Environmental Policy, Innovation, and Productivity Growth: Controlling the Effects of Regulation and Endogeneity

We analyze the environmental regulation-productivity nexus and add to the literature in two main ways. First, shadow prices of energy and industrial energy prices are employed as relative measures of policy stringency. To ensure the robustness of the results, the model is also estimated for five alternative measures that have been applied in prior research. Second, we address the endogeneity of environmental regulation, innovation, and trade openness. A cross-country multi-sectoral dataset is utilized, including newly industrialized countries and former transition economies. The estimates show that the positive effects of increases in environmental policy stringency on productivity, which have often been reported in the more recent studies, change to mainly insignificant effects once simultaneity is controlled for. Hence, no support for the strong Porter Hypothesis can be found. Instead, stricter environmental regulation fosters innovation and, therefore, has an indirect, yet not decisive, positive effect on productivity growth.