Unmasking the Porter Hypothesis: Environmental Innovations and Firm-Profitability

Environmental regulation. What economists usually associate with these words are barriers to competitiveness. The association of Porter (1991) and Porter and van der Linde (1995) is a different one. By relying on a few case studies, they argue that even if stringent regulations impose costs on affected firms, regulations can trigger innovations which finally overcompensate regulatory costs. This view has become known as the Porter hypothesis which postulates a so called “win-win” situation that is supposed to improve both environmental quality and firms’ profitability. We attempt to test this hypothesis based on comprehensive data of firms from Germany. In contrast to previous empirical work, we distinguish innovations that directly reduce resource consumption (and thus externalities) of the innovating firm on the one hand, and innovations that only reduce environmental externalities without increasing resource efficiency on the other. For both types of environmental innovation we separate between regulation-induced and voluntary innovations. Compared to firms that did not introduce any type of environmental innovation, both regulation induced and voluntary innovations that improve resource efficiency increase profitability. This positive effect is larger for regulation driven innovation since they lead to an 1.4 percentage point increase in profitability (measured with return on sales) while voluntary innovations only increase profitability by 0.8 percentage points. However, innovation that reduces environmental externalities reduce firms profitability by 0.8 percentage points if they are regulation-induced whereas voluntary abatement investment of this type does not lead to significant profitability effects. We use data from the German Community Innovation Survey (CIS) in 2009 (the Mannheim Innovation Panel 2009) since it includes a set of questions on environmental innovation adoption and whether this is due to regulation. German CIS data are an appropriate data source since Germany is one of the most regulated countries in the world.

Rexhäuser, Sascha and Christian Rammer (2011), Unmasking the Porter Hypothesis: Environmental Innovations and Firm-Profitability, ZEW Discussion Paper No. 11-036, Mannheim, published in: Environmental and Resource Economics.