Impacts of regulation on eco-innovation and job creation

Definition and determinants of environmental innovation

Environmental innovation has been defined in the literature as follows: “Eco-innovation is the production, application or exploitation of a good, service, production process, organizational structure, or management or business method that is novel to the firm or user and which results, throughout its life cycle, in a reduction of environmental risk, pollution and the negative impacts of resource use (including energy use) compared to relevant alternatives” [1].

This definition does not imply dependence on the outcomes of innovation activities. All innovations that lead to positive environmental effects are defined as environmental innovations. It may thus be possible that innovations are defined as “green” even if the respective innovation activities did not aim at improving the environment. For example, the re-design of a production process aimed at reducing labor costs may also lead to energy savings, thereby fitting the definition of an eco-innovation.

Following the general innovation theory, technology push and market pull factors are crucial for explaining the realization of innovation activities [2]. In addition, the factors listed in Figure 2 are also important determinants for eco-innovations. In contrast to other innovations, eco-innovations may depend on the environmental consciousness of consumers and firms, denoting an environmentally oriented demand pull effect. Furthermore, cost savings may be more important for eco-innovations compared to other innovations because they are often linked to a reduction in material or energy consumption.

Regulation is crucial for the realization of eco-innovation activities. This is the case because there may not be any clear economic incentives to develop new environmentally benign products and processes. From a traditional point of view, environmental policy imposes additional production costs, potentially reducing the international competitiveness of a firm [3]. For end-of-pipe pollution abatement technologies in particular, which often require additional and “unproductive” equipment, this argumentation seems to be justified. “In this static world, where firms have already made their cost-minimizing choices, environmental regulation inevitably raises costs and will tend to reduce the market share of domestic companies on global markets” [4]. However, in contrast to that view is the issue of possible innovation offsets; i.e. improved regulation-induced environmental performance may be accompanied by material and energy savings. These cost savings lead to increased competitiveness, so that additional production costs may actually be over-compensated for as a result of the environmental measures taken. Regulation might provide signals that reduce information deficits about the incomplete utilization of resources or the minimizing of discharges [4]. As an example, mandatory environmental audits push firms to search for causes of high-energy consumption, and presumably to address said causes, if feasible.

From an international perspective, new technologies resulting from regulation-induced eco-innovations may lead to first-mover advantages for regulated firms and their related suppliers in the value chain. A good example is the success of Danish wind turbine producers. Early political support led to the establishment of a successful wind energy industry, which became one of the successful first movers on an international scale. The Porter hypothesis assumes imperfect information, organizational problems, and market failures. In that sense, it questions a firm’s ability to maximize profit, indicating that managers may fail to recognize cost savings potential. This may stem from the problem that managers’ success is often measured by their short-term profit. These “present-biased managers” [3] will postpone eco-innovations because the associated costs must be paid immediately, but the benefits only appear in the long term.

It is important to mention that not all types of environmental regulations lead to innovation offsets [3]. For instance, regulations that explicitly require the implementation of specific end-of-pipe technologies, such as filters, will certainly raise production costs. In general, the empirical literature shows that market-based instruments, such as eco-taxes or tradable permits, are more likely to trigger eco-innovation compared to technology-based standards [5]. For example, introduction of the tradable permit system for sulfur dioxide emissions in the US led to improved removal efficiency compared to the old technology-based regulatory system [5]. Another example shows that price-based policy had a positive and significant influence on innovations related to solar, biomass, and waste energy [5].

Leading empirical studies confirm regulation’s role as an important determinant of eco-innovation. This phenomenon is known as the “regulatory push/pull effect” [6]. In the following, the “stylized facts” derived from this literature are briefly summarized. Unfortunately, because of the lack of adequate data, most of the studies are not based on experimental or quasi-experimental designs where the stringency or the choice of different environmental regulations vary across otherwise similar firms or industries.

Based on a patent analysis, the role of environmental regulation for eco-innovation has been analyzed [7]. Pollution abatement expenditures serve as an indicator for policy stringency. The authors find that abatement expenditures were positively correlated to environmental innovation. Alternate patent studies also show that innovation decisions were mainly driven by regulation activities.

The effects of regulation are shown to vary between different environmental technology fields. For instance, end-of-pipe technologies are mainly triggered by regulation, whereas cost savings and environmental management systems seem to be more important for promoting cleaner technologies. Furthermore, regulation and cost savings were identified in a study based on panel data as the main determinants for eco-innovation [2]. However, another paper by the same author shows that the influence of regulation varies significantly for different environmental technology fields. Whereas current and expected government regulations have a particular effect on air quality, water, or noise emissions, hazardous substances treatment, and the recyclability of products, they are less important for material and energy savings.

The Porter hypothesis tends to be confirmed with respect to innovations that improve resource efficiency, whereas end-of-pipe measures seem to reduce firm profitability. Different variants of the Porter hypothesis are tested using an OECD database for seven countries, for instance. This analysis supports the so-called “weak version” of the Porter hypothesis, which says that environmental regulation stimulates eco-innovations. The strong version, postulating that regulation-induced cost savings must over-compensate the compliance costs, is however not supported [3]. The impact of different policy instruments on renewable energy technologies has also been analyzed [5]. Based on a patent analysis, the authors show the high importance of feed-in tariffs for solar energy, whereas this policy instrument does not promote more cost-competitive technologies, such as wind power.

Most of these studies concentrate on the effects of environmental regulation with respect to the directly regulated firms. An overall assessment of the effects of environmental policy would require the analysis of additional effects and channels. One such study analyzes indirectly induced innovation in regulated and unregulated firms resulting from regulation-induced costs by evaluating the impacts from higher output prices and knowledge spillovers. The results “...suggest that indirect effects of regulation on innovation are at least as large as commonly estimated direct effects” [8].

A further strand of empirical literature analyzes whether regulation-induced environmental innovation efforts lead to a crowding out of other innovation activities. According to a study based on the Mannheim Innovation Survey for Germany, a small crowding out of the firms’ in-house research and development (R&D) indeed exists [9].

Finally, many studies show that environmental management tools, specialized organizational arrangements (e.g. dedicated R&D department, person responsible for environmental concerns, etc.), and cost savings as motivation are very important for the introduction of cleaner technologies but not for end-of-pipe measures. The important role of market demand for the realization of eco-innovation is also confirmed by many other empirical analyses. For instance, customer benefits are important for the introduction of environmental innovations if the environmental impact of a product denotes a higher added value for the customer [10]. This may be problematic for green electricity, for example, but environmental product innovations such as food or baby clothes may lead to substantial customer benefits.

Eco-innovation and employment

The relationship between (eco-)innovation and employment within a firm strongly depends on the nature of innovation, especially with respect to process and product innovation (Figure 3). Concerning process innovations, a further distinction between end-of-pipe and cleaner technologies is important. In general, process innovations may induce negative employment effects if they are accompanied by higher labor productivity, assuming a steady output. In other words, given the same output quantity, a more efficient process will generally reduce the associated labor requirements, thereby eliminating the need for some jobs.

Production-integrated cleaner technologies, such as heat recovery systems or solvent-free varnishing processes, often lead to less pollution or material or energy savings. These cost savings may be accompanied by an increase in total factor productivity (labor, capital, and energy) of the firm. A valid question then becomes: do cost saving process innovations also affect the share of labor in the corresponding production process?

Higher capital efficiency induced by the adoption of cleaner technologies may lead to a substitution of labor by capital (i.e. increased use of automated processes) because labor becomes relatively less valuable to the firm. This trend also leads to a decrease in wage levels, which may help to reduce the overall negative employment effects. Cleaner technologies may also be realized through organizational innovations and/or the improvement of human capital. In this case, the cost saving effects may be achieved by taking on more specialized and highly qualified employees who are able to reorganize production processes in a more resource-efficient way [11]. In sum, depending on the specific case, a higher, constant, or lower labor share may result. In any case, an increase in total factor productivity caused by the introduction of cleaner technologies strengthens the competitiveness of firms and thus may lead to positive employment effects [4]. In case of lower labor share, higher demand (e.g. resulting from first-mover advantages) may compensate for employment losses. In case of higher labor share, on the other hand, the competitiveness effect might further strengthen employment gains [11].

In contrast, end-of-pipe process innovations, such as the introduction of additional filter systems to the production process, require an alternative viewpoint. The construction, installation, and maintenance of a filter system may require additional staff, which would be associated with positive direct employment effects. The indirect effect, however, may be negative, since end-of-pipe technologies induce higher costs and thereby lower firm competitiveness. These factors can lead to a decline in output and in employment [11]. Given these mixed results, the effects of environmental process innovations on employment remain ambiguous and an ongoing empirical question.

The employment effects of environmental product innovations are also theoretically unclear. On the one hand, product innovations may induce additional demand if they create completely new markets or if they provide substitutes for competitors’ products. In this case, the effect on employment at the firm level is positive. At the macroeconomic level, the effect is not clearly determined and depends, among other things, on the labor intensity of the substituted products. Negative employment effects from product innovations may also arise because the introduction of a new product may provide the firm with a monopolistic position, leading to a reduction of overall output [11].

There are many empirical papers focusing on the general link between innovation and employment, but relatively few that focus on the specificities of eco-innovations. The general innovation studies mostly find positive effects of product innovations on labor demand, whereas the results for process innovations are mixed [12]. Due to data problems, analyses on the employment effects of environmental innovations are still rare. Most of these analyses do detect slightly positive effects of eco-innovations on employment [13]. In one such study, the positive employment effects at the firm level are small, and relate to both product and service innovations [13]. Cleaner production is shown to be more likely to increase employment compared to end-of-pipe technologies. A related analysis also shows that the introduction of cleaner technologies as process innovations is connected with higher employment growth [11]. The positive influence of environmental product innovations on employment is confirmed in further studies. Based on survey data of the Community Innovation Survey 2008, both environmental and non-environmental product innovations are shown to trigger employment, but non-environmental product innovations are more likely to increase employment.

In sum, the results from empirical studies suggest that environmental and energy policy can have positive net effects on employment. However, it seems clear that environmental policies should not be counted on to provide major employment growth at the macro level.