Drivers of environmental innovation - Vinnova

Drivers of 

environmental 

innovation 

VF 2001:1 

REVIEW OF CURRENT KNOWLEDGE

TITLE (english): Drivers of environmental 

innovation 

FÖRFATTARE/AUTHOR: 

Nils Markusson 

SERIE/SERIES: 

VINNOVA Innovation i fokus VF 2001:1 

Energimyndigheten ER 2001:1 

ISBN 91-89588-01-0 

ISSN 1650-3147 

PUBLICERINGSDATUM/DATE PUBLISHED: 

Februari 2001 

UTGIVARE/PUBLISHER: VINNOVA – Verket för 

Innovationssystem, Stockholm och 

Energimyndigheten 

VINNOVAs diarienr NUTEK 1A2-2000-731 

REFERAT (syfte, metod, resultat): 

Denna rapport är en översikt av befintlig litteratur om hur externa krav driver fram miljöinnovationer hos 

företag. Avsikten är att bidra med kunskap till svenska beslutsfattare. Den akademiska litteraturen har 

identifierats via kontakter med forskare samt genom att söka i databaser. Rapporter identifierades genom 

publiceringslistor för relevanta svenska och utländska organisationer, samt genom personliga kontakter. 

Några av policyslutsatserna är: Både hållbar utveckling och tillväxt kräver ökad samordning mellan 

innovationspolitiken och miljöpolitiken. Insatser bör rikta sig mot värdekedjor och nätverk, särskilt för att 

involvera små och medelstora företag. Man har att välja mellan snabba och stora resultat. Styrmedel bör 

samordnas för bästa effekt. Regleringar stimulerar innovationer - vad gäller övriga styrmedel vet vi inte, 

ännu. 

ABSTRACT (aim, method, results): 

This study aims to provide an overview of the existing literature on how external demands drive 

environmental innovations within firms. This is done with a view to contribute to the knowledge of Swedish 

policy makers. The academic literature has been identified through contacts with researchers and 

searching databases. Reports were identified through scrutinising the publication lists of relevant 

Swedish organisations, as well as by utilising personal contacts. Some of the policy conclusions are: 

Both sustainability and growth require increased cooperation between the areas of innovation and 

environmental policy. Policies should target value chains and networks, especially to involve SMEs. 

There is a choice to be made between quick results and large results. Policy instruments should be 

used in a coordinated manner for best effect. Regulation stimulates innovation - apart from that we do not 

know, yet.

Drivers of 

environmental 

innovation

VINNOVA Innovation i fokus VF 2001:1 

ISBN 91-89588-01-0 

ISSN 1650-3147 

Energimyndigheten ER 2001:1 

ISSN 1403-1892 

Omslagsfoto: Whitney Frank 

Tryck: Edhagens grafiska 2001

Preface 

Innovations such as new products, processes and organisations, have an 

important role to play in the development of a sustainable society as well as in 

economic growth. Therefore it is important for policy makers to understand the 

mechanisms behind environmental innovations, and how to enhance the 

development of environmentally less harmful technology and firm practice. 

Firms are stimulated to develop environmental innovations both by internal 

motivation and competence and by external demands from customers, public 

policy, interest groups and other actors. This study is about the role of external 

environmental demands on firms and their effects on innovations in firms. A 

special focus is put on the effects of environmental policy instruments on 

innovations. The study provides an overview of scientific articles and reports 

by public and private organisations. 

This report was written by Nils Markusson (project leader), VINNOVA, 

Department of Innovation Systems, and Annika Olofsdotter, Energi- och 

miljöekonomi. 

Göran Marklund 

VINNOVA, Division of Innovation Systems

Content 

SAMMANFATTNING................................................................................................... 7 

SUMMARY ................................................................................................................... 11 

1 INTRODUCTION .................................................................................................. 13 

1.1 Aim ................................................................................................................... 13 

1.2 Method ............................................................................................................. 13 

1.3 What is an environmental innovation? ............................................................ 14 

2 ENVIRONMENTAL INNOVATIONS IN FIRMS ............................................. 17 

2.1 Distinguishing features of environmental innovations .................................... 17 

2.2 Historical developments................................................................................... 17 

2.3 Information and knowledge requirements ....................................................... 19 

2.4 Organisational innovations ............................................................................. 20 

3 EXTERNAL FACTORS THAT DRIVE ENVIRONMENTAL 

INNOVATIONS............................................................................................................ 22 

3.1 There are limits to the price mechanism as a driving force ............................ 23 

3.2 A shift towards market drivers?....................................................................... 24 

3.3 Sector and firm size influence response to drivers .......................................... 25 

3.4 Inter-firm relations relay and transform environmental demands .................. 27 

4 ENVIRONMENTAL POLICY INSTRUMENTS AS DRIVERS ...................... 29 

4.1 Types of policy instruments used ..................................................................... 29 

4.2 Regulatory instruments .................................................................................... 30 

4.3 Economic instruments...................................................................................... 34 

4.4 Communicative instruments............................................................................. 40 

4.5 Summary and comments .................................................................................. 44 

5 CONCLUSIONS ..................................................................................................... 46 

5.1 Conclusions on drivers of environmental inovations ...................................... 46 

5.2 Policy conclusions ........................................................................................... 47 

5.3 Areas for further studies .................................................................................. 48 

REFERENCES.............................................................................................................. 50 

APPENDIX 1 THEORETICAL APPROACHES TO INNOVATIONS..................................... 54 

APPENDIX 2 ENVIRONMENTAL POLICY AND COMPETITIVENESS .............................. 58

Sammanfattning 

Denna rapport är en översikt av befintlig litteratur om hur externa krav driver 

fram miljöinnovationer hos företag. Avsikten är att bidra med kunskap till 

svenska beslutsfattare. Innovationer har en stor potential att bidra till att göra 

samhället uthålligt. Krav på företag för en uthållig utveckling är en drivande 

kraft för innovativitet i företag, och politiska initiativ kan, utifrån denna 

drivkraft, bidra till att stärka företagens utveckling och möjlighet att vara 

innovativa. 

Miljöinnovationer kan definieras som ”innovationer som tjänar att förebygga 

eller minska antropogena bördor på miljön, hantera redan skedda skador eller 

diagnostisera och övervaka miljöproblem”. Miljöinnovationer innefattar många 

kunskapsområden och många industriella sektorer och är därför ofta komplexa 

och påverkar stora delar av näringslivet. 

Kapitel 2 beskriver hur miljöinnovationer tas fram i företag, och behandlar de 

särskilda utmaningar miljöinnovativa företag ställs inför. Den historiska 

utvecklingen av företagens miljöarbete presenteras. Miljöarbetet har övergått 

från att fokusera på hantering av utsläpp, till att finna lösningar på problemen 

vid dess källa i produktionen och till ett livscykelperspektiv på produkterna. 

Övergången orsakades bland annat av mer omfattande och striktare 

lagstiftning, samt av den ökade uppmärksamheten på diffusa miljöproblem. 

Det behövs ett bredare urval av kompetenser för miljöinnovationer än för andra 

typer av innovationer, och de kräver mer organisationsförändringar. Kunder 

och leverantörer är informationskällor som används i miljöinnovationsprocesser, 

men även universitet och högskolor kan vara viktiga källor. 

Kapitel 3 fokuserar på de olika externa faktorer som driver fram miljöinnovationer 

i företag. De viktigaste drivkrafterna är offentliga krav och 

marknadsrelaterade drivkrafter, såsom konkurrens och viljan att nå ökade 

marknadsandelar. Marknadsrelaterade drivkrafter har på senare år stärkt sin 

ställning som drivkraft, men offentliga krav är dock fortfarande viktiga. 

Vissa sektorer är mer beroende av miljöinnovationer än andra, exempelvis 

kemiindustrin. Variationer mellan sektorer kan helt enkelt vara resultatet av 

skilda externa krav. Det kan även bero på att sektorer reagerar olika på 

likadana externa krav. Mogna sektorer tenderar att stå emot radikala 

förändringar, men kan å andra sidan vara öppna för åtgärder som leder till 

ökad effektivisering. Generellt sett tycks större företag ägna sig mer åt miljöinnovationer 

än mindre företag. Stora företag stimuleras av både interna och 

externa drivkrafter, medan små företag överlag framför allt reagerar på externa 

faktorer, såsom lagar. 

7

Konsumtionsvaruföretag och stora företag ställer idag ofta miljörelaterade krav 

på sina leverantörer, och på så sätt sprids miljökrav från konsumenterna och 

från staten till leverantörsföretagen. Detta kan vara en stark drivkraft för 

miljöarbete, speciellt i mindre företag. En kombination av regelverk och 

miljöengagemang inom hela värdekedjan, från råvaruleverantörer till 

producenter, distributörer, konsumenter och avfallsaktörer, behövs för att 

initiera miljöinnovationer. 

Kapitel 4 behandlar olika miljöpolitiska styrmedel och vad som är känt om 

deras effekter på innovativiteten. Tre huvudsakliga kategorier kan urskiljas: 

administrativa, ekonomiska och kommunikativa styrmedel. Administrativa 

styrmedel kan beskrivas som institutionella åtgärder med syfte att direkt 

påverka miljöarbetet i företag. Administrativa styrmedel inkluderar lagar och 

förordningar som beskriver mål, standarder och tekniker. Ekonomiska 

styrmedel innefattar beskattning, subventioner och handel med 

utsläppsrättigheter. Kommunikativa styrmedel är icke-tvingande styrmedel där 

staten på andra sätt utövar påtryckning eller stimulans till miljömedvetenhet 

och miljöansvar. Utbildning, information, frivilliga överenskommelser och 

nätverksskapande insatser ingår i denna kategori. Kommunikativa styrmedel 

används ofta tillsammans med administrativa och ekonomiska styrmedel. 

Det finns inget enkelt svar på vilken typ av styrmedel som är mer fördelaktigt 

än andra, vad gäller effekter på innovativiteten. Olika styrmedel verkar 

stimulera olika typer av innovationer. Det finns få empiriska resultat och det är 

svårt att säga något säkert om vilka effekter de olika miljöpolitiska styrmedlen 

har på innovativiteten. De empiriska resultat som finns indikerar att de flesta 

styrmedel endast har haft begränsade effekter på innovativiteten. Hårda 

regleringar som inte går att möta med dagens teknik har en stor potential att 

stimulera radikala innovationer, men kan samtidigt orsaka höga kostnader i 

företagen. 

Slutsatser 

Innovationer kan bidra till en hållbar utveckling. Med det som mål finns det 

utrymme för att utveckla miljöpolitiken, såväl som den miljömotiverade 

innovationspolitiken: 

• Både hållbar utveckling och tillväxt kräver ökad samordning mellan 

innovationspolitiken och miljöpolitiken 

Miljöpolitiska styrmedel är sällan utformade för att driva fram innovationer. 

Mer uppmärksamhet på innovationsfrågor och vidareutveckling av de 

miljöpolitiska styrmedlen kan öka miljöpolitikens möjligheter att lösa 

miljöproblemen. Till exempel behövs hårdare, men samtidigt mer flexibla, 

regleringar. 

8

Övergången mot ett mer marknadsdrivet miljöarbete i näringslivet medför att 

miljöaspekten blir allt viktigare för tillväxt och förnyelse. Miljöfrågor bör få 

större utrymme inom innovationspolitiken. 

• Insatser bör rikta sig mot värdekedjor och nätverk, särskilt för att involvera små och 

medelstora företag 

Företag förmedlar miljökrav till sina leverantörer, men kraven översätts och 

omformas på vägen. Inte alla miljömedvetna företag har kommit igång med att 

ställa miljökrav på sina leverantörer. Detta kan medföra att underleverantörsföretag 

inte alltid upplever några miljökrav från sina kunder, även om 

miljöfrågorna är strategiskt viktiga. Därför är det viktigt att använda sig av 

styrmedel som riktar sig mot hela värdekedjor och nätverk, snarare än enskilda 

företag. 

• Man har att välja mellan snabba och stora resultat 

Ökade investeringar i redan tillgänglig teknik kan göras snabbare än 

framtagande av ny teknik, vilket kräver utvecklingsarbete och ibland till och 

med långsiktig forskning. 

När nya styrmedel ska utformas är det viktigt att tänka på tidsaspekten. 

Utveckling av ny teknik och nya produkter tar tid, och det kan vara en fördel 

att ge företag respit med att leva upp till miljökrav för att inte avskräcka dem 

från att utveckla innovationer. 

• Styrmedel bör samordnas för bästa effekt 

Eftersom det inte finns något enskilt styrmedel som alltid är bäst, eftersom olika 

styrmedel har olika styrkor och svagheter, och eftersom styrmedel påverkar 

varandra bör politiker och tjänstemän ge stor uppmärksamhet åt de problem 

och möjligheter som finns i samtidig och koordinerad användning av mer än ett 

styrmedel. 

• Regleringar stimulerar innovationer. Vad gäller övriga styrmedel vet vi inte, ännu. 

Vi vet idag att regleringar kan stimulera till och med radikala innovationer. I 

fall där dagens teknik inte räcker, men där ny teknik kan utvecklas för en rimlig 

kostand och inom rimlig tid kan regleringar stimulera innovationer. 

Regleringar kan dock orsaka stora kostnader i företagenn. Det är också viktigt 

att ta hänsyn till den internationella konkurrensen vid införande av regleringar. 

Utöver regleringar finns det alltför lite kunskap om olika styrmedels effekter på 

innovationer. Det är också svårt att säga vilka styrmedel som har vilken effekt 

på innovativiteten. Mer kunskap behövs. Ett viktigt sätt att få reda på vad som 

9

fungerar är att experimentera, och använda många olika styrmedel. 

Utvärderingar bör ta upp effekter på innovationer. 

Ännu så länge finns många brister i utbudet av litteratur och undersökningar 

vad gäller olika styrmedel och deras effekt på miljöinnovationer. Det finns ett 

stort behov av fler empiriska resultat på området. Viktiga teman är 

miljökommunikation mellan företag, kompetensfrågor, implicita miljökrav på 

företag, systeminnovationer och olika styrmedels effekter på innovationer. 

10

Summary 

This study aims to provide an overview of the existing literature on how 

external demands drive environmental innovations within firms. This is done 

with a view to contribute to the knowledge of Swedish policy makers. 

Innovations hold a large potential to contribute to the greening of society. Firmexternal 

demands for sustainable development is a driving force of innovation 

within firms, and public policy may contribute to strengthing firm growth and 

capability to innovate based on this driving force. 

Environmental innovation can be defined as ”innovation that serves to prevent 

or reduce anthropogenic burdens on the environment, clean up damage already 

caused or diagnose and monitor environmental problems”. Environmental 

innovations involve many areas of knowledge and many industrial sectors and 

may therefore be systemic and complex. 

Chapter 2 describes more specifically the nature of environmental innovations, 

and includes the specific challenges imposed on firms engaged in 

environmental innovation efforts. The historical development of environmental 

work is presented, with the shift from end-of-pipe solutions to more integrated 

solutions to environmental problems being outlined. The shift is due partly to 

more comprehensive and stricter legislation, as well as to the increased 

attention being paid to more diffuse environmental problems. 

It appears that a broader range of competences is needed for environmental 

innovations than for other types of innovations, and that they require more 

organisational changes. Customers and suppliers are sources of information 

used in environmental innovation processes, but the public knowledge 

infrastructure, for example universities and technical colleges, may also be 

important. 

In chapter 3 the focus is on the different external factors that drive 

environmental innovation activities in firms. The most important drivers are 

regulations and market related drivers, such as competition and the hope of 

increased market shares.A shift is taking place away from regulation as the 

main driving force as market drivers become increasingly important. 

Government demands, however, remain a very important driver of 

environmental innovation. 

Business to business interaction can act to diffuse environmental demands from 

consumers good firms and large firms to other firms. This can potentially be a 

powerful driver of environmental work, especially in small firms. The 

combined action of regulation and social concern within the entire value chain, 

from raw material suppliers to intermediate manufacturers, final producers, 

11

distribution, final customers and disposal chain, is needed to trigger green 

innovation. 

Chapter 4 presents the different environmental policy instruments and what is 

known about their effects on innovation. Three principal categories are 

discerned: regulatory, economic and communicative instruments. There is no 

simple answer to which type of instrument is the most advantageous in terms 

of their effects on innovations. Different instruments seem to drive different 

types of innovations.The lack of empirical results ensures that we can not 

comment on the effects on innovation of the different environmental policy 

instruments used. The empirical results at hand seem to show that most 

instruments have only had limited effects on innovation. Technology forcing 

standards may hold the largest potential for radical innovations, but at a large 

cost to the firms. There are, however, large gaps in the empirical data on many 

instruments, and other instruments may be as effective. 

Conclusions 

Industrial innovations may contribute to shifting society towards sustainable 

development. For this to happen there is a need for improved environmental 

policy as well as environmentally motivated innovation policy: 

• Both sustainability and growth require increased cooperation between the areas of 

innovation and environmental policy 

• Policies should target value chains and networks, especially to involve SMEs 1 

• There is a choice to be made between quick results and large results 

• Policy instruments should be used in a coordinated manner for best effect 

• Regulation stimulates innovation. Apart from that we do not know, yet. 

1 Small and medium sized enterprises 

12

1 Introduction 

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Dowlatabadi, 1999) 

This quote illustrates the importance of technological development and 

innovations in societies striving towards sustainability. Existing technology 

must be diffused, but there is also a need for new technology. The required rate 

of technical change – of innovation - is high and this motivates studying what 

drives such change, and to understand what governments can do to support it. 

1.1 Aim 

The aim of this study is to survey the existing literature on how external 

demands drive environmental innovation in firms, and to provide an overview 

of the field. The material used includes academic articles, scientific papers and 

reports from public and private organisations. 

The study has been undertaken with a view of contributing to the work of 

Swedish policy makers. This is achieved through providing knowledge on what 

role the external demands for sustainable development has as a driving force 

for innovations in firms, and on how public policy can strengthen firm growth 

and innovation capability. 

1.2 Method 

The academic literature has been identified through contacts with researchers 

and searching various databases 2 . In a second round articles were identified by 

following up on references. The reports were identified through scrutinising the 

publication lists of relevant Swedish organisations 3 , as well as by utilising 

personal contacts. The articles and the reports were summarised and then 

organised into the present report structure. 

2 Environmental abstracts, LIBRIS, EconLit, Compendex and DADS. 

3 OECD, NUTEK (Swedish National Board for Industrial and Technical Development), IVA (Royal 

Swedish Academy of Engineering Sciences) and Miljöteknikdelegationen (The Swedish Delegation for 

Sustainable Technology). 

13

It can be observed that the material on environmental drivers of innovations is 

limited. This study, therefore, covers much of the existing literature. 

The identified material shows a strong bias towards policy instruments, rather 

than market related and other drivers, and their effects on environmental 

innovation. An explanation for this may be that the market as an important 

driver of environmental innovation is a relatively new phenomenon and has as 

yet not received much attention by researchers. 

1.3 What is an environmental innovation? 

Innovation can be defined in many ways. A definition commonly referred to is 

that of Schumpeter: “the commercial or industrial application of something new 

– a new product, process or method of production; a new market or source of 

supply; a new form of commercial, business or financial organisation” 

(Schumpeter, 1934). New is usually interpreted as new to the economy, and not 

just new to a single firm. The diffusion of technology already on the market is 

thus not included within innovation. Most of the literature identified in this 

study is focussed on product and process innovations, and to a lesser extent on 

organisational innovations. 

Environmental innovations could in principle be defined in two ways: firstly by 

the effects of the innovation on the environment and, secondly, by the intention 

of the innovator to reduce the environmental impact of processes or products. 

Innovations that are not driven by a conscious intention to reduce 

environmental impact may nevertheless have this quality. An example might be 

increased fuel efficiency of a car arising from the incremental improvement of 

the motor. The prime motivation for such an innovation is most likely 

performance or price considerations, but the effects on environmental 

performance may anyhow be positive. 

Hemmelskamp defines environmental innovation as an ”innovation which 

serves to prevent or reduce anthropogenic burdens on the environment, clean 

up damage already caused or diagnose and monitor environmental problems” 

(Hemmelskamp, Forthcoming). Hemmelskamp also differentiates between endof-pipe 

and integrated environmental technologies, where end-of-pipe 

technologies are by their very nature incremental process innovations 

(Hemmelskamp 1997). 

Malaman defines a closely related concept, cleaner technologies, as: ”all 

modifications in processes and products which reduce impact on the 

environment, as compared to the processes and products which they have 

substituted” (Malaman, 1996). 

Both these definitions appear to focus on the effects of innovations rather than 

on the intention. A problem with this may be deciding which innovations in 

practise actually reduce the environmental impact of products and production. 

14

But there are also problems with a definition that focuses on the intention of the 

innovators. As industry moves on from end-of-pipe solutions to integrated 

technologies and product innovations, the environmental motivation for the 

innovation may become entangled with other motivations. It may also be 

difficult to establish the relationship between the dedicated environmental 

activities of firms and the environmental performance of industry. 

The OECD emphasises the systemic character of environmental innovations. In 

the past environmental technology referred to pollution control or end-of-pipe 

technologies, but today integrated solutions are more common and all 

technologies can be considered environmental in cases were they are employed 

to reduce environmental impact. The use of integrated solutions increases the 

number of areas of knowledge and technology that may contribute. 

Environmental innovations will also occur in all industries rather than only in 

the dedicated environmental goods and services sector. Innovations in a wide 

range of industries have significant environmental impacts. Some innovations, 

for example information and communication technology innovations induce 

structural changes in the economy generating ”unintentional” environmental 

benefits. Both these aspects illustrate that environmental innovations may to a 

large extent be systemic and complex in that they involve many areas of 

knowledge and many different industrial sectors (OECD, 2000). 

One way to address and reduce this complexity is to categorise environmental 

innovations according to differences in their use. Kemp and Malaman list 

similar categories of environmental innovations: 

Kemp 

Pollution control technologies 

Waste management 

Clean technology 

Recycling 

Clean Products 

Clean-up technology 

Monitoring and assessments 

technologies 

(Malaman, 1996; Kemp, 1998). 

Malaman 

Cleaner products 

Input reduction 

Input substitution 

Energy saving technologies 

Cleaner production processes 

Recovery and recycling technologies 

Cleaner products which modify the 

production process of other firms 

Environmental diagnostics and monitoring 

Add-on or end-of-pipe technologies 

Other researchers stress that all technologies may contribute to environmental 

innovations, but the above lists appear to be both categories of use as well as 

distinctive technologies. It is unclear if they are selected by their effect on the 

environment or by the intention of the innovator. 

15

Environmental innovations can also be brought about by organisational 

changes. Examples of such innovations include: firm environmental statements, 

development of environmental programmes, introduction of environmental 

learning techniques, allotment of responsibilities, establishment of 

communications channels and teams, and establishment of inter-organisational 

networks and partnerships (Kemp, 1998). 

See appendix 1 for a more in-depth account of theoretical approaches to 

innovations. 

16

2 Environmental innovations in firms 

In this chapter the nature of environmental innovations will be further 

investigated. Included within the discussion will be the specific challenges 

posed on those firms engaged in environmental innovation efforts. 

2.1 Distinguishing features of environmental innovations 

In addition to their environmental qualities, some researchers claim that 

environmental innovations, in spite of their diversity, have some traits in 

common that differentiates them from other types of innovations. Malaman 

(1996) claims that market demand for cleaner technology innovations is 

generally slack and difficult to predict. Four reasons for this are provided:: 

1) The objective of cleaner production is lower on the agenda of firms than that 

of profit. 

2) In the introductory stage cleaner technologies may feature higher costs and 

inferior quality. 

3) Information problems seem to be greater than in other cases, due to the 

complexity of environmental aspects and lack of knowledge. 

4) Environmental innovations call for more organisational and institutional 

changes. 

Another distinguishing factor reported is that awareness of environmental 

issues may play a role as an additional incentive to those involved in the 

environmental innovation process (OECD, 2000). The importance of staff 

awareness is also confirmed by an Italian study which shows awareness to be of 

medium importance for environmental innovations. Awareness is less 

important than regulation and market factors, but more important than, for 

example, changes in supply (Malaman, 1996). 

The nature of environmental innovation and the conditions in environmentally 

innovating firms have, however, changed over time. To understand the 

characteristics of environmental innovation today we should first look back in 

time. 

2.2 Historical developments 

The conditions for the environmental work of firms and for the authorities 

dealing with environmental issues have changed radically during the last 30 

years. In the 1970s environmental work was often aimed at combating acute, 

localised pollution. The polluters were identifiable, the uncertainty was low and 

urgent action was required. The results were often end-of-pipe-solutions. 

17

Since then laws as well as the environmental problems have changed. In most 

countries legislation has become stricter and more comprehensive. 

Environmental problems are nowadays often diffuse and their scope and effects 

are often controversial. Problems like global warming, ozone depletion and 

cross-border water pollution are seldom spotted directly, and represent risks 

that must be prevented. The consequences of this change are important: 

whereas in the past the identification of polluters, of the Best Available 

Technology and of costs was quite easy, the innovation process is nowadays 

more complex (Aggeri, 1999). 

The response of firms to environmental problems has evolved accordingly. 

Four historic stages in the development of cleaner technologies can be 

discerned: 

1) first energy shock – early 1970s 

Environmental innovations primarily motivated by energy savings. 

2) mid 1970s – mid 1980s 

Environmental policy developed by Government. Industry responded 

passively and adopted end-of-pipe technologies. 

3) second half of the 1980s 

Firms adopted a defensive medium-term approach. Innovations usually timed 

with systems renovation. 

4) end 1980s – present 

Environmental objectives included in corporate strategy and innovations are 

also aimed at acquiring competitive advantage. 

New technologies must be integrated into the broader technical, economic and 

social systems. This requires not only a complex innovation process but also 

new skills, new organisational structures and new regulations. The earliest 

cleaner technologies developed were add-on or end-of-pipe technologies, which 

were relatively easy to develop and employ within existing technological 

systems (Malaman, 1996). 

Today, a larger share of environmental innovations than was hitherto the case 

are product rather than process innovations. The level of development of 

innovations was classified in the Italian study on a scale from R&D 4 via 

prototype and first application to maturity. Product innovations were generally 

at a lower level of development than process innovations, and it is likely that 

the proportion of product innovations will further increase (Malaman, 1996). 

Some support for the development as presented by Malaman comes from a 

WBSCD 5 study. Almost 90 per cent of the firms in the study agreed that 

4 Research and development 

5 World Business Council for Sustainable Development 

18

”sustainable development is a key business driver for the firm”. The most 

important factors supporting this view were firm image and brand value. Of 

medium importance were new product and service advantage, staff values and 

principles and cost advantage. Direct demands from regulators, customers and 

special interest groups were considered to be the least important. Firm image 

and brand value were thus considered much more important than customer or 

regulator demands (Dearing, 2000). 

2.3 Information and knowledge requirements 

As noted above environmental innovations are said to encompass more 

information problems than other innovations. However, what are the 

information and knowledge requirements of environmental innovations? 

Environmental innovations must not only be environmentally beneficial, but 

must also meet a range of other demands such as user requirements on 

functionality and cost. It should also be possible to produce environmental 

innovations with the existing production processes (Kemp, Forthcoming). A 

basic restriction is that development and production will have to be performed 

with the knowledge and competence already existing in the firm. Although 

new competences can be acquired through learning processes, such processes 

are time consuming. This illustrates the path dependency that environmental 

innovations share with other innovations. 

Environmental innovations also give rise to special problems. The information 

requirement of environmentally innovative firms is higher than in other cases. 

Firms find it hard to gain an overview of the available environmental 

technologies, and to obtain full information on their effect and applicability 

(Hemmelskamp, Forthcoming). 

A broader range of competences is needed for environmental innovations than 

for other types of innovations, and managing this variety of competences can be 

difficult. The WBSCD has studied how 80 firms with an expressed commitment 

to sustainable development and environmental protection incorporate their 

commitment into innovation management. The respondents – often senior 

managers with responsibility for aspects of innovation, product development 

and technology management - generally felt uncertain of their ability to manage 

and assess the creative skills required to address the broader agenda of 

sustainable development (Dearing, 2000). 

What do firms do to meet the information and knowledge needs they face when 

engaged in environmental innovation? Part of the solution lies in receiving 

information from external sources. Equipment manufacturers play an 

important role in the supply of information to the suppliers of environmental 

innovations. Suppliers of materials and components provide important 

information for developing environmentally friendly products and reducing 

consumption of materials. The results of a German study indicate that 

19

customers do not influence the provision of information for environmental 

product innovations. Instead the public infrastructure: universities and 

technical colleges, as information providers, exert a strong influence on the 

development of environmentally friendly products (Hemmelskamp, 

Forthcoming). 

Another strategy to satisfy information and knowledge needs is internal 

learning in the form of R&D. However, Hemmelskamp found that the 

importance of environmental innovation objectives falls as R&D intensity rises. 

A proposed explanation for this is the dominance of end-of-pipe solutions. 

These are essentially incremental improvements to existing technological 

solutions and can be bought on the market, with the consequence that R&D is 

only required to a limited extent (Hemmelskamp, Forthcoming). 

2.4 Organisational innovations 

Organisational factors influence the innovative response of firms to 

environmental demands. As stated above by Malaman this is especially true for 

environmental innovations. 

The organisational strategy of firms in relation to environmental activites has 

changed over time. Greoenwegen and Vergragt present a stage-based account 

of the development of organisational environmental innovations inside large 

industrial corporations: 

- 1980 Small environmental units, with their activities mainly restricted to 

reacts to government regulation, by producing reports based on 

scientific research. 

1984-88 Increased activity. Education and training for staff in all levels of the 

organisation. 

Late 80s Increased activities in some firms, with environmental issues being 

viewed in a strategic way. A proactive and preventive course is 

followed. 

They claim that there has been a trend towards integrating environmental 

concerns into business strategy, and towards more strategic handling of these 

issues. Growing public concern and the increased geographical scale of 

environmental problems drive the trend (Groenewegen and Vergragt, 1991). 

A confirmation of the interdependence of organisational factors and 

environmental innovations is given by Sanchez and McKinley. They show that 

customisation has a positive correlation with product innovation response to 

environmental regulation (Sanchez and McKinley, 1998). 

Organisational factors influence innovative behaviour, but environmental 

innovations also influence a firm’s organisation. Green et al studied how firms 

change their innovative practices in response to environmental pressures. There 

20

was in general no larger change in the innovation practices. Strategic changes 

indicating major new directions in technological development like increased or 

reorganised R&D, inflow of technical staff with new skills or changed 

collaboration patterns received low or average scores. However, in the case of 

major technological change, strategic changes in the innovation practices were 

made more often than for minor technological changes (Green et al, 1994). 

21

3 External factors that drive environmental 

innovations 

In the previous chapter some of the characteristics of environmental 

innovations were presented. We now turn to the question of which external 

factors drive environmental innovation activities in firms. 

Many external factors may influence a firm’s environmental activities. This is 

illustrated by a British study examining both internal and external factors that 

prompt environmental innovations. In this study regulations and marketrelated 

drivers, like competition and the hope for increased market shares, are 

found to be the most important drivers. But other external drivers like 

insurance firms, new products of suppliers, environmental campaigns etc have 

been found to have some importance in stimulating environmental innovations 

(Green et al, 1994). The wide array of external drivers is confirmed by the 

OECD, which lists customers, consumers, media, employees, environmental 

organisations, stockowners and other citizens as external drivers (OECD, 2000). 

Either regulation or market-related drivers are reported as the strongest driver 

by many researchers. 

The price of inputs and products will influence a firm’s innovative behaviour. 

Firms have an economic interest to restrict their resource use. If it is possible to 

produce a certain product with less input of resources, while the quality 

remains the same, the production process becomes less expensive. Price 

changes, or their expectations, can make the incentives stronger or weaker. If 

there is a restriction of resources then prices will inevitably rise. The usual 

notion that firms have a profit-maximising behaviour is thus a driving force to 

technological development. 

Future demand and prices are however uncertain and difficult or impossible to 

predict. The interest in environmental issues and the environmental demands 

placed by external actors may or may not translate into future willingness to 

pay. This situation creates uncertainty to which firms will respond differently. 

Some firms see the economic advantages in introducing environmentally sound 

products onto the market and are willing to take the risk, while others are more 

reluctant to do so. 

Governmental environmental demands can also provide incentives for 

technical development. Governmental authorities use a wide spectre of 

instruments to make firms improve their environmental performance. Policy 

instruments other than those of environmental policy may also have an impact 

on environmental innovations. An example is innovation policy support to 

R&D, like information technology development projects, which may have 

22

positive environmental effects although they are not explicitly targeted at 

achieving environmental goals. Also, the broader range of transport, 

agricultural, financial politics etc will be important. This study is, however, 

restricted to environmental policy. 

This chapter discusses the drivers of innovations without trying to estimate 

whether the innovations will contribute to firm competitiveness or not. 

Competitiveness is discussed in appendix 2. 

3.1 There are limits to the price mechanism as a driving force 

Price is an important, but insufficient, mechanism in governing the economic 

efficiency as well as the environmental innovativeness of firms. 

To the extent that prices reflect environmental costs, the price mechanism 

should induce firms to optimise their behaviour and thereby reduce their 

environmental impact. Historical data show that energy efficiency improves 

more dramatically during times of economic crisis than during periods of 

growth. These observations are consistent with the belief that high prices on 

energy lead to a demand-pull model of technological change, triggering 

structural change and innovations that can improve the efficiency of energy 

use. However, in the course of studying energy investments Azar and 

Dowlatabadi found that energy costs are only one factor influencing corporate 

R&D efforts and technological development. To the extent that energy costs are 

significant, efforts to improve existing technologies are often directed to 

improve energy efficiency. But, if energy costs are low, then other 

characteristics, for example performance, may play a more important role. 

Technology clearly has the potential to improve energy efficiency, but energy 

costs or efficiency standards have to prominently appear in economic activity 

for technological change to deliver improved energy efficiency and reduced 

energy intensity (Azar and Dowlatabadi, 1999). 

For many energy users, energy is not a dominant cost factor. Industrial energy 

users, except for raw materials processes, rarely have energy as a significant 

component of their operating costs. In households, the costs of accumulating 

and processing the appropriate information to optimise energy (or indeed any 

resource) are too high. Simon 6 coined the term ”satisficing” to describe the 

notion that, once a decision-maker satisfies the constraints that are faced, the 

extra steps needed to refine this activity and achieve the optimum resource use 

are rarely undertaken. The pattern of most energy investments is better 

explained by satisfying constraints than by optimising investments in 

technology and energy consumption (Azar and Dowlatabdi, 1999). 

6 Simon HA., 1982, Models of bounded rationality, Cambridge, MA: MIT Press, 336 pp 

23

3.2 A shift towards market drivers? 

The historical account in the previous chapter suggests that firms today more 

often see environmental issues as an integrated part of their business idea, and 

environmental innovations as enhancing their competitiveness. This suggests 

that market drivers should be more important than before and increasingly 

more important than policy. Research results offer some support to this, but 

there are also results pointing in other directions as well. 

The importance of market drivers is shown by a Swedish report based on a 

survey of 300 manufacturing firms. In 1991 very few of the firms stated that 

market drivers were important, and that demands emanating from the various 

branches of government were the dominant driver. Thirteen per cent of firms 

stated that they did not experience any environmental demands whatsoever. 

But in 1996, the strongest driver of the firms in 36 per cent of cases were 

customers, in 24 per cent of the cases the concern and in 19 per cent of the cases 

demands from government authorities (Heidenmark, 1999). 

Similar results were found in an earlier Swedish study. In 1991, 72 per cent of 

the firms stated that government demand was the prime source of 

environmental demands, and 15 per cent that customers were the prime source. 

In 1995 the corresponding figures were 38 per cent and 29 per cent. This 

illustrates that customers have become a more important driving forces but also 

that the sources of environmental demands has diversified. Other, less 

important, sources were owners, employees and public opinion (IVA, 1995). 

The shift towards more integrated environmental process innovations and 

more environmental product innovations described in chapter 2, may be related 

to the shift towards market drivers. Green et al found that product innovations 

are driven more by market drivers than process innovations, whereas cost 

savings are more important for process innovations (Green et al, 1994). 

Malaman states that environmental conservation through cleaner technologies 

appears to be an objective integrated into the primary objective of balancing the 

budget, in contrast to end-of-pipe technologies, which always implies costs 

(Malaman, 1996). 

Older studies, however, indicate government policy as more important than 

market drivers. One reason for this conclusion may be that the time period 

studied is older. Hemmelskamp refers to such a study of the German textile 

industry by Maas from 1987, when environmental innovations were mainly 

implemented because of regulative pressure (Hemmelskamp, 1997). But the 

difference in results may also be related to differences between countries and 

regions. Connell and Flynn present a study published as recently as 1999 (data 

from 1996/97), showing that firms in South Wales were driven mainly by 

policy demands. Environmental demand pressures are likely to vary between 

countries. Another reason is probably that the industrial structure varies 

between countries. 

24

That location also plays an important role in determining firm response is 

confirmed by a WBSCD study. Asian firms were more inclined to see a direct 

connection between their commitment to sustainable development and sales. 

They were also most likely to believe that sustainable products and services will 

provide competitive advantage. Australian firms saw themselves in the early 

stages of addressing sustainable development. North American firms focused 

on cost advantage and were less likely to include environmental considerations 

as part of their published mission. European firms scored average values 

(Dearing, 2000). 

Other studies report government policy, in particular regulation, as the 

strongest driver, but with market drivers as a close second. Green et al found 

that regulation got the highest scores for prompting both product and process 

innovations, and that there was a significant correlation between the influence 

of regulation and of commercial factors. (Green et al, 1994). Malaman found 

that in more than 80 per cent of the innovations studied, legislation influence 

was medium or high. In more than 60 per cent of the cases the innovations were 

associated with a desire to increase market shares or enter new markets, and in 

almost 80 per cent of the cases the relationship with core business was found to 

be very strong (Malaman, 1996). These studies were conducted in the UK and 

Italy respectively. It may be that the shift has evolved further in Sweden, 

explaining the differences between these studies and the Sweden. 

These studies show that market today is a strong driving force, but also that 

policy remains a strong driver. The shift in emphasis means that the market has 

partially replaced and is partially complementary to policy as a driver. 

3.3 Sector and firm size influence response to drivers 

Some sectors are more dependent on environmental innovations than others. 

Chemicals and synthetic fibre industries are examples of such sectors. Other 

environmentally innovative industries are machines and mechanics, electrical 

materials and the automotive industry (Malaman, 1996). 

Another illustration of this is provided by Hemmelskamp. The share of 

environmentally innovative firms varies in his study between sectors: 

- food, beverages and tobacco (84 %), 

- wood processing, paper, printing and publishing (83 %) and 

- refineries, chemicals, rubber and plastics (82 % ) 

In contrast, those sectors with low rankings were: 

- ceramics, chalk and cement (47 %) and 

- control engineering and metrology (47 %). 

“Environmentally-innovative companies” were in the study defined as those 

considering environmental related objectives as significant or highly significant 

to their innovative activities (Hemmelskamp, Forthcoming). 

25

Variation between sectors may simply be the result of varying external 

demands. A Swedish study compared drivers between industrial sectors. 

Industry sectors where customers were more important than authorities as 

drivers were construction and real estate. The opposite was true for petroleum 

products and metal manufacturing. These conclusions are however based on a 

somewhat meagre statistical basis. The result may illustrate the relatively 

strong regulatory pressure on petroleum products and metal manufacturing, 

and shows that industrial sectors differ with regard to what demands are 

placed on them and what drives their environmental work (IVA, 1995). 

But it may also be the case that sectors react differently to the same external 

pressures. Kemp describes a number of factors affecting the innovative 

behaviour of industry in relation to environmental regulations. The results 

show that although high volume, mature sectors were resistant to change, they 

were very amenable to environmental monitoring and process controls that 

improved efficiency. Two suggested explanations for this are presented: firstly 

that rigidity may come with maturity in a sector and, secondly, those powerful 

sectors are better at fighting off regulations and imposed change. Smaller firms 

and potential new entrants tended to develop more innovative responses. The 

environmental goods and services industry provided compliance strategies that 

were at best incrementally innovative, but which diffused fast, due to their lack 

of disruption and to their acceptability to regulators (Kemp, Forthcoming). 

Plant age may be another determining factor. Sanchez and McKinley indicate 

that product innovation response to environmental regulation increases with 

plant age. Young plants appear to be inhibited in generating new products in 

response to high environmental regulatory impact. A proposed explanation is 

that an experienced workforce may respond more flexibly to regulatory 

pressure. Another explanation may be more routinised procedures to change 

the manufacturing process (Sanchez and McKinley, 1998). Interestingly, this 

result seems to contradict Kemp’s argument about mature sectors being 

resistant to change. 

Firm size is also an important factor in determining firm response. In general 

large firms are more prone to environmental innovations than small firms. A 

study of Welsh firms shows that large firms were nearly 50 percent more 

motivated to make environmental improvements than SMEs. Frequent 

responses by SMEs to the questions asked were “we are to small to have any 

significant effects”. Nearly 70 per cent of firms considered themselves as 

harmless to the environment. Large firms were likely to be stimulated by both 

external and internal motivators, whereas in general small firms were more 

likely to be prompted by just external factors (such as legislation) (Connell and 

Flynn, 1999). 

A Swedish study categorised the environmental work of the studied firms into 

five categories ranging from environmentally passive to environmentally 

26

adapted, with the latter indicating the most proactive, permeating level of 

environmental work. Firm size was strongly correlated to the advancement of 

environmental activities. The smallest firms (1000 employees) had either adopted a strategy 

to optimise their activities in relation to current and future demands from the 

market and from authorities, or, as in the majority of the cases, had an even 

more ambitious strategy. In the latter case the firms could be said to be 

proactive and would include a environmental dimension in their decision 

making and strategy development (Heidenmark, 1999). 

However, a partially deviating result is presented by Hemmelskamp. 

Environmental innovations were shown in this study to be a priority above all 

in very small and very large firms and less so in middle-sized ones. A possible 

explanation proposed is that the dedicated environmental technology industry 

is mainly composed of small firms (Hemmelskamp, Forthcoming). 

3.4 Inter-firm relations relay and transform environmental demands 

Firms producing consumer goods have been at the forefront of environmental 

work. This is confirmed by Malaman, who states that product innovations in 

the area of cleaner technology are more likely to be driven by spontaneous 

market demand than process innovations (Malaman, 1996). 

Business to business demand on environmental issues is a channel of 

environmental demands from consumer goods firms and large firms, and thus 

a potentially powerful driver of environmental work in small firms. This was 

also studied by Heidenmark, who found in her study that 75 per cent of the 

largest firms (>1000 employees) placed environmental demands on their 

suppliers, and only 10-20 per cent of the smallest firms (

technologies and products. It may also be that the environmental demands are 

translated into and fused with functional or other demands, so that the 

responding party may not be aware of the environmental dimensions in the 

total of demands experienced. Noci and Verganti confirm this. They claim that 

in most cases an SME will not explicitly classify its innovations as 

environmental, because these drivers are not explicit. Environmental drivers 

are instead merged and hidden in the requirements of the immediate 

downstream customer. The more a firm is positioned in the early stages of the 

value chain, the higher the number of drivers indirectly experienced and the 

less explicit the environmental origin of the customer specifications. The 

difficulties for SMEs to correctly recognise environmental threats and 

opportunities are a consequence of the implicitness of environmental 

innovations drivers. 

Therefore, any analysis of the environmental drivers of SMEs must focus on the 

entire value chain. Consequently, although a firm’s immediate customer seems 

to have a low concern for environmental issues, this does not entail that the 

environment is not a strategic issue. In fact, changes in distribution, disposal 

and consumption regulations will probably change the requirements of both 

dealers and customers, whatever the market segment (Noci and Verganti, 1999). 

Whether a firm is part of a larger concern or not can also influence its 

environmental activities. Heidenmark found a strong correlation between being 

part of a larger concern and advancement of environmental activities 

(Heidenmark, 1999). 

The interaction between firms will cause other firms to innovate in response to 

environmental demands other than those they experience themselves. In the 

case of policy regulation, firms outside the targeted industry may well innovate 

more than the regulated firms do. Kemp refers to Heaton, 1990, who states that 

in general outsiders are more likely to develop radical solutions to 

environmental problems. The reason presented is that they may have the 

technological capabilities that the regulated industry lacks. They may also have 

a stronger interest in developing compliance technology, as it will mean 

increased sales, as compared to the investment costs of the regulated industry 

(Kemp, Forthcoming). 

28

4 Environmental policy instruments as drivers 

In the previous chapter environmental policy was shown to be an important 

driver of environmental innovations. This chapter reviews the environmental 

policy instruments used and what is known about their effects on innovation. 

These are drawn from neo-classical economics as well as from innovation 

systems research. The text comprises both theoretical and empirical results. 

The relationship between policy makers and industry is not a one way relation, 

and policies can be seen as the result of a negotiated process. This contributes to 

explaining why the dynamic effects of environmental policy instruments in 

practise differ from the ideal instruments analysed in theory. One reason for 

this may be that a political process in which legislators, industry and other 

actors interact influences the real design of the instruments. Another reason is 

that environmental policy instruments is but one of many determinants of 

innovations. The impact of the policy instrument strongly depends on a wide 

range of other factors, such as technological opportunities, market structure, 

and appropriability opportunities (Hemmelskamp, 1997). Nevertheless there 

are many studies on environmental policy taking an instrumental view, and 

this will be the perspective in the following sections. 

4.1 Types of policy instruments used 

Some public interventions in the field of industrial environment have adopted a 

command and control approach, through regulations and a market-based 

approach that includes the use of economic instruments such as incentive taxes 

and tradable permits. A third option has emerged during the last years which is 

based on co-operation with firms and incorporates new criteria such as 

prevention and polluters-pays-principle and new instruments such as 

voluntary agreements (Aggeri, 1999). Three principal categories of 

environmental policy instruments can be discerned 7 : 

Regulatory instruments can be described as institutional measures aimed at 

directly influencing the environmental performance of firms by establishment 

and enforcement of laws and regulations. These laws and regulations proscribe 

objectives, standards, and technologies that polluters must comply with. Their 

main feature is that the choice is left to the polluter to comply with, or to face 

penalties through judicial and administrative procedures. 

7 Based on similar typologies presented in OECD, Applying Economic Instruments to Evironmental 

Policies in OECD and Dynamic Non-member Economies and Kemp, 1998. 

29

This approach, which is often called ”command and control”, remains the most 

commonly used in environmental policy, although policy makers show 

increasing interest in the economic instruments described below. 

Regulatory instruments are sometimes enforced with financial penalties, with 

the consequence that the boundary between regulatory and economic 

instruments is blurred. 

Economic instruments “can be defined as proxies for market signals in the form 

of change to relative prices (through, for example, taxation of certain products) 

and/or a financial transfer (for instance, a tax or a charge to be paid)” (Barde 

and Opschoor, 1994). Subsidies and tradable permits are also included within 

this group. 

Communicative instruments. The third category of instruments, which is often 

used in conjunction with regulatory or economic ones, includes those which 

aim at internalising environmental awareness and responsibility into individual 

decision-making by applying pressure, persuasion or stimulation either directly 

or indirectly. This category includes approaches such as education, information 

extension, training, social pressure, negotiation and other forms of “moral” 

suasion. Voluntary agreements and network creation - match making - are also 

included in this category. 

The term “communicative instruments” highlights that these instruments are 

based on interactive communication rather than one-way imperatives. The 

difference may however be smaller than indicated by the name. For example, 

there is usually interactive communication in the decision process proceeding 

all instruments. 

4.2 Regulatory instruments 

Regulation 8 

Regulations include among other things product standards, product bans, 

technological specifications and take back-requirements. 

The technological responses to regulation range from the diffusion of existing 

technology, incremental changes to processes, product reformulation to 

product substitution and the development of new processes. Kemp has 

reviewed the literature relating to the impact of actual environmental 

regulations on compliance innovation and clean technology. The most common 

responses to regulation are incremental changes to processes and products and 

the diffusion of existing technology (in the form of end-of-pipe solutions and 

non-innovative substitutions of existing substances). Long before the 

regulations are issued there is a search process for solutions to the problem, 

8 Several authors use the term ”regulation” as a synonym for all regulatory instruments including 

requirements, standards etc. Whereas others treat different types of regulatory instruments separately. 

30

oth in the regulated industry and outside with, for example, suppliers. Often 

firms outside the regulated industry develop the innovations (Kemp, 

Forthcoming). 

Product regulations tend to call forth product innovation, whereas component 

or pollutant regulations elicit process regulations. Process regulations can 

stimulate process as well as product innovation (Ashford et al, 1985). Standards 

can stimulate innovation to reduce energy consumption (Hemmelskamp, 

Forthcoming). 

A distinction in the regulating pressure placed upon the firms can be made 

between Permit Based Regulation (PBR) and Incident Based Regulation (IBR). 

PBR firms are those that release certain amounts of regulated substances and 

have to seek permission from environmental regulators before releasing 

polluting media to the atmosphere, land or water. IBR firms are the majority of 

firms and they have very limited interaction with environmental regulators. 

They will only come in contact with the regulators if an environmental problem 

has been traced back to the firm in question. A British study showed that IBR 

firms lag behind PBR firms in all of the key motivators to environmental 

innovation. PBR firms are likely to be stimulated by both external and internal 

motivations, whereas IBR firms are more likely to be prompted by external 

factors alone such as legislation which do not significantly affect them. 

Generally the PBR firms surveyed could see more benefits from making 

environmental improvements than IBR firms could (Connell and Flynn, 1999). 

Theoretical observations associate several disadvantages with regulation. 

Mostly it is pointed out that requirements constitute the most expensive option 

for society, since all polluters are treated on an equal basis, irrespective of their 

individual avoidance costs. Thus emissions below the fixed level do not result 

in costs for the emitter, and consequently the emitter is no longer interested in 

the more far-reaching emission-reducing measures. Tightening of the standards 

makes steady development possible (Hemmelskamp, 1997). 

There are other disadvantages. Inefficiencies arise out of the varying costs of 

individual firms and from increasing marginal costs of avoidance. Lock-in 

effects may also be a result, if new production installations are subject to lower 

limiting values or to new technology standards adjusted to the current level of 

development that may also entail increased costs. This will decrease firms' 

incentives to invest in new equipment. Updating state-of-the-art technology 

lists is a lengthy procedure and there is a risk of the lists lagging behind new 

technology developments (Hemmelskamp, 1997). 

On the other hand, there are also theoretical advantages. As long as there is 

adequate monitoring and enforcement, regulatory instruments provide 

certainty of the policy outcome. This is necessary in case of toxic pollutants, 

which should be banned or rigorously controlled. Another advantage is that the 

authorities have longstanding experiences of this approach (OECD, 1994). 

31

There are several aspects to bear in mind when designing regulations. The most 

important factor influencing the effects on technological innovation is the 

stringency of regulation, which is specified as the regulation requiring 

significant environmental improvements, being costly or requiring significant 

technological change (Ashford et al, 1985). Technology-forcing standards 

appear to be a necessary condition for bringing about innovative compliance 

responses, but they may impose high costs on industry. Kemp recommends 

that they are used only when technological opportunities are available that can 

be developed at low enough costs. Strict standards should be used when the 

environmental risks are large and acute, and when there is a consensus about 

the most viable technological solution or trajectory (Kemp, Forthcoming). 

Regulations should at the same time be flexible, with regard to the means of 

compliance, penalties for non-compliance and compliance time periods. 

Otherwise firms may judge that the compliance strategy of developing new 

technology is too risky. In designing standards it is important to give the 

industry enough time to develop solutions that are environmentally benign and 

meet the requirements of important users. Time may also be needed for finding 

out whether a solution is environmentally benign and does not impose hazards 


Regulations should be adapted to different sectors, and this may contribute to 

the development of superior technological responses (Kemp, Forthcoming). 

32

Table 1 

Summary of innovation effects of regulations 

Effects on 


• diffusion, incremental 


• innovation outside 

regulated sector 

• affect small firms less 

than big 

• search process also 

before implementation 

Theoretical 

pros & cons 

+ certainty of the policy 

result 

+ authorities have much 

experience 

- inefficiency due to 

increasing marginal 

costs 

- much work for 

government may cause 

lagging standards 

- no effect after 

compliance is achieved 

- inefficiency due to that 

compliance cost varies 

between firms 

- lock-in effects 

Recommendations 

• stringency 

• flexible response to 

failure of compliance 

• sectoral adaptation 

• continuous review of 

technical standards 

Liability law 

Liability law should also be included among the regulatory instruments as it 

provides the judicial basis for law suits against firms that inflict ecological 

harm. 

Liability law provides a large degree of freedom for the firms to choose 

measures and the risk level of their strategies. There are two types of liability 

principles: liability based on fault and liability regardless of fault. The former 

tend to give static innovation incentives as firms can restrict themselves to 

comply with standards of due care. Liability regardless of fault gives raise to a 

general and dynamic interest in innovations on the part of firms. There are also 

various types of limited liabilities. Limitations require third parties to pay the 

bill of caused damages and are unlikely to lead to full internalisation of costs. 

Problematic may be that the injured third party may be in a weaker position 

with regard to the information needed for proving the causality between action 

and damage. Firms and authorities are likely to be in stronger positions 

(Hemmelskamp, 1997) 

33

Table 2 Summary of innovation effects of some specific regulatory 

instruments 

Effects on 


Technology forcing 

standards 

Theoretical 

pros & cons 


• give industry enough 

time to comply 

• radical innovations • use when technological 

opportunities are 

available at low cost 

Product regulation 

• product innovation 

(whereas component 

and pollutant regulation 

cause more process 

innovations) 

Permit based regulation 

• larger effects than 

incident based 

regulation 

Liability law + large freedom of firms 

to choose strategy 

+ liability gives stronger 

incentives than fault 

- limitations may put cost 

on third party 

4.3 Economic instruments 

Economic instruments are flexible in that they provide firms a large space for 

manoeuvre, and is believed to lead to the cost-effective attainment of objectives. 

Economic instruments give firms economic freedom to choose and to adapt 

their activities, leaving them free to maximise profit through whatever solution 

is the most economically efficient in their particular case (Barde and Opschoor, 

1994). Economic instruments have the theoretical benefit of flexibility in the 

sense of offering a choice between compliance and paying the polluter’s bill 


When fixed at the proper level, economic instruments facilitate the costeffective 

attainment of objectives. Polluters reduce their emission as long as the 

34

marginal cost of abatement is lower than the charge rate, and prefer paying the 

charge when the marginal costs of reducing more emissions are higher than the 

charge rate. In this way, economic instruments always offer incentives for 

environmentally adapted behaviour because of the possibility of both 

abatement cost and charge payment savings. This creates a constant demand for 

innovation. Firms, however, are not always responsive to price signals. The 

price incentive must be sufficiently high to induce firms to develop and 

implement new technologies (Kemp, Forthcoming). 

From the policy makers viewpoint economic instruments also have advantages. 

They are easily introduced and therefore engender lower decisional costs 

(Kemp, Forthcoming). Once introduced, they can also easily be modified. 

Economic instruments are also revenue raising for the government. 

Disadvantages are the uncertainty of how the polluters respond and the total 

costs (abatement costs and tax payments), which are likely to be high. Tradable 

pollution quotas do not suffer from the latter disadvantage. There are also 

problems with international competitiveness (Kemp, Forthcoming). 

The overall theoretical conclusion is that economic instruments like levies are 

more likely to prompt innovations than juridical measures such as 

requirements. Juridical measures favour end-of-pipe technology innovations, 

whereas economic instruments mostly prompt innovation in the field of 

integrated technologies (Hemmelskamp, 1997; Kemp, Forthcoming). 

However, economic instruments or regulations are better suited than voluntary 

agreements to stimulating the diffusion of end-of-pipe technologies, but less 

suited than voluntary agreements to stimulating integrated innovations. 

Diffusion of end-of-pipe technologies does not require co-ordination of firms as 

much as strong individual incentives and/or sanctions. In line with this there is 

an extensive use of economic instruments and regulations in process sectors, 

like in energy efficiency, plant emissions, waste incineration plants etc (Aggeri, 

1999). 

35

Table 3 

Summary of innovation effects of economic instruments 

Effects on 


Theoretical 

pros & cons 

+ cost-effective 

+ large freedom of firms to 

choose strategy 

+ continuous incentive 

+ easy to introduce and 

modify 

+ give revenue to 

government 

- affect international 

competition 

- uncertainty of outcome 

- firms may be 

unresponsive to the cost 

- too weak co-ordination 

of firms 


Taxes 

Effluent levies have been charged in Germany since 1981, and were 

complemented in 1990 by a state-of-the-art technology based standard 

regulation. The mere announcement of the levy laws initiated responses by 

firms. Compliance problems were related to difficulties in obtaining 

information and uncertainty about the costs for small and medium sized firms. 

Some firms changed their product range or externalised areas of production. 

The combination of levies and standards has been criticised by several 

researchers, claiming that taking into account state-of-the-art technology 

mitigates the effects of the levy (Hemmelskamp, 1997). 

Environmental taxes can stimulate a reduction in the environmental impact 

arising from the production and development of environmentally friendly 

products, whereas standards would have no or a negative impact, according to 

a German study. Standards, on the other hand are shown to stimulate 

innovation to reduce energy consumption. Taxes hamper such innovations. 

These results should be interpreted with caution as the experience of 

environmental taxes in Germany in 1991 was very limited, and the results may, 

36

according to Hemmelskamp (Forthcoming), reflect the lively debate on 

environmental taxes at the time. The results seem to show that economic 

instruments have advantages in the case of environmental product innovations, 

but that there are no general advantages of one type of instrument over another 

related to environmental process innovations (Hemmelskamp, Forthcoming). 

A common criticism against environmental taxation is that countries, which 

unilaterally adopt such policy measures, lose competitiveness. Carraro and 

Galeotti have reviewed studies that provide additional critical remarks. On the 

grounds of efficiency, emission permits have been shown to improve on 

emission charges when the inter-temporal decisions of agents, particularly on 

innovation, cannot be neglected. Moreover, when more than one externality has 

to be accounted for, environmental taxation must be combined with other 

policy instruments to achieve the social optimum. Information asymmetries 

(such as in non-point source pollution problems) invite policy interventions that 

are far more complex than environmental taxation (Carraro and Galeotti, 1997). 

A tax and its related revenue can be directed to foster technological innovation, 

but Carraro and Galeotti point to some recent analysis that shows that 

environmental taxes or emission permits are likely to be sub-optimal 

instruments for achieving an adequate level of technological innovation. 

Studies have shown that, in a dynamic framework, taxes or permits can lead to 

the over investment in environmental innovation (Carraro and Galeotti, 1997). 

Charges 

Charges stimulate voluntary and individual adaptations in order to prevent or 

reduce environmental impacts. Quite simply, the bigger the cost advantage of 

innovating as compared to paying the charges the greater the incentive to 

innovate. The political process of fixing the rate of the charges is, however, 

difficult. Finding the most effective level presupposes information on the 

marginal avoidance costs of all polluters, information that in real life does not 

exist. Rather trial-and-error methods are used, and this hampers efficiency 

(Hemmelskamp, 1997). 

Tradable permits 

The term tradable permits refers to deliberately created markets where actors 

buy and sell “rights” or permits for actual or potential pollution. 

There are two basic models on how to construct a system of tradable 

permits/reductions: the cap and trade model and the baseline and credit 

model. 

The cap and trade model defines a total ceiling of pollution from polluters 

included withn a system. The total amount of pollution in the pollution cap is 

divided between the polluters. The shares allocated to the polluters could be 

given out free of charge or be auctioned off. At the end of the period that is to 

37

e controlled that the emission from a source equals the total permits held by 

the polluter. In the cap and trade model questions about the size of the cap, the 

distribution of the permits, control and sanctions etc are decided at the start of 

the process. After these questions are settled, actors can trade with only a 

minimal degree of intervention from the authorities, thereby reducing the 

overall transaction costs incurred. 

The baseline and credit model is based on projects intent on reducing pollution. 

A hypothetical baseline scenario must be made up for every project, and 

describes how much pollution would be emitted without the project. This 

scenario is then compared with the emissions within the project. To be valid all 

emission reductions created must be approved. The transaction cost could end 

up being high (SOU 2000:45). 

Tradable permits have the advantage of offering a permanent innovation 

incentive. The setting of permit levels presupposes information on the desired 

goals in terms of environmental quality and permissible emission volumes, 

which is not always available. Another problem may be that it is possible for 

incumbent firms to create entry barriers by hoarding emission entitlements, 

thereby making new production facilities illegal or more likely artificially 

expensive. Time limited permits offer authorities the possibility to respond 

more flexibly to changed political objectives or to changed ecological 

parameters. Time limits incur a cost on firms, as they impose a large uncertainty 

on firms, which may result in incremental and end-of-pipe solutions being 

favoured. Unlimited permits, however devalued by authorities, create better 

conditions to innovate (Hemmelskamp, 1997). 

Subsidies 

Subsidies include various forms of financial assistance such as grants, soft 

loans, tax allowances or charge relief. Subsidies change the incentive structure. 

They intend to encourage reductions in pollution or environmentally sound 

management of resources. 

Subsidies and taxes theoretically have the same impact on the rates of return 

faced by consumers of energy, but subsidies have been found to be three times 

more effective than taxes in promoting investment in energy-efficient 

technologies (Azar and Dowlatabdi, 1999). 

However, several studies in the Netherlands have shown that subsidies have 

most often had a limited impact on decisions concerning investment in 

environmentally beneficial technologies. Three different subsidy schemes were 

investigated and it was observed that subsidies were the primary reason for 

investment in only 0 - 2 per cent of the investigated firms. Factors like fuel 

economy, road performance and comfort (silent trucks), health and safety 

considerations (PCB) and environmental regulation (manure storage) were 

more important (Kemp Forthcoming). 

38

The Dutch studies looked for the primary reason of investment decisions. This 

may underplay the smaller, but non-negligible, contribution that subsidies 

make to investment decisions. 

Investment in technology may refer to purchases of existing technology, as well 

as to efforts to develop new technology. 

R&D subsidies 

R&D subsidies may take the form of a general instrument when implemented 

as a tax relief or as a targeted instrument when implemented as payments to 

selected R&D projects. 

Uncertainty about the demand for cleaner technologies may call for the use of 

R&D subsidies or loans. The use of subsidies should be restricted to 

environmentally beneficial technologies for which a market does yet not exist, 

due to, for example, long development times or problems of appropriating 

innovation benefits. Uncertainty about the solutions to problems is another 

rationale for using R&D subsidies. The subsidies may in this case be used to 

increase the number of potential solutions to the problem (Kemp, 

Forthcoming). 

Results, though scarce, on the effectiveness on R&D subsidies suggest that they 

have a limited impact on investments in environmental technologies research. 

A Danish example indicates that the active match making of firms, institutes etc 

for co-operative projects increases the effectiveness of R&D subsidies (Kemp 

Forthcoming). 

39

Table 4 

Summary of innovation effects of specific economic instruments 

Effects on 


Theoretical 

pros & cons 


Taxes 

• some effects on product 

and process innovation 

• search process also 


Charges - difficult to set rates 

Tradable permits + continuous incentives • unlimited time of permits 

Subsidies 

• limited effects (diffusion) 

• more effects than taxes 

(energy, diffusion) 

- difficult to set goals • devalued permits 

- may give entry barriers 

R&D subsidies + increase number of 

candidate solutions 

• when uncertainty about 

demand or solution 

hampers innovation 

• limited effects (R&D) • active match making for 

cooperative projects 

4.4 Communicative instruments 

Voluntary agreements 

Voluntary agreements are undertakings made collectively by parts of industry, 

often when facing an implicit threat of compelling policy actions. The implicit 

threat blurs the boundary between voluntary agreements and compelling 

regulatory or economic instruments. 

40

Kemp claims that the effectiveness of voluntary agreements is typically small. 

When environmental improvements were achieved, this was more due to 

autonomous technological change, external regulations and the evolution of 

market demand than to voluntary agreements. There is little evidence the 

voluntary agreements foster technological innovations (Kemp, Forthcoming). 

Integrated innovations may concern a wide range of actors, organisations, and 

technologies, since many problems are tackled on an international scale and 

require extensive co-operation between heterogeneous actors. The larger the 

number of actors and transformation stages and the higher the level of 

uncertainty, the greater is the need for the strong co-ordination of firms. 

Needing to act towards such an environmental threat with high uncertainty, 

pinpointing the general interest is not self-evident. It is not impossible to set 

targets, but problems lay in the fact that the targets must be recognised by all 

parties, who must also accept the risk that an initial error of orientation may 

occur and that the targets may be revised when new information comes to light. 

In such circumstances voluntary agreements may be justified, especially when 

they are devised from the start as schemes for learning and for monitoring 

innovation, and not as inviolable contracts. If stronger incentives are needed 

however, voluntary agreements could be complemented by the use of economic 

instruments (Aggeri, 1999). 

Other advantages and disadvantages of voluntary agreements are identified by 

Kemp. By handing over responsibility for achieving environmental 

improvements to industry, voluntary agreements may stimulate the 

environmental responsibility of firms. This is important for the wider 

integration of environmental concerns into the decisions taken by firms. On the 

other hand there is a risk of ”institutional capture” of policies by special 

interests. Voluntary agreements are attractive to regulatory bodies because they 

lower the administrative burden and establish a better, more co-operative 

relationship with business. However, the disadvantages with voluntary 

agreements is that they allow for free-rider behaviour, encourage firms to claim 

that is impossible to meet the targets and therefore lead to the underexploitation 

of innovation opportunities. They also offer little incentives for 

third-party suppliers to develop compliance technologies (Kemp, Forthcoming). 

It is necessary to draw up clear and transparent rules prior to the agreement. 

Voluntary agreements should include quantitative objectives, designation of 

responsibilities, know-how transfer rules, monitoring schemes, etc (Aggeri, 

1999). 

Eco audits 

Eco Audits are required of firms in order for them to be certificated in 

accordance with some environmental management standards. Such standards 

can be implemented by law. They aim at facilitating environmental work within 

firms and communication about firms’ environmental work. 

41

Experience show that eco-audits can result in management and other functions 

of the firm, such as R&D, being integrated into environmental policy. They can 

also improve the internal transparency of firms, which may make it possible to 

identify unnoticed starting points for environment-relieving measures, in 

particular they may identify integrated measures (Hemmelskamp, 1997). 

There are other potential advantages and disadvantages with eco-audits. Ecoaudits 

have begun to be used as a public relations instrument. This may be a 

problem if the focus of attention is shifted away from in-house conditions. The 

soft regulation allows for a firm to take only superficial measures, reducing the 

impact on firm activities. It is also the firms who have the responsibility to 

compile a catalogue of measures to be taken. The regulation is also limited to 

“economically justifiable” measures, which is open to interpretation and 

reduces pressure on firms. As competitiveness and demand pressures increase 

on SMEs to take part in the EC eco-audit scheme, they may catch up on the 

larger firms in working with eco-audits. This way the regulation could produce 

effective impacts on innovations in such firms (Hemmelskamp, 1997). 

Network creation 

Network creation can be achieved in several ways, such as through dialogue 

and subsidies. Network creation aims at stimulating co-operation and 

increasing access to external competence. 

A Danish programme shows that network creation can be successful in 

stimulating innovations. Five case studies of clean technology development 

projects in Denmark were conducted. Most of the technological solutions 

developed were process oriented. Some firms were able to cut costs by 

substituting inputs, and some results were patented or introduced onto the 

market. A success factor of the initiative was that the eligibility criteria took into 

consideration that other than the polluting firm may contribute to the 

technological solution, and hence supported collaboration between polluting 

firms, customers, suppliers and consultants (Hemmelskamp, 1997). 

42

Table 5 Summary of innovation effects of communicative instruments (1) 

Effects on 


Theoretical 

pros & cons 

Voluntary agreements + integrated innovations, 

product innovations 

• small effects + coordination of actors 

around complex 

problems 

+ network development 

+ stimulate responsibility 

of firms 

+ stimulate co-operation 

between industry and 

government 

+ can be dynamic 

+ low administrative 

burden 

- free riders 

- low third party 

incentives 

- too week 

steering/incentives 


• should include a wide 

array of clear and 

transparent rules 

• use when uncertainty 

and need fro coordination 

is high 

Eco audit standards + R&D & management 

integration 

Network creation 

• some effects 

+ transparency giving 

impulses for innovation 

+ may give focus on 

public relations rather 

than internal problems 

+ may involve SMEs 

- too weak incentives 

43

Examples of communicative instruments are missing from this report due to 

the lack of relevant material are procurement – both standard and advanced 

technology procurement - and information supply. 

4.5 Summary and comments 

There are few empirical results to enable anything certain to be said about the 

effects on innovation of environmental policy instruments. Most instruments 

studied have had only limited effects on innovation. Technology forcing 

standards may hold the largest potential for radical innovations. 

Table 6 

Overview of effects on innovation 

Regulatory instruments 

Regulations - diffusion, incremental 


- innovation outside 

regulated sector 

- affect small firms less 

than big 

- search process also 


Economic instruments 

Taxes - some effects on process 

and product innovation 

- search process also 


Subsidies - more effects than taxes 

(regards energy and 

diffusion) 

- limited effects 

Technology 

forcing standards 

- radical innovations 

Product 

regulation 

Component, 

pollutant 

regulation 

Permit based 

regulation 

- product rather than 

process innovations 

- process rather than 

product innovations 

- larger effects than 

incident based 

regulation 

Communicative 

instruments 

Voluntary 

agreements 

- small effects 

Network creation - some effects 

There are, however, large gaps in the empirical data on many instruments, and 

the instruments may be more or less effective than indicated here. One reason 

for the lack of data is that some of the instruments have been implemented 

quite recently and only in a handful of instances. It is also possible that the 

extensive literature search has not identified all of the studies undertaken. 

44

There is clearly a need for more empirical research on the effects on innovations 

of environmental policy instruments. 

This analysis is made from the perspective of effects on innovation. Other 

perspectives will highlight other properties of the instruments and result in 

other insights and recommendations. 

45

5 Conclusions 

The aim of this study has been to survey the existing literature on how external 

demands drive environmental innovation in firms, and to provide an overview 

of this literature. This is done with a view to contributing to the work of 

Swedish policy makers. 

5.1 Conclusions on drivers of environmental inovations 

Environmental innovations are driven by specific environmental demands and 

may contribute to decreased environmental impact, but they also seem to 

possess other properties that single them out in comparison to other 

innovations. Among other things environmental innovations involve social 

awareness, draw upon knowledge from a very wide range of fields and require 

complementary organisational innovations. 

The conditions that favour environmental innovations are complex and difficult 

to study for many reasons. The incentive structure is complex with many 

drivers and many interested parties. Inter-firm communication of 

environmental demands is interwoven with the communication of other 

demands. The knowledge fields that may contribute to environmental 

innovations are diverse. Environmental innovations may take place in all 

industry sectors. 

There is little knowledge about the environmental demands of customers and 

the market related environmental dynamics independent of environmental 

policy. Yet, regulation is considered by most authors to be a very important 

driver. The role of government in environmental innovations is probably bigger 

than for most other types of innovations. A change towards market driven 

environmental work in firms is taking place. 

Also little is known about the effects of environmental policy instruments, not 

least because empirical results are scarce. Probably environmental policy 

instruments have had limited effects, but on the other hand stimulating 

innovation has usually not been an aim when introducing them. There is thus a 

need to adapt environmental policies to stimulate innovations, as well as to 

integrate environmental and technology policies into a coherent whole. 

Different theoretical perspectives lead to different policy recommendations. 

Economics tend to advocate economic instruments for efficiency reasons, 

because they uniformly affect all players within an industry and thus do not 

disturb market competition. Innovation researchers are more prone to propose 

communicative measures, arguing that policy instruments should explicitly 

target coordination, networking, learning processes and system specific 

46

conditions. These perspectives are to some extent contradictory but they are 

also complementary. Economic, regulatory and communicative instruments 

may all stimulate environmental innovations. 

5.2 Policy conclusions 

Industrial innovations may contribute to shifting society towards sustainable 

development. For this to happen there is a need for improved environmental 

policy as well as environmentally motivated innovation policy. The following 

aspects should be taken into consideration. 

• Both sustainability and growth require increased cooperation between the areas of 

innovation and environmental policy 

Environmental policies seldom explicitly target innovation processes. Increased 

attention to innovation issues and improving policies to this end may increase 

their effectiveness in addressing environmental problems. Stringency, flexibility 

and timing of instruments are examples of aspects to consider. 

There is a shift going on from regulation as the main driver of environmental 

innovations to a situation where both regulation and market forces drive. With 

this shift comes the increased strategic awareness in firms of the importance of 

environmental innovation. The shift would bring about more integrated 

process innovations and product innovations. The strategies of firms broaden 

from regulation compliance and cost reduction to the exploitation of the profit 

potentials that lies in environmental innovativeness. This implies that increased 

attention should be given to environmental innovation within innovation 

policy both to increase growth and to reduce the impact on the environment. 

• Policies should target value chains and networks, especially to involve SMEs 

The systemic interdependencies of a firm’s innovation processes may 

contribute to explain why small firms experience, to a lesser extent, 

environmental demands. Environmental demands from customer firms may be 

mixed with, and translated into, other demands, thereby creating an 

environmental pressure that is not experienced as such by the supplier. It may 

also be the case that environmental issues are important to customer firms, even 

if they have not begun to make environmental demands on their suppliers. 

Supplier firms need to be aware of the strategic importance of such 

unexpressed interests. This implies that policies should target value chains and 

networks rather than individual firms. 

47

• There is a choice to be made between quick results and large results 

Increased investment in already available technology may bear fruition sooner 

than new technology, which requires time consuming development work and 

at times lengthy research. 

It is important to give more attention to the time span involved in developing 

technology and new products when designing policy. This is an important 

factor determining the outcome in terms of innovations. Instruments also vary 

with respect to when the innovation effects will appear. 

• Policy instruments should be used in a coordinated manner for best effect 

Since there is no single best instrument, with instruments have differing 

strengths and weaknesses, and influence one another, policy makers should 

give ample attention to the problems and possibilities of simultaneous and 

coordinated use of more than one instrument. 

• Regulation stimulates innovation. Apart from that we do not know, yet. 

Regulation can stimulate innovations, even radical ones. Regulations that 

cannot be met with available technology, but where appropriate technology can 

be developed at a reasonable cost and in the not too distant future, can 

stimulate radical innovations. Such regulations may however impose high costs 

on the regulated firms. Concern should also be given to the effect on the 

international competitiveness of firms when using regulations. 

Apart from regulations there is little knowledge about the effects on 

innovations of environmental policy instruments. It is also difficult to say what 

environmental policy instrument really has what effect on innovations. How an 

instrument is implemented may strongly influence the outcome. More 

knowledge is needed to understand how best to stimulate environmental 

innovation. A broad range of instruments should be used in order to 

experiment and find out what works best. Evaluations should include the 

innovation dimension. All these require innovation orientated studies to be 

conducted. 

5.3 Areas for further studies 

To better understand the possibilities and limitations of government action in 

this area, it is important to give some areas more attention in future studies. 

48

This study shows that the way environmental demands enter into business 

processes is complex. Firm interaction mediates and transforms environmental 

demands. The relation between customers and suppliers in value chains is a 

vital part of most innovation processes. Customers have a role in the provision 

of information necessary for suppliers to develop environmental innovations. 

Customer supplier co-operation is likely to be an important and efficient means 

of mutual learning. 

A very broad range of competences is necessary to deal with the environmental 

dimension of the innovation process. The problem-solving networks related to 

environmental innovations may be more complex than for other types of 

innovations, and deserve special attention. Additionally, the public knowledge 

infrastructure must be adapted to meet the broad range of needs related to 

environmental innovations. 

Most likely a lot of innovations contribute to environmental progress without 

having this as an objective. It is important to understand what innovations, 

which improve the environmental status of production, would be developed 

without explicit environmental ambitions in firms, and what is to be gained 

adding from environmental drivers to those already in place. 

Sustainable development demands radical shifts in society, and systemic shifts 

of production, distribution and consumption. For this to occur there is a need 

for systemic environmental innovations. Good historical examples of such 

innovations may inspire future action, by shedding light on the preconditions 

and possible role of government in the innovation processes. 

Too little is known about the effects on innovations of environmental policy 

instruments. There are some results on regulatory instruments, but less on 

economic and communicative instruments. Voluntary agreements are especially 

interesting, as there is much current interest in them among policy makers. 

They may also illustrate the strengths and weaknesses of interactive policy 

making, an area that receives a lot of interest in Sweden today. 

49

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14 Working Group on Innovation and Technology Policy 

52

Appendix 1 

Theoretical approaches to innovations 

For a long time the dominant perspective on innovation was a model usually 

referred to as the linear model. In this perspective basic research produced 

results that could be further developed initially in applied research, and then 

later on in product and process development. The final phase is the 

introduction of new products and services onto the market. The linear model 

presupposes that knowledge is always articulated and codifiable, and that it 

can readily be shipped from one production site (basic research institutions) to 

another (applied research institutions) etc. This perspective works well in 

conjunction with the basic assumption of neo-classical economics that all 

existing information is available to everyone, everywhere, and that new 

knowledge is immediately accessible to everyone. 

This assumption is crucial to the traditional neo-classic models where 

technology is treated as an external factor. At any specific time there is suppose 

to be a stock of publicly shared technical knowledge. When new knowledge is 

produced it immediately becomes part of the stock, and is available to 

everyone. Neo-classical and new classical economics focus on problems of 

allocation of resources in a general equilibrium context. The problem for a 

rational agent is to choose among possible allocations of scarce resources in a 

situation where all relevant information is known. The sum of the choices of all 

agents in a market will result in an equilibrium situation where demand and 

supply meet in the most cost efficient way. 

When studying growth, economics researchers determined that traditional 

production factors could only explain part of the observed growth in the 

economy. The remainder was termed the technology factor. This has become 

the starting point of later work that has tried to model technological 

development as an endogenous factor within the framework of traditional 

economics. 

There has also been a development of economic theories and research 

approaches that more fundamentally depart from the assumptions of 

traditional economics. Nelson and Winter in the late 1970s claimed that there is 

more than one techno-economic solution that is effective, in contrast is the one 

optimal solution advocated by traditional economics. In the 1980s Rosenberg 

presented a new model of innovation which replaced the linear model. This 

new model emphasises feedback and interaction among the actors in the 

innovations process.Other contributors are Lundvall, whose work has focused 

on learning in the economy, and Freeman who has concentrated his attention 

towards national innovation systems. 

The new perspective is often presented as the innovation system approach to 

economics. It stresses that innovation processes – the on-going creation and 

diffusion of new things and new ways of doing things – take place in a situation 

54

characterised by genuine uncertainty and continuous disequilibria. According 

to this perspective, the innovating agent does not have complete information or 

knowledge about, for example, available technological solutions or future 

technological possibilities. 

Learning, rather than decision making about resources allocation based on 

complete information, is the basis of innovation processes (Lundvall, in Kuusi 

(ed) 1996). Learning processes as a rule are chronologically long lasting. 

Therefore, the study of innovations must have an explicit historic perspective in 

order to deal with the dynamics of innovations. A strong emphasis is also 

placed on the fact that learning takes place in interactions between firms and 

other agents. Complementary knowledge is acquired through mutual learning 

processes. Networks of actors built on long-term, trusting relations are of great 

importance. Innovative firms are characterised, among other things,by the way 

that they competently manage their external relations. This is one of the reasons 

why a systems view on innovation is necessary. 

The innovation systems perspective also places strong emphasis on institutions, 

that is organisations as well as regulations, norms and habits. Institutions play a 

major role in determining how people relate to each other and, therefore, they 

determine how people interact and learn. As many institutions are not firm 

specific, this provides another reason why a systems view is necessary. 

A strength of the innovation systems perspective is its ambition of using a 

holistic, integrative systems approach. However, a weakness is that there is still 

a strong need for a more systematic theoretical basis. Traditional economics 

may be said to be at times overly reductionist and prone to make far-reaching 

simplifying assumptions in orderfor its model to be used. On the other hand, 

this does mean that traditional economics and developments are based on 

stringent theory, and are able to develop elaborate quantitative statistical 

models. 

The study of innovations is thus multidisciplinary, including traditional 

economists and innovation systems researchers. The latter group in turn is 

composed of business academics, economic historians, sociologists and other 

disciplines. Major theoretical insights and antecedents can be found in the 

theories of evolutionary economics and of interactive learning. 

The role of government in theory 

With respect to government action there are also different approaches 

depending on which theoretical framework is employed. Classical economics 

identifies market failures relating to, for example, the lack of information or the 

costs to society not being reflected in market prices, and gives government a 

role in compensating for these failures. 

The innovation systems approach provides a theoretical legitimisation of 

government action. The system failure rationale focuses on actors in a system 

55

and their interaction. It opens up to innovation policies that focus on the 

shaping of technological variety, that is, on the generation and selection 

mechanisms. Not only is R&D included here, but so are other policy domains 

such as education, competition and labour markets. Government should design 

an institutional system that facilitates innovation activities in firms. This 

ensures that there are many possible areas for initiatives. These initiatives 

should also be co-ordinated at the ministerial and public agency levels. Due to 

the complexity of innovation systems there is also a justification for policy 

experimentation. This in turn means that the evaluation of initiatives are 

necessary, to ensure policy learning and for avoiding government failure. There 

is no optimal innovation policy and policy-making must be based on informed 

use of theory, information and subjective judgement. There is a need for an 

adaptive policy maker, as opposed to an optimising policy maker, and policy 

learning as an integrated part of the policy-making process. In this approach 

the policy maker is not seen not as being superior to firms as knowing different 

things than firms (Hauknes and Norgren 1999). 

The innovation system approach also stresses that policy makers are not 

independent of the firms were innovation takes place. Rather they should be 

seen as actors in the system, interacting with the other actors. The multitude of 

factors influencing innovative behaviour and the two-way relationship between 

policy makers and firms, means that policy instruments can not be understood 

in a simple stimulus response model. The stimulus and the response go both 

ways. Thus policy instruments should not be conceived as abstract rules 

imposed by government guaranteeing a specific outcome in firms, but rather as 

social interaction. An extreme version of this argument is presented by Kemp, 

“The significant choice is not among abstractly considered policy instruments 

but among institutionally determined ways of operating them” (Kemp, 

Forthcoming). Interaction between firms and policy makers takes place in both 

policy design and policy implementation. 

56

Appendix 2 

Environmental policy and competitiveness 

This appendix will try to summarise an on-going debate among researchers on 

the issue of whether environmental policy can strengthen a firm’s 

competitiveness. A central theme in this debate focuses on innovation and so 

we will also return to the question of whether regulation drives innovations or 

not. 

Environmental regulation has from the viewpoint of traditional economic 

theory been seen as raising the cost of production. However, during the 1990s 

this theory has been questioned, especially by Michael E Porter and Claas van 

der Linde. In the discussion below we shall outline the arguments of Porter and 

van der Linde and present some studies that have contributed to the debate, 

and test what has come to be called the Porter hypothesis. 

The Porter Hypothesis 

Porter criticises the perceived wisdom that firms always seek to minimise costs 

and/or maximise profits, and that they are assumed to possess perfect 

information. Porter argues that the conflict between environmental protection 

and economic competitiveness stems from a static view of competition. Strict 

environmental regulations do not inevitably hinder a firm’s competitive 

position against its foreign rivals, but could instead enhance it. He argues that 

tough standards trigger innovation and upgrading (Porter, 1991). 

Porter also argues that the U.S. has lost in competitive performance in 

environmental technologies since the mid-1970s. In the same period there has 

been a foot-dragging in implementing environmental legislation. Other nations, 

such as Germany and Japan, have instituted tight environmental regulations, 

and appear to have a lead in the patenting and exporting of environmental 

technology. Both countries also continue to surpass the U.S. in the rates of GNP 

and productivity growth. The U.S. as well as Britain has suffered, with the large 

majority of pollution control equipment being imported into these countries at 

the time of the article in 1991. In areas where the U.S. happens to have the 

strictest regulation, for example in pesticides, the country has a lead. Porter 

goes so far as to say, “the resurgence of concern to the environment, should be 

viewed not with alarm, but as an important step in regaining Americas preeminence 

in environmental technology.” The mandate for the Environmental 

Protection Agency should be to stimulate investment and innovation, not just to 

set limits (Porter, 1991). 

Porter and van der Linde oppose the view that environmental policy and 

competitiveness are negatively correlated. Environmental regulation inevitably 

raises costs in a static economy where technology, products and customer needs 

are fixed and firms make cost-minimising choices and are profit maximisers. 

According to the authors, competitive advantage rests neither on static 

58

efficiency nor on optimising within fixed constraints, but on the capacity for 

innovation and improvements that alter these constraints. Porter and van der 

Linde argue that properly designed environmental standards can trigger 

innovation that may partially or more than fully offset the costs of complying 

with them. When complying, by innovatings, firms can obtain advantages over 

foreign firms that are not subject to similar regulations. 

The possibility that regulation might act as a spur to innovation arises because 

firms do not always make optimal choices. In reality, “the actual process of 

dynamic competition is characterised by changing technological opportunities 

coupled with highly incomplete information, organisational inertia and control 

problems reflecting the difficulty of aligning individual, group and corporate 

incentives.” 

Porter and van der Linde argue in support of the so-called early mover 

advantage. They state that firms that foresee the changing world demand 

towards more environmentally adapted products and production processes 

and adapt to this, will have a competitive advantage. 

As long as the regulations are designed in an appropriate way they can provide 

at least six advantages: 

1. Regulation can signal to firms areas of likely resource inefficiencies and 

potential technological improvements. 

2. Regulation focused on information gathering can achieve major benefits by 

rising corporate awareness. 

3. Regulation reduces the uncertainty that investments to address environment 

will be valuable. 

4. Regulation creates pressures motivating innovation and progress. 

5. Regulation levels the transitional playing field. During the transition period 

to innovation-based solutions, regulation ensures that one firm cannot 

opportunistically gain position by avoiding making environmental 

investment. 

6. Regulation is needed in the case of incomplete offsets. When innovation 

cannot completely offset the cost of compliance, especially in the short term, 

learning can reduce the cost of innovation-based solutions. 

Porter and van der Linde also argue that more stringent regulation, rather than 

lax ones, focuses firm attention on discharges and processes, and compliance 

requires more fundamental solutions, such as reconfiguring products and 

processes. 

According to the authors, innovation in response to environmental regulation 

can take two broad forms. Firstly, the firms become smarter about how to deal 

with pollution once it occurs. Secondly, and central to the claims that regulation 

59

actually can increase industrial competitiveness: at the same time as addressing 

environmental impacts, the innovation also improves the affected product itself 

and/or related processes. 

How should regulation be implemented to stimulate innovation? 

According to the Porter and van der Linde, for environmental standards to 

foster innovation, three principles must be attained: 

- They must create the maximum opportunity to innovation, leaving the 

approach to innovation to industry and not the standard-setting agency. 

- Regulation should foster continuous improvement, rather than locking in 

any particular technology 

- The regulatory process should leave as little room as possible for 

uncertainty at every stage. 

Environmental regulation should focus on outcomes, not technologies. To allow 

for more flexibility in innovation, the governing principle should be to regulate 

as late in the production chain as practical. The Environmental Protection 

Agency should look towards total discharges and total impacts instead of single 

mediums like air, water and so on. Where possible, regulation should include 

the use of market incentives, including pollution taxes and tradable permits. 

The EPA should also promote an increased use of pre-emptive standards by 

industry and should play a major role in collecting and then disseminating 

information on innovation offsets and their consequences. 

The regulatory agencies could also help in creating demand pressure for 

environmental innovation, through for example, eco-labelling schemes. 

Regulatory agencies should also harness the role of government as a 

demanding buyer of environmental solutions and products. The authors 

recommend employing demonstration projects to stimulate and seed 

innovative new technologies, and argue that incentives for innovation must be 

built into the regulatory process itself. A final priority is new forums for settling 

regulatory issues that minimise litigation. 

The traditional view 

According to the traditional economic view, the costs of complying with 

environmental regulation always give rise to the lower competitiveness of firms 

through lowered productivity. This is based on two assumptions. Firstly, the 

crowding-out effect. This means that investments in, for example, 

environmental control equipment are made at the expense of other 

“productive” investments. Secondly, as the firm enjoys a lower productivity 

their room for manoeuvre is smaller, and this means that its cost of production 

are higher compared to its competitors (Marklund, 1997). 

Another way of analysing the connection between competitiveness and 

environmental policy is by arguing in terms of patterns of trade. This is based 

60

on the theory of terms of trade. A firm’s or country’s competitiveness is shaped 

by its ability to take advantage of costs lower than their competitors. Trade 

between two countries begins when one has a comparative advantage 

compared to the other. This in turn is the consequence of the fact that the 

countries are differently endowed in terms of their factors of production. 

Translated to the context of pollution and emission control, it could be argued 

that when a firm pollutes it is using a natural resource in the form of a clean 

environment. When the firm is forced to reduce the emissions it seems that it 

suddenly has relatively less of this resource. The firm loses all or a part of its 

right to pollute and, therefore, loses more or less of its competitive advantage. 

This results in lower exports of the products for which the environment was 

used as a factor of production (Marklund, 1997). 

Critique and attempts to test the Porter Hypothesis 

There have been many reactions to the articles by Porter and van der Linde. 

Researchers have attempted to test their ideas. Agencies and governmental staff 

alike have considered these new ideas to be important and of interest to policy 

making regardless of their verification difficulties. If there is a possibility to 

decouple the conflict between environmental protection and competitiveness, 

there is much to gain for the industry and the individual nations, the question 

then becomes how to make this happen. 

Porter and van der Linde do not, in a formal sense, test whether the hypothesis 

can be rejected or not. Instead they offer examples in the form of case studies to 

verify the hypothesis. In part this is what the opponents of the hypothesis 

criticise, as the studied firms are just a fraction of the industry in question. As 

Palmer et al express: “It would be an easy matter for us to assemble a matching 

list where firms have found their costs increased and profits reduced as a result 

of environmental regulations, not to mention cases where regulation has 

pushed firms over the brink into bankruptcy” (Palmer et al, 1995). Jaffe and 

Palmer call the evidence of the case studies, provided in support of the 

hypothesis, “largely anecdotal”. They continue: “while these case studies 

indicate that environmental regulation may create incentives for innovation in 

certain situations, they do not provide a general assessment of the impact of 

environmental regulation on innovative activity.” 

Jaffe and Palmer also argue that a more systematic economic analysis of the 

hypothesis is hindered by ambiguity as to exactly what the hypothesis is. One 

example of this ambiguity is that Porter points to the importance of regulation 

focusing on outcomes and not processes. Jaffe and Palmer argue that this 

implies that certain types of environmental regulation stimulate innovation, but 

other types do not. Unfortunately, they write, almost all of the existing U.S. 

environmental legislation is not of the type prescribed by Porter but rather it is 

setting both the goals of regulation and the processes for achieving those 

61

goals 15 . Thus, Porter's case studies do not provide us with any evidence about 

the empirical implications of existing regulation. Another interpretation of the 

hypothesis is that Porter assumes environmental regulation to be a free, or even 

paid, lunch. By this Jaffe and Palmer mean that “regulation induces innovation 

whose benefits exceed its costs, making the regulation socially desirable even 

ignoring the environmental problems it was designed to solve.” 

The authors also discuss the problems of systematically testing the model of 

Porter, due to the limitations of data. It would have been a problem even if the 

model had been specified more precisely. The only comprehensive measure of 

the environmental regulatory burden on industry is regulatory compliance 

expenditure, they argue. This fails to provide a truly exogenous measure of the 

regulatory burden because the cost level also depends on the nature of an 

industry’s response to regulation. Porter suggests that a firm’s response to 

stricter regulation are fundamental changes of its products or processes to make 

them more “green”. But these changes are unlikely to be reflected to any 

significant extent in published industry output measures. 

Jaffe and Palmer review the literature on environmental regulation and R&D 

and note that almost all existing literature is theoretical in nature. A large 

subset of this literature centres its interest on the incentives a firm confronts to 

undertake R&D to reduce environmental compliance costs, or to reduce 

pollution, under different approaches to environmental regulation. 16 In general 

these studies come to the conclusion that incentives for R&D tend to be stronger 

under environmental policies that are incentive-based rather than under 

command and control policies. 

The authors also discuss research which studies the relationship between 

stringency of environmental regulation and incentives for R&D and technology 

diffusion. Oates, Palmer and Portney 17 use a simple model of a profitmaximising 

firm in a perfectly competitive industry to show that increasing the 

pollution tax rate increases the firm’s incentive to adopt a more efficient 

abatement technology. Schmalensee argues that stricter environmental 

15 Jaffe and Palmer discuss that ”Strictly speaking environmental regulation rarely require polluters to 

employ a particular pollution control technology. However, since emissions standards are often based on 

the performance of a particular technology, regulated firms have an easier time obtaining environmental 

permits and may be less heavily scrutinised when they employ the technology that provides the basis for 

the standard.” 

16 Zerbe, R. 1970 ”Theoretical Efficiency in Pollution Control,” Western Economic Journal 8: 364-376 

Downing P.B. and L.J. White.1986. ”Innovation in Pollution Control”, Journal of Environmental Economics 

and Management 8: 225-271 

Milliman, S.R. and Prince, R. 1989. ”Firm Incentives to Promote Technological Change in Pollution 

Control,” Journal of Environmental Economics and Management 17: 247-265. 

17 Oates, W.E., Palmer, K. and Portney, P.R.. 1993. ”Environmental Regulation and International 

Competitiveness: Thinking about the Porter Hypotheses”, RFF Discussion Paper 94-02, (Washington,DC: 

Resources for the Future). 

62

egulation may lead to increases in R&D devoted to environmental compliance, 

but that the research increases are likely to come at the expense of other, maybe 

more profitable, research efforts. 18 McCains argues that if firms forecast that 

any resulting gains in the efficiency of pollution control could lead to a 

tightening of regulatory standards, regulated firms may be reluctant to 

innovate or to adopt efficient pollution control technologies. 19 The firm’s 

incentives can also change in nature if the firm is placed within the context of an 

imperfect competitive market, and if other regulatory claims are imposed. 

Biglaiser and Horowitz explicitly model strategic interactions among regulated 

firms in the research market. They show that, given a requirement that the 

more inefficient firms adopt one of the newly developed efficient technologies 

after it becomes available, an increase in the emission tax rate will decrease the 

level of aggregate research. Lanjouw and Mody found that increases in 

environmental compliance costs led to increases in patenting of new 

environmental technologies with a one to two year lag. 20 Thus these authors 

support one version of the Porter hypothesis as interpreted by Jaffe and Palmer, 

namely that regulation stimulates certain kinds of innovation. The authors also 

refer to several econometric studies that suggest that environmental regulation 

has a negative impact on productivity growth. 

The results of a study by Jaffe and Palmer indicate that when the compliance 

expenditure within an industry increases, there is an associated increase in 

R&D shortly afterwards. However, the authors found little evidence that the 

inventive output of an industry, as measured by successful patent applications, 

was related to compliance costs. 

These results do not offer any substantial insight into the different 

interpretations of the Porter hypothesis. However, the findings are consistent 

with the hypothesis that environmental regulation will stimulate certain types of 

innovation. Mody and Lanjouv found that regulatory compliance costs have a 

positive effect on patenting of environmental technologies. Taken together 

these studies suggest that, the disincentive for R&D attributed to commandand-control 

approaches to environmental regulation may be overcome by the 

high returns that regulation creates for new pollution-control techniques. 

According to another survey of a different set of literature, which among other 

things did study the Porter hypothesis (Marklund, 1997), it is hard to find 

theoretical support for Porter’s arguments. The strongest argument against it is 

18 Schmalensee, R., 1994. ”The Costs of Environmental Protection” in Balancing Economic Growth and 

Environmental Goals”, Mary Beth Kotowski, ed., American Council for Capital Formation Center for Policy 

Research, pp 55-75 

19 Mc Cain. 1978. ”Endogenous Bias in Technical Progress and Environmental Policy” American 

Economic Review 68: 538-46 

20 Lanjouw, J.O. and Mody, A. 1993. ”Stimulating Innovation and the International Diffusion of 

Environmentally Responsive Technology: The Role of Expenditures and Institutions,” mimeo. 

63

that firm’s voluntarily can choose to make the investments and the emission 

reduction that is given by Porter’s reasoning. The fact that they do not choose to 

do so tells us that they do not assume these investments to be profitable. Even if 

there were profits to be made, it is no proof that it is environmental investments 

that are the best way to realise these profits. Marklund also argues that Porter’s 

argument, that environmental regulation forces the firms to seek more efficient 

solutions, is not without its problems. All firms strive continuously to make 

such improvements and environmental investments crowd out other 

investments, which could have given higher productivity gains. 

On the other hand it is hard, if not impossible, to fully reject Porter’s ideas from 

theory alone. The empirical literature on the subject can, in a very minor way, 

be used to verify Porter’s ideas. However, Marklund concludes that results 

from American studies show that the productivity loss in the later half of the 

1970s could only to a very restricted extent be the result of more stringent 

environmental regulation. Scandinavian studies show mostly the same results. 

The development of productivity seems to be independent of the 

environmental policy. 

Scandinavian studies on plant level are interesting because they connect to the 

Porter hypothesis in a more direct way than other studies do. But the results 

from these studies are ambiguous. A Norwegian study shows that firms, which 

are subject to the strongest environmental regulations in the pulp and paper 

and the iron and steel industries, have a higher frequency of employment and 

have been less inclined to be shut down plants, compared to other firms. 

However, studies of Swedish and Finnish forest industry show that the firms 

find pollution reduction to be associated with higher costs. The Finnish study 

also shows a negative correlation between regulation pressure and efficiency. 

A reason for the weak conclusion is, according to Marklund, that among the 

empirical literature there are very few studies that test the ideas of Porter 

directly. The empirical literature is traditional in the sense that they are 

grounded on traditional economic theory, for example, from the assumption of 

profit maximisation or cost minimisation and firms with perfect information. 

However, that is exactly what Porter objects to. His hypothesis stems from the 

assumption that firms do not have perfect information and that they can have 

goals other than maximising profits. Marklund points to that serious tests of 

Porters ideas must emanate from frames of reference other than the traditional 

ones (Marklund, 1997). 

A recent study by Xepapadeas and de Zeeuw, 1999, on the ideas of Porter and 

van der Linde attempts to explore the validity of the hypothesis. The study 

includes firm’s reactions with respect to both the type and the quantity of 

equipment in which they invest in response to changes in production costs. The 

results showed that an increase in production costs, brought about by 

environmental policy, triggers a restructuring of the capital stock so that the 

64

average productivity increases. This is in line with the hypothesis. However, 

the authors are interested in the development of net profits and come to the 

conclusion that the trade-off between environmental conditions and profits of 

the home industry remains opposed to the hypothesis. But the trade-off is less 

sharp because of industry downsizing and modernisation (Xepapadeas and de 

Zeeuw, 1999). 

Defence arguments 

Porter and van der Linde themselves answer some of the critics of the earlier 

argument, that strict environmental regulation can be fully consistent with 

competitiveness, in their article from 1995. One criticism was that while 

innovation offsets are theoretically possible, they are likely to be rare or small in 

practice. Porter and van der Linde disagree and argue that fundamentally 

pollution is a manifestation of economic waste and involves unnecessary, 

inefficient or incomplete utilisation of resources, or resources that are not used 

to generate their highest value. In many cases, emissions are a sign of 

inefficiency and force a firm to perform non-value-creating activities such as 

handling, storage and disposal. Along the life cycle of the product there are 

many hidden costs of resource inefficiency. They point to efforts to reduce 

pollution and maximise profits share the same basic principles, including the 

efficient use of inputs, substitute of less expensive materials and the 

minimisation of unneeded activities (Porter and van der Linde, 1995). 

Another criticism of the hypothesis was, according to Porter and van der Linde, 

that the studies interpret the high costs of compliance with environmental 

regulations, as evidence that there is a fixed trade-off between regulation and 

competitiveness. Porter and van der Linde answer that estimates of regulatory 

compliance costs prior to enactment of a new rule typically exceed the actual 

costs. Also early estimates of compliance cost tend to be exaggerated because 

they assume no innovation. A third criticism was that even if regulation fosters 

innovation, it will harm competitiveness by crowding out other potentially 

more productive investments. The authors write that many firms have, given 

incomplete information, devoted limited attention to environmental 

innovations and the inherent linkage between pollution and resource 

productivity. It is, therefore, certainly not obvious that this line of innovation 

has been so thoroughly explored that the marginal benefits of further 

investment would be low (Porter and van der Linde, 1995). 

Comments 

The conclusion made by Marklund, that Porter’s ideas must be tested within 

frames of reference other than the ones usually used by economists illustrates 

the difficulties of studying innovations within standard economics frameworks. 

Investing in innovations differs from routine investments in a number of ways. 

Routine investments are made to increase or change production in a foreseeable 

65

manner. There is readily available knowledge as to the outcome and the cost of 

investing when the investment decision is made. When investing in innovative 

efforts neither the outcome nor the cost is known beforehand. Not even the risk 

of the assessment may be easily judged. Therefore, it is not obvious how costs 

should be minimised in the best way, nor what constitutes the most costefficient 

decision. Innovative efforts are genuinely risky ventures that may or 

may not increase competitiveness. It is most difficult to compare alternative 

strategies, even after the innovative venture is carried through. Innovations are 

inherently unique and there is no way to measure their cost-effectiveness. 

Therefore, there is no point in assessing how regulations affect their costeffectiveness. 

It is, however, reasonable to believe that innovations contribute substantially to 

competitive advantage, and to the extent that regulations stimulate innovations 

they may contribute to competitiveness. 

66

VINNOVA, SE-101 58 Stockholm, Sweden 

vinnova@vinnova.se www.vinnova.se

Drivers of environmental innovation - Vinnova

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