Incentive Structures: A Case of Market and Non-Market Failures?
Text by Serafim Agrogiannis, PhD Candidate in Business Administration at Misum
Navigating the aspects that distil the situation to its very essence requires openness. Not a polarized stance in the debate about uncritically urging firms to raise their environmental performance standards. Such an approach is underpinned by the aim to disprove criticism of the industry lagging behind in sustainability efforts where such a verdict is invalid and to raise awareness and possibly improve amongst other the utilization of low-carbon management where disapproval is due.
Climate change is more topical than ever. Unnerving times about its impact have pervaded considerations of the shipping industry’s role towards GHG emissions reductions. The latest study of the International Maritime Organization (IMO) depicts a current increase of 70% and projects escalation up to 250% by 2050 compared to the baseline year of 1990. This reveals an estimated increase of 200-300% in shipping activity (IMO, 2014) and according to the European Parliament’s report it will comprise of almost 17% of global carbon emissions if left unregulated (ENVI, 2015).
Such evidence serves as an eye-opener. It has vindicated a multitude of tenets held dear by proponents arguing against the shipping sector’s exemption from the Paris Agreement on climate change in 2015. The IMO’s reaction has been to persuasively establish the case that forthcoming carbon data collection requirements would supplement existing initiatives and formulate a coherent response for alleviating the industry’s impact on climate change. Parallel to this, is the new EU regulation (2015/717) on monitoring, reporting and verification (MRV) of carbon emissions for all ships reaching European ports effective from the 1st of January 2018 onwards. Both initiatives reflect a willingness to deal with information asymmetries through increasing transparency and data reliability.
But how do these attempts relate to the market overall? The majority of the shipping sector functions under a risk-based approach adopting only the necessary measures compliant with legislation and operational on-journey ramifications for achieving fuel efficiencies (Poulsen et al., 2016; van Leuween and van Koppen, 2016). In this case, stringent environmental, safety and health standards for reasons of customer/shipper vetting procedures (e.g. oil industry) and for certain management guidelines such as the International Safety Management (ISM) code prevail. Even in the container segment, which is alleged to be more advanced concerning environmental considerations, large shippers only partially deal with carbon management. Instead, reputational and cost reduction concerns prevail. Such a cost-cutting strife and commoditization eradicates any potential of incentive-shifting solutions. This largely invalidates proponents’ stance (e.g. Vandenbergh, 2013; King et al., 2012) for market based measures (MBM’s) and the internalization of environmental externalities. Add to this the weaknesses in data accountability, ambition as well as improvement levels (Scott, 2017) and the landscape becomes clear.
Apart from this indisputable market rigidity, the industry context itself is challenging. First, shipping is extremely capital intensive, freight with cyclicality related to the world economy as well as the time lag in order to couple supply and demand of ships. As such, sustainability-related postulations remain far from a straightforward matter where elaborations encompass dynamic and uncertain juxtapositions against cost-effectiveness and corresponding time horizons in order to evaluate potential trade-offs through certain technology investment choices and related bunker prices. Second, regulation within the industry constitutes the main driver towards environmental upgrades. The existing Energy Efficiency Design Index (EEDI) as well as the Ship Energy Efficiency Management Plan (SEEMP) illuminate a reality where attempts are made to further reduce GHG emissions. Given that the majority of shipping market segments point towards intense competition, these compliance strategies are viewed as means of retaining current position within the industry. With respect to differentiation, market segmentation practices within the different segments (e.g. cargo, dry, bulk) pose varying contract award criteria where cost, quality, flexibility and reliability have stronger effects on shipping firms’ environmental performance compared to product differentiation advantage through the ships themselves “offering the services” in question. Third, and given the outsourcing of the ship management function, many shipping firms focus on the applicability of best practices toward carbon reduction through task specialization and knowledge diversity allowing for the creation of unique bundles of resources and capabilities.
As a remedy, the discussion should embrace a wider perspective. Adopting a supply chain context (e.g. LSP’s) or its procurement function, could unveil potential of improvement. Issues proving material in the near future would also include shipbreaking procedures and the extent that strict working and environmental conditions, exceeding the baseline set by the United Nations’ Hong Kong Convention, are met. Given that recycling of steel is treated through a global commodity lens, the price paid for dismantling a ship is crucial: the lower the shipyards’ standards, the greater the profit potential of the shipping firm due to reduced commission prices paid. Recently, the EU published a list of approved shipyards that abide by certain standards and as an extension shipping firms could potentially agree on an industry-wide level to accept recycling practices conducted in certified shipyards. Revitalizing supporting infrastructure and making respective facilities more competitive and sustainability lenient through ports’ energy and environmental upgrade as well as their seamless integration with maritime operations and hinterland connections could provide added value and promote specialized shipping service clusters.
A steady hand could be offered by the financial sector as well. The newly announced initiative from ABN AMRO, ING and NIBC banks about the Responsible Ship Recycling Standard (RSRS) is telling. The introduction of alternative financing options in the wake of the global financial downturn almost a decade ago and due to stricter liquidity regulations for the banking system (e.g. Basel III) seems promising towards forging new partnerships empowering responsible and patient capital on the investors’ side and augmented oversight of key sustainability results.
Beyond doubt, sustainable shipping presupposes an engaged scholarship approach. Not sticking our heads in the sand. Empirical matters should be combined with multi-functional conclusions in terms of anticipating and influencing the type of knowledge needed for enlightening academic and practitioner spheres. In addition to normative research this calls for issue-oriented inquiry answering the wide diversification of practices involved within the policy-practice field, financial systems and supply chain management.
This is what we do at Misum. All the academic staff and colleagues have deep knowledge and tackle leading issues within our certain disciplines in a collaborative manner. The overarching aim is to invite attention from all across the policy, intellectual and practical spectrum in order to effectively tackle the challenges on the pressing and changing world of not only sustainable shipping but the role of business and society and their reinforcing interplay. We seek to further strengthen the ongoing dialogue about the most central concern nowadays: how to possibly make amendments in current business practices accompanied by appropriate policy-imbued interventions towards the benefit of the common good.
Written by Serafim Agrogiannis, PhD Candidate in Business Administration at Misum