When Does Environmental Regulation Stimulate Technological Innovation?

July 23, 2018

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by David M. Hart (Information Technology and Innovation Foundation) There’s no magic bullet to ensure firms will respond to environmental regulation by innovating. But a literature review shows certain conditions that will raise that likelihood, pointing the way to some important rules of thumb for policymakers.

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My review of a growing expert literature on the topic yielded 12 such conditions, which are elaborated in this report:

Compliance with regulation is expected to be expensive.
Higher authorities are unlikely to force regulators to relax.
The threat of regulatory enforcement is legitimate and credible.
Industry expects regulation to become increasingly stringent over time.
The technological landscape for regulatory compliance is target-rich.
Regulated firms have slack resources.
The regulated industry is competitive.
Prospects for shifting production to “pollution havens” are limited.
Regulators rely on performance standards.
The regulatory process induces an open exchange of information.
Regulators have a sophisticated understanding of the regulated industry.
Technology policy complements regulation.

The presence of each condition raises the likelihood that firms will respond to environmental regulation by innovating. But the literature does not show any single condition (or even a combination of conditions) to be a magic bullet that will ensure this outcome in any particular case. Nor does it suggest all 12 must be present for innovation to occur.

Even though the literature does not yield simple prescriptions for environmental policymakers, this list of conditions allows them to diagnose complex situations, so that their actions increase the odds of an innovative response to regulation. To do so, they should adopt an open-minded, patient, long-term, and goal-oriented approach.

This report first defines the key terms of this long-running argument among experts and explain why it is important enough to occasionally take on a quasi-religious tone. It then summarizes each of the 12 conditions that influence whether environmental regulation will stimulate technological innovation. The report concludes by spelling out five rules of thumb to guide environmental policymakers:

Study whether the conditions they cannot control in a given case are likely to favor an innovative response from regulated firms.
When those conditions are favorable, set regulatory goals over the long term that assume the costs of compliance will decline due to innovation.
Be patient but vigilant in the intermediate term as regulated firms explore promising pathways that appear to have the potential to meet long-term goals.
Encourage competition among regulated firms to devise specific products and processes that would aid regulatory compliance, while also driving technology policy to create general knowledge they can all draw upon.
Develop a sophisticated understanding of the technical and economic challenges facing the regulated industry, in order to credibly and independently assess its progress, and to make adjustments, including loosening standards and schedules, when appropriate.