Environmental Issues and Technological Innovation - The Relevance the Porter Hypothesis has Today

Senior Fellow, RIETI


At the Tokyo Motor Show, which was held at the end of October, exhibitions of many new types of vehicles utilizing cutting edge environmental technology were attracting attention, including fuel-cell vehicles and hybrid vehicles. Japanese automakers are said to have taken the lead in the development of such vehicles. The strengthening of environmental regulations worldwide is considered to be a factor prompting this move, as the world's leading automakers compete furiously with each other to respond to environmental issues (Nikkei Shimbun, October 23).

Such technological innovation may be the key to achieving coexistence between the environment and the economy, a balance that has been becoming increasingly important since the start of the 21st century. However, what type of relationship exists between the strengthening of environmental regulations and technological innovation? Does the strengthening of environmental regulations promote technological innovation, thereby increasing a firm's competitiveness? If so, in order to maintain the superior position of Japanese automakers, it is vital that Japan strengthen environmental regulations further to exceed those of other countries. In reality, though, the issue is not so simple.

Theoretical and empirical disputes over the Porter hypothesis

The Porter hypothesis, expounded by Professor Michael Porter in 1991, is often cited when the relationship between environmental regulations and industrial competitiveness is discussed. The Porter hypothesis asserts that, "Appropriately planned environmental regulations will stimulate technological innovation, leading to reductions in expenses and improvements in quality. As a result, domestic businesses may attain a superior competitive position in the international marketplace and industrial productivity may improve as well." This hypothesis has leapt into the limelight as a direct counterargument to the standard view that environmental regulations have negative effects on productivity and competitiveness, as they lead to increased expenses for businesses.

Porter himself cites as evidence for his hypothesis examples of the U.S. chemical industry's competitiveness in the international chemical marketplace - an industry in which environmental protection costs have been increasing compared to other U.S. industries - and the high increase in productivity of the chemical industries in Japan and Germany, which adopted stricter environmental regulations in the 1970s. Although Porter himself does not touch on this, his hypothesis is occasionally cited with regard to the automotive industry as well, as an explanation of the assertion that Japan's adoption of stricter emissions regulations in 1978 under the Japanese version of the Muskie Act led to the subsequent advances made by Japanese automobiles in the U.S. market. From this point of view, the strengthening of regulations beyond those of other developed nations appears to have been an effective policy in the competition to develop environmentally-friendly automobiles, as discussed in the introduction.

However, the results of theoretical and experimental examinations of the Porter hypothesis by many economists have, if anything, tended to contradict it, and a consensus has not been reached on its soundness. A major reason for this is the fact that the processes of realizing technological innovation and increased productivity are related to various peripheral factors other than environmental regulation that are ignored by the Porter hypothesis. These include, among other factors, competition between firms, strategic actions taken between businesses and their regulators, conditions of demand, and the economic support measures taken by governments. It goes without saying that in a situation in which there is no possibility of the actualization of technological innovation through regulations, the strengthening of regulations cannot result in increases in productivity or competitiveness. Furthermore, from an experimental point of view, in an environment in which various factors are complexly intertwined, it is extremely difficult to pinpoint in terms of data the direct effects of environmental regulations.

In a research project indirectly commissioned by the Ministry of Economy, Trade, and Industry, a research group, including myself, is pursuing several case studies and examinations of what types of policies (regulations and other measures) achieve technological innovation and the resulting environmental protection and increase in productivity, in order to consider the relationship between environmental regulations and technological innovation in greater detail. From the research we have conducted thus far, it is clear that the relationship between environmental regulations and technological innovation/improvement in productivity is far from simple. It has become evident that the cases cited as examples of environmental regulations creating technological innovation and rising productivity do not in reality support such claims. For example, the advances made by Japanese automobiles in the U.S. auto market in the 1980s resulted primarily from the ability of Japanese automakers to respond to changes in the structure of demand, with consumers shifting to smaller automobiles due to high oil prices after the first oil shock. This phenomenon was not related to the comparative advantages or disadvantages of emission reduction technology. In fact, as a by-product of this phenomenon, Japanese vehicles were beaten by European vehicles, particularly in terms of their competitive strengths with regard to safety. In addition, automakers have been prompted to produce the hybrid vehicles that have gained attention in recent years, not necessarily in response to specific individual regulations, but in order to achieve superior competitive positions in the marketplace given the consensus that there is a trend to strengthen regulations generally and in the long-term. In fact, there appear to be no examples of automakers being able to sell vehicles based solely on their environmental performance.

Planning a system of environmental regulations for a new era

So what types of regulations are desirable in order to inspire innovation in environmental technology and achieve both environmental protection and increases in productivity? In Japan, where environmental measures involve high marginal costs due to implementation of, amongst other factors, the Kyoto Protocol, devising means of inducing technological innovation that can provide a breakthrough in the handling of environmental regulations is a critical challenge. Although our research group plans to continue considering these points, we believe that taking sufficient note of changes in the value that business management places on environmental measures is vital.

The number of businesses that are actively proceeding with environmental measures on their own, whether by implementing such measures in the absence of environmental regulations or, when possible, attempting to achieve levels of environmental protection exceeding those required by such regulations is said to have been increasing in recent years. We have clearly observed this tendency in our case studies. As the background to such efforts, we can point to companies' motivation to try and take the initiative in risk management efforts based on historical experience since the implementation of pollution control measures, as well as to changes in business management concepts reflecting the increased environmental awareness of consumers and capital markets. Although the Porter hypothesis implies that "appropriately planned environmental regulations" that would promote technological innovation and improve the competitiveness of businesses should be those that leave a discretionary margin for businesses to select technologies, when we consider the desirable form that such a regulatory system should take, it seems crucial to focus on realizing as flexible a mechanism as possible, in order to provide the aforementioned maximum level of incentives for businesses.

October 28, 2003

October 28, 2003