Environmental Analysis: Porter's Hypothesis

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Porter’s Hypothesis
The traditional view among economists and managers concerning environmental protection is that it comes at an additional cost imposed on firms, which may erode their global competitiveness. Environmental regulations (ER) such as technological standards, environmental taxes, or tradable emissions permits force firms to allocate some inputs (labor, capital) to pollution reduction, which is unproductive from a business perspective. Technological standards restrict the choice of technologies or inputs in the production process. Taxes and tradable permits charge firms for their emissions pollution, a by-product of the production process that was free before. These fees necessarily divert capital away from productive investments.
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The Porter Hypothesis has met with great success in political debate, especially in the United States, because it contradicts the idea that environmental protection is always detrimental to economic growth. The PH has been invoked to persuade the business community to accept environmental regulations, as it may benefit from them in addition to other stakeholders. In a nutshell, well-designed environmental regulations might lead to a Pareto improvement or “win– win” situation in some cases, by not only protecting the environment, but also enhancing profits and competitiveness through the improvement of the products or their production process or through enhancement of product quality.
Causal Links in the Porter Hypothesis
Porter and van der Linde (1995a, 99–100) go on to explain that there are at least five reasons why properly crafted regulations may lead to these outcomes: .
 “First, regulation signals companies about likely resource inefficiencies and potential technological improvements.” .
 “Second, regulation focused on information gathering can achieve major benefits by raising corporate awareness.”
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Jaffe and Palmer (1997) first distinguished among the “weak,” “narrow,” and “strong” versions of the Porter Hypothesis. First, properly designed environmental regulation may spur innovation (as shown in the first two boxes of Figure 1). This has often been called the “weak” version of the Porter Hypothesis because it does not indicate whether that innovation is good or bad for firms. Of course, the notion that regulation may spur technological innovation is not a new idea in economics and would not itself have led to the controversy about the Porter Hypothesis. Second part of the Porter Hypothesis (the lower right-hand side of Figure 1) is that in many cases this innovation more than offsets any additional regulatory costs—in other words, environmental regulation can lead to an increase in firm competitiveness. This has often been called the “strong” version of the Porter Hypothesis. Finally, in what has been called the “narrow” version of the Porter Hypothesis, it is argued that flexible regulatory policies give firms greater incentives to innovate and thus are better than prescriptive forms of regulation. Indeed, Porter challenges regulators to examine the likely impacts of their actions and to choose those regulatory mechanisms, particularly economic instruments, that will foster innovation and competitiveness.

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