Monday, December 12, 2005

Porter Hypothesis

The Economist latest issue takes (again) on the global warming. It includes a story on how yet another big shot goes green -- this time the General Electric. As I said before, the main likely reason why they go green is, well, profit motive. And there's nothing wrong with that. Over at Env-Econ, John Whitehead has his take on what has been called "Porter Hypothesis". It's worth reading.

And here's my take:

“Porter Hypothesis” (Porter, 1991) is a three-level hypothesis. First, a strict environmental regulation can benefit the firms providing environmental services (e.g. scrubber producers) on their customers (e.g. electric utilities). Second, a stricter regulation benefits some regulated firms (i.e. more competitive ones) at the cost of other regulated firms (i.e. less competitive ones). Finally, stricter regulation would enhance the competitiveness of a nation as a whole. Porter and van der Linde (“PL”, 1995) extend the discussion of environmental policy and technology adoption by introducing the notion of “innovation offsets”. They argue that the costs of complying with environmental standards might be offset (partially or fully) by innovation induced by the regulations. This is supported by the fact that the activity to reduce pollution is in many cases coincident with productivity improvement with regards to resource use. Therefore, they conclude, firms may achieve net benefits from more stringent environmental regulations.

I find this argument flawed. Coincidence between reducing pollution and improving productivity is not sufficient to accept the hypothesis that strict regulations can enhance competitiveness. One needs to systematically prove this conjecture before reaching such strong conclusion. Innovation offsets, albeit theoretically possible, are rare in practice. PL argue that emissions and discharges of pollution are the manifestations of inefficiency. Instead of dealing with them, firms can enjoy substantial innovation offsets by improving their resource productivity, and this can be obtained through technology adoption. I agree. However, I barely see any reasons to expect that this can only (or, better) be achieved by environmental regulation.

PL believe that loose regulation can be complied with secondary treatment. Stricter regulation, on the other hand, forces firms to comply more seriously with fundamental solutions so as to lead them to innovation. They argue further that the potential for innovation offsets may exceed the cost of complying with stricter regulation so it is possible that net cost of compliance decrease as regulation becomes more stringent. It may even become net benefit. Again, I find this argument weakly supported and highly speculative. I believe that as one acts rationally, she would choose to innovate, provided that it pays her some positive benefit, and this may have nothing to do with regulation. A study by Altman (2001), for example, proves that there is no reason not to expect that a firm will be reluctant to “becoming greener”, if such transformation is costly and only serves to offset the private costs. In addition, Khanna and Zilberman (1997) find that even in the absence of any environmental policy, a firm may adopt technology that reduces emission when some “precision technology” is available.

That said, I believe that not all idleness are wasteful. It seems that PL overlook the concept of “slack capacity” (Oi, 1981). Idleness may occur in equilibrium state due to some opportunity costs (for example, why schools are closed at weekend?). Forcing a stricter regulation may only deteriorate the existing condition.


  • Altman, Morris. 2001. When Green Isn’t Mean: Economic Theory and the Heuristics of the Impact of Environmental Regulations on Competitiveness and Opportunity Cost. Ecological Economics. 36:31-44.
  • Khanna, M. and D. Zilberman. 1997. Incentives, Precision Technology, and Environ-mental Protection. Ecological Economics 23:25-43.
  • Oi, W.Y. 1981. Slack Capacity: Productive or Wasteful? American Economic Review. 71(2):64-69.
  • Porter, M.E. April 1991. America’s Green Strategy. Scientific American. 264:168.
  • Porter, M.E. and C. van der Linde. Fall 1995. Toward a New Conception of the Environmental-Competitiveness Issue. Journal of Economic Perspectives. 9(4):97-118.

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