The environmental Porter hypothesis: theory, evidence, and a model of timing of adoption

Abstract

The Porter hypothesis postulates that the costs of compliance with environmental standards may be offset by adoption of innovations they trigger. We model this hypothesis using a game of timing of technology adoption. We will show that times of adoption will be earlier if the non-adoption tax is higher. The environmental tax will turn the preemption game with low profits into a game with credible precommitment generating higher profits (pro-Porter). If there is a precommitment game without environmental taxes, the introduction of a tax will lead to lower profits (anti-Porter). An evaluation of the empirical literature indicates that the Porter hypothesis will hold even for profit-maximizing firms under multiple market imperfections such as imperfect competition, X-inefficiency, and agency costs. These are more likely to be present in sectors with large firms. In many case studies that we have evaluated, though, we detected an element of explicit or implicit subsidies for environmentally friendly behaviour, which is in line with Pigovian policies.

Keywords:

• environmental policy
• strategic trade theory
• technology adoption
• Porter hypothesis

JEL :

• Q2
• F1
• H7
• O3

Acknowledgements

We would like to thank the editor and two anonymous referees for their valuable comments.

Notes

τ could also be introduced by using country-specific cost functions; however, our purposes treating it as a separate ‘cost’ serves our purpose best.

The number in brackets is the number of firms that have adopted: 0, 1, or 2. The subscript 1 (0) indicates that a firm has (not) adopted.

The cost of adoption, c(t), is defined to be the present value of the cost of adopting the new technology at time t.

The first T on the left-hand side denotes the firm's own adoption time, the second the other firm's adoption time.

Stated differently, given both technologies without any cost of adoption, the new technology would always be preferred.

See Propositions 2.6 and 2.8.

A large π₀ (1) makes the desire to lead weaker, because it gives a higher weight to the timing shift effect. But a larger π₂ (1) has opposing effects directly and from Equation (5).

The parameter values presented in the table give the most relevant variations for this simulation exercise. We have tried other parameter values, which confirm the results we present here.

A complication arises here if a customer switches to the foreign competitor after adoption of the home firm. It is reasonable to assume that this does not decrease the total benefit of the consumers of the home firm.

This implies that we do not look again at some papers of the older literature, which have been made independently of but published during the same years as the PL papers and tackled the Porter hypothesis only as a side remark. Exceptions are papers, which are held to be relevant by several other papers selected (from the Journal of Economic Literature and the literature database ‘econpapers’) in the above-mentioned manner. Ambec and Barla (2005), by virtue of writing earlier, consider less recent literature, more old literature, emphasize the energy sector and econometric methods, and by implication ignore case studies.

Table 5 summarizes the results of the papers. See also Ambec and Lanoie (2007) for an overview of related papers.

International Association for Energy-Efficient Lighting (IAEEL), IAEEL Newsletter 1 (1999).

Energy Star And Other Climate Protection Partnerships, 2005 Annual Report.

SenterNovem, Projectenboek CO₂-reductieplan, October 2005. Similar forerunner programs have been discussed by Steger et al. (2004, section 7.3.1).

Many other examples can be found in PL (1995a, 1995b, in particular on page 123) and in IAEEL (1999).

Capital composition is discussed in Xepapadeas and de Zeeuw (1999) and in Feichtinger et al. (2005). Note in particular that additional R&D and patenting through regulation are additional costs as suggested by the neoclassical static first principles, which still need to be transformed into profits, productivity, etc. Therefore, they should not be interpreted as support for the Porter hypothesis unless they lead to higher profits as in some of the two-stage Cournot models.

Interpretation of his calculations of revealed comparative advantage indices gives no clear results because they suffer from the EU accession in 1995 with its trade diversion and creation effects and the recession in 1998 in connection with the Austrian budget deficit reductions. For a discussion of early papers using cost function estimates and the associated problems, see Smith and Walsh (2000).

To the extent that these inefficiencies reflect different technologies, the question is why technologies are different. Are there reasons for differences in timing of adoption with the limiting case of never adopting?