurement to EMS-based voluntary programs insulates firms' long-term investments in environmental programs from abrupt, short-term political changes. While we agree with much of Arnold and Whitford's proposal, we believe some important caveats and clarifications are in order, a charge we take up in the remainder of this article. In doing so, we hope to provoke discussion about how to improve the institutional design of voluntary programs. As we have argued elsewhere 3 the payoff of an institutionalist approach to policy design--an approach in line with Arnold and Whitford's proposal as well as our own work in this area--is that instead of looking at each program in isolation, theory helps identify design features that influence program efficacy, thereby facilitating comparisons across voluntary programs. Eventually, empirically grounded theory will help sort the effective policies from the failures, which in the case of voluntary environmental programs are derisively called "greenwashes." Our central contention is that EMS-based programs vary in their efficacy and are therefore not all equally suitable for Arnold and Whitford's EMS-based government procurement proposal. Some EMS-based programs have turned out to be greenwashes either because their sponsors have willfully designed them that way or because their weak institutional architecture does not provide for monitoring and sanctioning to ensure that having joined the program, firms do not shirk. Before endorsing EMS-based programs as preconditions for participating in government procurement, we need to pause and carefully identify the institutional features of EMS-based programs that induce firms to take environmentally progressive action. Without such careful attention to institutional design, policy makers may find themselves endorsing ineffective voluntary programs. Below we outline our perspective on institutional design for voluntary programs and identify several suggestions for how these programs may be adopted for the type of EMS-government procurement program that Arnold and Whitford propose. EMS-Based Regulations and the Promise of Environmental Procurement Arnold and Whitford are rightfully optimistic about the promise of EMS-based voluntary programs. As a process-based approach to environmental governance, the philosophy behind EMS-based programs is: (1) instead of exclusively relying on command and control regulations to channel firms' policies and behaviors in socially desired directions, firms can devise their own self-regulatory standards through their EMSs; (2) appropriately designed EMSs produce desired public goods by improving firms' compliance with public law and reducing their pollution emissions. In return for taking such environmentally progressive action, firms can receive several types of monetary and non-monetary payoffs. In our own work, we argue that voluntary programs (which we call "green clubs") provide firms' stakeholders with a low transaction cost tool to differentiate environmentally progressive firms from laggards. 4 As a result, stakeholders can reward the environmental leaders and punish the environmental laggards. A voluntary program's reputation or brand image is the crucial carrot that entices firms to take on the cost of joining the program. In a voluntary program, the goodwill a firm receives for program participation need not be at the cost of another firm that has also subscribed to the program because each member contributes to the program's reputation and goodwill by adopting the EMSs the program prescribes. The marginal cost of producing the goodwill declines with each new firm joining the voluntary programs as the "network effects" 5 increase the program's brand visibility and therefore the goodwill benefits that emanate from joining it. 6 As stakeholders in firms' environmental performance, government regulators are in position to encourage and perhaps even induce firms to take on the non-trivial costs of establishing well functioning EMSs. EMSs may improve compliance with governmental laws and regulations by requiring firms to actively seek out and identify their regulatory obligations and establish internal management systems to ensure compliance with them. 7 After all, as scholars have suggested, firms' non-compliance is often rooted in their ignorance of the law rather than in their desire to willfully evade regulatory responsibilities. 8 Regulators can reward firms' voluntary program membership by granting regulatory relief in the form of fewer inspections, fast tracking permit applications, or reduced fines in the event firms are out of compliance. 9 Arnold and Whitford's EMS procurement proposal should be viewed in this context because it looks to harness firms' private motives (pursuing higher profits) to serve broader public ends (reducing pollution and other environmental harms). Although firms may sometimes provide environmental goods (such as pollution reduction) of their own goodwill, obviously this does not occur often enough or we would not have the

Page 3 Institutional Design for EMS-Based Government Procurement Policies Global Environmental Politics November 2006 environmental problems we see around the world today. At a fundamental level, as profit seeking actors, firms will be unlikely to incur private costs to produce sufficient public benefits. Command and control regulation uses the fiat of the law to ensure that firms protect the environment. The diminishing returns to command and control 10 suggest the importance of finding less costly policy approaches which can supplement, though perhaps not supplant, it. In the US, total government spending accounts for about 30 percent of GDP, 11 and a large and growing share of that is produced through procurement contracts with private firms, non-profits and other governments. 12 Requiring firms to produce public goods such as lowering pollution as a condition for participating in public sector procurement therefore makes sense. It is a classic "Third Way" approach that seeks to pursue the goals of the left--a cleaner environment--through the means of the right--harnessing private profit motives for public ends. Arnold and Whitford's proposal, however, is still in need of some fundamental refinements because there are important reasons to temper optimism about EMSs and voluntary programs. 13 Voluntary programs, with or without EMSs, do not always improve firms' regulatory and environmental performance. 14 To briefly summarize some of the important literature in this area, consider first some voluntary programs that mandate specific pollution reduction targets without requiring EMSs. In their study of the 33/50 program sponsored by the US Environmental Protection Agency (EPA), Khanna and Damon 15 do find that that participating firms reduced releases of targeted pollutant chemicals as a result of their program participation. On this count, the 33/50 program was effective, although it did not require firms to adopt any kind of EMS. In contrast, Welch et al. 16 report that electric utilities participating in the EPA's Climate Change program did not reduce their CO2 emissions--the program's key performance indicator--more than non-participants. Very much like the 33/50 program, the Climate Change program did not require firms to establish an EMS; however, 33/50 was effective and Climate Change was not. As these examples suggest, the absence of EMS is not consistently associated with program success or failure. The voluntary programs that require participating firms to adopt EMSs also have a mixed track record. Take the case of the American Chemistry Council's (formerly, the Chemical Manufacturing Association) flagship voluntary program, Responsible Care. Firms participating in Responsible Care are required to adopt a fairly extensive EMS, 17 yet there is evidence that these participating firms did not improve their environmental performance. 18 Now take the case of ISO 14001, an EMS-based environmental program sponsored by the International Organization for Standardization that has achieved worldwide prominence. In their study of 236 Mexican firms in the food, chemical, nonmetallic minerals and metal industries (which together generate 75 percent to 95 percent of Mexico's industrial pollution), Dasgupta et al. 19 find that ISO 14001 adopters show better compliance with government environmental regulations, an important finding given that many developing countries have difficulties enforcing government regulations. In his analysis of 316 US electronics facilities, Russo 20 finds that ISO 14001 membership is associated with decreased toxic emissions. Our own studies of about 3,000 US facilities regulated under the Clean Air Act indicate that ISO 14001 adopters, in comparison to non-adopters, pollute less 21 and show better compliance with the law. 22 EMS-based voluntary programs vary in their effectiveness in part because they have varying standards for what constitutes an acceptable EMS. In other words, there is no single standard for what constitutes a full-scale EMS. In a recent paper, Anton et al. 23 examined factors that lead firms to adopt more comprehensive EMSs. They found that consumer pressures induce firms to progress from limited EMSs to more comprehensive ones. Thus, Arnold and Whitford's proposed policy requiring EMS adoption for firms to participate in government procurement would require identifying specific EMS features and principles that participating firms would need to adopt. Complicating matters further, even if firms adopt identical EMSs on paper, their environmental and regulatory performance may vary considerably in practice because they may implement them differently. A firm might adopt a stringent EMS but may not implement it in a way that really moves the firm's operations in environmentally progressive directions. Indeed, rewarding firms with EMSs via government procurement processes may have the unfortunate byproduct of inducing shirking; that is, unscrupulous firms will have

Page 4 Institutional Design for EMS-Based Government Procurement Policies Global Environmental Politics November 2006 incentives to adopt a "paper" EMS but not implement any of its managerial practices. Policy Lessons Effective EMS voluntary programs must include two design features: first, they must specify some minimum standards for their EMSs; second, they must require program members to establish monitoring and enforcement mechanisms as a part of their EMSs. Drawing on Anton et al. 24 we list some of features that EMSs should have: 1. The firm has a formal and written environmental policy. 2. The firm demonstrates top management support for its environmental program by assigning a senior manager (who sits on the Management Committee) with exclusive responsibility for the environmental function. 3. The firm must require its overseas subsidiaries and suppliers to establish comparable EMSs. 4. The firm has a policy to reward environmental innovation. 5. Every employee must receive a certain number of hours of environmental training every year. 6. The firm has clear provisions to protect environmental whistle blowers. 7. The firm is required to demonstrate continual improvement in environmental performance Even if a firm adopts on paper an EMS with all of the above features, it may not fully implement them. Monitoring and enforcement mechanisms that ensure firms implement in practice what they have adopted on paper are therefore an important counter to shirking in voluntary programs. Political economists from Thomas Hobbes 25 to Elinor Ostrom 26 have identified monitoring and enforcement as essential components for effective rule structures. As we have argued elsewhere, 27 monitoring and enforcement in voluntary programs can occur via three mechanisms: third-party monitoring, 28 public disclosure of audit information, and sanctioning by program sponsors. Sponsors of an EMS-based voluntary program can require participating firms to periodically bring in external, accredited auditors to verify that they are implementing the EMS prescribed by the voluntary program. To prevent firms from shirking their EMS commitments, voluntary programs must have features to mitigate information asymmetries among firms, their outside stakeholders, and program sponsors. As is done by the European Management and Audit System (EMAS), program sponsors could require firms to promptly disclose audit information, perhaps by mandating that the audit reports be made available in the public domain. The logic is that firms are more likely to establish and comply with comprehensive EMSs if their key stakeholders want them to do so and can identify firms' EMS features. In words of Justice Brandeis, "Publicity is justly commended as a remedy for social and industrial diseases. Sunlight is said to be the best of disinfectants." 29 Finally, instead of (or in addition to) relying on external stakeholders to reward or punish firms, the sponsoring organization may itself establish rules for audits of firms' program participation. Sponsors' monitoring and enforcement mechanisms should clearly lay out how shirkers will be identified and sanctioned. Table 1 summarizes different monitoring and enforcement programs assuming that EMSs incorporate the essential features we have previously identified. Table 1. Institutional Design of Voluntary Programs Institutional Design Public disclosure of Program Type No Sword Weak swords Third-Party Audits no yes Audit Information no no Sanctioning no no

Page 5 Institutional Design for EMS-Based Government Procurement Policies Global Environmental Politics November 2006 Table 1. Institutional Design of Voluntary Programs Institutional Design Public disclosure of Program Type Medium swords Strong swords Third-Party Audits yes yes Audit Information yes yes Sanctioning no yes

"Strong sword" programs have all three components of effective monitoring and enforcement programs: third party audits, public disclosure and sanctions. Programs with these features are most likely to curb shirking because they mitigate information asymmetries among participating firms, program sponsors, and external stakeholders. Firms' stakeholders and program sponsors are thus able to sanction shirking firms. Programs with "strong sword" monitoring and enforcement procedures such as the Forest Stewardship Council are the ideal candidates for serving as prerequisites for firms to participate in government procurement. 30 "Medium sword" programs require third-party audits and public disclosure. Although they do not provide for sanctioning by the sponsoring organization, they are likely to curb shirking because, with public disclosure of audit information, external audiences and the firm's stakeholders can punish the shirkers for failing to live up to their commitments as program members. The European Union's Environmental Management and Audit System (EMAS) is an example of "medium sword" programs. In this program, firms are subjected to third-party audits and the information on their environmental performance is made available to the public. Medium sword would also provide adequate preconditions for firms participating in government procurement. "Weak sword" programs require only third-party audits. ISO 14001 is an example of a "weak sword" program. The International Organization for Standardization, the program's sponsoring organization, is not known to aggressively sanction the shirkers. Importantly, the absence of public disclosure of audit information weakens stakeholders' ability to sanction shirking. While a "weak sword" program such as ISO 14001 can outperform a "no sword" such as Responsible Care, 31 we believe that weak sword programs should not qualify as satisfying the preconditions for public procurement. This is because while ISO 14001 may be effective, many recent financial accounting scandals have greatly undermined the credibility of third-party auditing. Thus, basing public procurement on a weak sword program is likely to invite opposition from environmental groups, 32 many of whom are already quite suspicious of voluntary regulation programs. At minimum, medium swords (along with credible EMSs) should become the precondition for participating in government procurement. Conclusion We applaud Whitford and Arnold's thoughtful proposal to further exploit the policy potential of EMS-based voluntary programs to improve firms' environmental and regulatory performance. While joining EMS-based programs can create several benefits for firms, Whitford and Arnold suggest that such incentives will be strengthened if joining such programs were to be become a precondition for public procurement. While we support the idea of using public policy, including public procurement, to create private incentives for firms to adopt environmentally progressive policies, we are concerned about giving a carte blanche to every EMS-based program. EMSs must impose real requirements on firms and must have in place monitoring and sanctioning systems to ensure that such requirements are complied with. Only then will EMS-based voluntary programs likely be effective and legitimate with stakeholders. FOOTNOTES
1 Arnold and Whitford 2006, this issue. 2 Elsewhere, we have empirically examined the role of international trade (Prakash and Potoski 2006b) and foreign direct investment (Prakash and Potoski 2006c) in the cross-country adoption of ISO 14001.

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3 Prakash and Potoski 2006a. 4 Prakash and Potoski 2006a. 5 Liebowitz and Margolis 1995. 6 One could point to the "green dividend" hypothesis which can be interpreted to suggest that well functioning EMSs are self-financing (Porter and Van der Linde 1995). This is because pollution represents resource waste, well functioning EMSs can help firms to uncover such waste and reduce costs. 7 Potoski and Prakash 2005a. 8 Brehm and Hamilton 1996. 9 Prakash and Potoski 2006a. 10 Fiorino 1999. 11 US Government Printing Office 2005. 12 Brown and Potoski 2003. 13 We are not commenting on the issue of political proofing because it not clear why policies stipulating EMSs as preconditions to governmental procurement will be less susceptible to political ebbs and flows than other governmental policies. We are not aware of any evidence that governments change policies more often than do nongovernmental actors that sponsor voluntary programs. Recent changes enacted by the Bush administration bring into question the issue of policy stability across regime types. We therefore limit our comment on the policy merit of Arnold and Whitford's proposal rather than its political merit. 14 As an aside, Arnold and Whitford's proposal in practice would obviously require a bit more specificity to fit particular governments and circumstances. After all, environmental concerns are not relevant to all goods and services a government might purchase. For example, a government may hire non-profit groups to provide mental health counseling to the homeless. Requiring a mental health non-profit to demonstrate that it is continually striving to reduce its impact on the natural environment would make little sense and might even be counter productive by distracting the non-profit from its core mission. 15 Khanna and Damon 1999. 16 Welch et al. 2000. 17 Prakash 2000. 18 King and Lenox 2000. 19 Dasgupta et al. 2000. 20 Russo 2001. 21 Potoski and Prakash 2005b. 22 Potoski and Prakash 2005a. Some other studies which do not employ sophisticated statistical techniques as the above mentioned ones (specifically, controlling for potential endogeneity problems between firms' decision to join ISO 14001 and the effect of ISO 14001 on their performance) suggest that ISO 14001 is ineffective. Dahlstrom et al. (2003) report that ISO 14001 did not improve regulatory performance of British facilities. For the US case, Andrews et al. (2003) suggest that ISO 14001 did not affect firms' environmental performance. 23 Anton et al. 2004. 24 Anton et al. 2004. 25 Hobbes 1651. 26 Ostrom 1990. See her discussion on design principles. 27 Potoski and Prakash 2005b. 28 We do not believe that first-party and second-party monitoring (Gereffi et al. 2001) are credible. 29 Brandeis 1914.

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30 We thank Graeme Auld for drawing our attention to the following example of FSC enforcement: http://www.rainforest-alliance.org/programs/forestry/smartwood/documents/prime_suspended.pdf 31 Potoski and Prakash 2005b. 32 Steinzor 1998.

SUBJECT: ENVIRONMENTAL INDUSTRY (90%); PUBLIC CONTRACTS LAW (90%); PURCHASING & PROCUREMENT (90%); PUBLIC POLICY (90%); PUBLIC CONTRACTING (89%); ISO 14000 (89%); SELF REGULATING ORGANIZATIONS (77%); REGULATORY COMPLIANCE (77%); ENVIRONMENTALISM (73%) LOAD-DATE: January 4, 2007 LANGUAGE: ENGLISH BIBLIOGRAPHY: References Andrews, R.N.L, D. Amaral, N. Darnall, D.R. Gallagher, D. Edwards, A. Huston, C.D. Amore, L. Sun, and Y. Zhang. 2003. Environmental Management Systems: Do they Improve Performance? Final Report, 30 January 2003. Available at http://ndems.cas.unc.edu/, accessed 7 November 2004. Anton, Wilma Rose Q., George Deltas, and Madhu Khanna. 2004. Incentives for Environmental Self-Regulation and Implications for Environmental Performance. Journal of Environmental Economics and Management 48(1): 632-654. Arnold, Richard, and Andrew B. Whitford. 2006 (this issue). Making Environmental Self-Regulation Mandatory. Global Environmental Politics 6 (4): 1-12. Brandeis, L.D. 1914. Other People's Money, Available at http://library.louisville.edu/law/brandeis/opm-ch5.html, accessed 9 July 2004. Brehm, J., and J.T. Hamilton. 1996. Noncompliance in Environmental Reporting: Are Violators Ignorant, or Evasive, of the Law? American Journal of Political Science 40 (2): 444-477. Brown, Trevor L., and Matthew Potoski. 2003. The Influence of Transactions Costs on Municipal and County Government Choices of Alternative Modes of Service Provision. Journal of Public Administration Research and Theory 13 (4): 441-468. Dahlstrom, K., C. Howes, O. Leinster, and J. Skea. 2003. Environmental Management Systems and Company Performance. European Environment 13 (July): 187-203. Dasgupta, Susmita, Hemamala Hettige, and David Wheeler. 2000. What Improves Environmental Compliance? Evidence from Mexican Industry. Journal of Environmental Economics and Management 39 (1): 39-66. Fiorino, D.J. 1999. Rethinking Environmental Regulation. Harvard Environmental Law Review 23: 441-469. Gereffi, Gary, Ronnie Garcia-Johnson, and Erika Sasser. 2001. The NGO-Industrial Complex. Foreign Policy (July/August): 56-65. Hobbes, Thomas. 1651. The Leviathan. Available at http://oregonstate.edu/instruct/phl302/texts/hobbes/leviathan-contents.html, accessed 15 August 2005. Khanna, M., and L.A. Damon. 1999. EPA's Voluntary 33/50 Program: Impact on Toxic Releases and

Page 8 Institutional Design for EMS-Based Government Procurement Policies Global Environmental Politics November 2006 Economic Performance of Firms. Journal of Environmental Economics and Management 37 (1): 1-25. King, Andrew, and Michael Lenox. 2000. Industry Self-Regulation without Sanctions: The Chemical Industry's Responsible Care Program. Academy of Management Journal 43 (August): 698-716. Liebowitz, S.J., and S.E. Margolis. 1995. Are Network Externalities a New Source of Market Failure? Research in Law and Economics 17: 1-22. Ostrom, Elinor. 1990. Governing the Commons. New York, NY: Cambridge University Press. Porter, Michael, and Claas van der Linde. 1995. Toward a New Conception of the Environment-Competitiveness Relationship. Journal of Economic Perspectives 9 (4): 97-118. Potoski, Matthew, and Aseem Prakash. 2005a. Green Clubs and Voluntary Governance: ISO 14001 and Firms' Regulatory Compliance. American Journal of Political Science 49 (2): 235-248. _______. 2005b. Covenant with Weak Swords: ISO 14001 and Firms' Environmental Performance. Journal of Policy Analysis and Management 24 (4): 745-769. Prakash, Aseem. 2000. Greening the Firm. Cambridge, UK: Cambridge University Press. Prakash, Aseem, and Matthew Potoski. 2006a. The Voluntary Environmentalists: Green Clubs, ISO 14001 and Voluntary Environmental Regulation. Cambridge, UK: Cambridge University Press. _______. 2006b. Racing to the Bottom? Globalization, Environmental Governance, and ISO 14001. American Journal of Political Science 50 (2): 347-361. _______. 2006c. Investing Up: FDI and the Cross-National Diffusion of ISO 14001. Unpublished manuscript. Russo, M.V. 2001. Institutional Change and Theories of Organizational Strategy. Available at http://lcbl.uoregon.edu/mrusso/ISOstudy.htm, accessed 7 November 2004. Steinzor, R.I. 1998. Reinventing Environmental Regulation: The Dangerous Journey from Command to Self-Control. Harvard Environmental Law Review 22 (1): 103-202. US Government Printing Office. Citizen's Guide to the Federal Budget: Fiscal Year 2000. Available at http://www.gpoaccess.gov/usbudget/fy00/guidetoc.html, accessed 2 December 2005. Welch, E., A. Mazur, and S. Bretschneider. 2000. Voluntary Behavior by Electric Utilities. Journal of Policy Analysis and Management 19 (3): 407-425. PUBLICATION-TYPE: Magazine

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