Bachelor thesis
Chinese industrial enterprises’ performance analysis based on
environmental regulation—validity demonstration of Porter hypothesis in
China
Chen, Pan
International economics and finance
S419870
Supervisor: Drs. J.T.R. Stoop
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Contents
1 Introduction ............................................................................. 3
2 Literature review on the Porter hypothesis .............................. 4
2.1 Main points of the Porter hypothesis .................................... 4
2.2 Opponents and proponents of the Porter hypothesis........... 10
3. Case study: Haier.................................................................. 19
4. Data analysis......................................................................... 22
5. Conclusion ............................................................................ 24
6. Recommendations ................................................................ 25
7. Appendix............................................................................... 27
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8. List of references .................................................................. 28
1. Introduction
After The Earth Summit held in Rio de Janeiro in 1972, more and more countries
around the world enhance environmental regulation one after another. This trend has
attracted remarkable attention of different scientists to the micro-effect of
environmental regulation on industrial competitiveness. The Porter hypothesis,
expounded by Professor Michael Porter in 1991, is often cited when this issue is
discussed. It asserts that, "Appropriately planned environmental regulations will
stimulate technological innovation, leading to reductions in expenses and
improvements in quality. As a result, domestic businesses may attain a superior
competitive position in the international marketplace and industrial productivity may
improve as well" (Porter, 1991). Since the hypothesis was raised, it has been a
world-wide spotlight as a counterargument to the traditional view that the regulation
has negative effect on industrial productivity and competitiveness, as it leads to brings
about increased costs for the firm. With respect to the fierce debate, in this paper, I
will do some literature review first, then look into one real life case study about the
performance of a Chinese household-electrical-appliances manufacturing company as
a result of environmental regulation implementation and finally make a simply data
analysis to test the validity and feasibility of Porter hypothesis in China. China, the
biggest developing country, is experiencing a considerable economic growth. Its every
movement is attracting worldwide attention. In the current situation that
environmental problem is on the slide, to realize the collaborative development of
economy and environment, China is devoting itself to environmental conservation
through implementation of various environmental regulations. As a most important
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player in the world, its actions do not only affect itself but also other countries.
Therefore, testing the effect of environmental regulation in China is significative and
meaningful. In this way, my research question is formed: Chinese industrial
enterprises’ performance analysis based on environmental regulation—validity
demonstration of Porter hypothesis in China.
2. Literature review on the Porter hypothesis
In this section, I will do some literature review on the Porter hypothesis based on its
main points and opinions of its opponents & proponents respectively.
2.1, Main points of the Porter hypothesis
2.1.1, There is not necessarily a tradeoff between environmental conservation and
competitiveness.
According to Porter’s perspective, it is not appropriate that the traditional dichotomy
regards environmental conservation and firm’s competitive power as two mutually
conflicting parties. Strict environmental regulations can spur on firms to undertake
technological innovations, which help firms to be more internationally competitive.
Therefore, there is not necessarily a tradeoff relationship between them (Porter, 1991).
In traditional concepts, environment protecting activities will impose a heavy
economic burden on firms, which always causes people to think of the tradeoff
between social welfare and private cost. Nevertheless, on the contrary, Porter thinks
that only in a static model, can the tradeoff between environment and economy be
inevitable. In such a model, firms seek for cost minimization while holding
technologies, products, producing processes and customer demands fixed. Once they
have to make extra investment in the environmental conservation, their production
costs will be necessarily increased, which do harm to their competitive power. Porter
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points out that in the recent 2-3 decades, international competitiveness has not been an
issue in a static model any more, but a new dynamic model instead, which is
established on the basis of innovation. Generally speaking, firm’s being more
competitive means that it has higher productivity or lower cost than competitors.
Varieties of case studies show that the reason why some big companies can be
internationally competitive is not that they use the cheapest production inputs or have
the biggest scale, but because they are capable enough to keep with technological
improvement and innovation; competitive advantages are not achieved through the
static effectiveness or optimization with restricted conditions, but achieved by
changing the original restriction owing to the innovative capability to enhance
productivity.
2.1.2, A dynamic viewpoint is necessary to measure competitiveness.
Porter thinks that in order to respond to the dynamic trend of international
competition, every country should revise its traditionally static analysis model and
instead, a dynamic viewpoint is necessary to measure and assess the relationship
between environmental regulation and competitiveness. In such a case, the focus of
regulation should be fixed on the final result instead of process (Porter, 1991). As is
expounded by Porter, during the process of pollution control, it is possible for firms to
be less competitive at the beginning because of increased costs, especially in the
international competition, facing other foreign competitors who do not take
pollution-control activities, they have temporary competitive disadvantage. However,
since nothing is kept constant for ever, their continuous technological progress will
urge them to adjust production processes: adopt innovative technologies to reduce the
lavishness and make the production more efficient and then improve productivity. In
this way, environmental regulation can stimulate technological innovation and owing
to the innovation, firms can finally become more competitive as well as reducing
pollution. Porter thinks that the reason why traditional economists hold opponent
attitudes is that they have made some hypothesis not conforming to the real
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competition model—assuming that the firm is experiencing a static competition
model. According to their points of view, without the supervision of regulation, the
firm will go to exploit every beneficial business opportunity and not ignore the
so-called regulatory benefits by Porter. However, in the real life, the firm is locating in
a dynamic environment that its production input combination and technology are
continually changing and innovated, which leads to its failure in making the actually
optimal strategic decision and miss some profit-seeking opportunities. As a result, as
long as there is some stimulating power behind (regulation), there are still various
beneficial opportunities such as engagement in pollution control activities existing in
reality, which are waiting for the firm to exploit. For example, environmental
regulation enforces the firm to undertake pollution control, which stimulates its
technological innovation and then improves productivity and bring about competitive
advantage to the firm finally. Consequently, Porter has the idea that appropriately
designed regulation can stimulate the firm to carry out more technological innovation,
improve the producing procedure such as designing a procedure with little pollution
that conforms to the environment protecting criteria and produce products that have
more applicable efficiency: reducing the use of scarce resources or toxic resources on
one hand and recycling resources that are nor used effectively on the other hand. In
such a case, innovation not only mitigates the economic burden, but also improves
product quality and reduces production cost at the same time and then enhances firm’s
productivity and improves product’s competitiveness. To support his standpoints,
Porter (1991) cites 3M as an example to illustrate the relationship between
environmental regulation and competitive power. Since 1975, owing to its
implementation of pollution control strategy, it has saved expenditures of more than
480 million dollars and because of elimination of 0.5 million ton wasted materials and
pollution, energy using expenses have been reduced by 650 million dollars. This fact
shows that the investment in pollution control will not impose any economic burden
on the firm. Instead, it can offset those increased costs by innovation and then make
the firm more competitive. In brief, regulation can trigger innovation offsets through
substitution of less costly materials or better utilization of materials in the process
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(Porter and van der Linde, 1995).
2.1.3, Type of regulation
In Porter’s study about environmental economics, there are three main instruments for
environmental policy making, which are emission quota, environmental taxes and
tradable permits. Emission quota sets an upper limit of emissions for polluters, which
commands them to carry out production within some constraints. As a
standard-oriented instrument, the tax here is based on price-standard approach
(Baumol & Oates, 1971), which achieves a specific emission target that does not have
to be Pareto efficiency. In other words, the implementation of taxes can make
someone better off without harming anyone else. In the assessment of these
instruments, Porter expounds the comparison between them. He points out that for the
design of regulatory criteria, government should think about carefully whether they
have included the use of market incentives, including pollution taxes, deposit-refund
schemes and tradable permits. In his opinion, pollution taxes can be implemented as
effluent charges on the quantity of pollution emissions, as product charges based on
the potential pollution of a product. Under a tradable permit system, like that included
in the recent Clean Air Act Amendments, a maximum amount of pollution is set, and
rights equal to that cap are distributed to firms. Firms must hold enough rights to
cover their emissions; firms with excess rights can sell them to firms who are short.
Such instruments as pollution taxes and tradable permits often allow considerable
flexibility, reinforce resource productivity, and also create incentives for ongoing
innovation, whereas mandating outcomes by setting emission quota is not able to
provide firms with enough incentives for their efforts into continuous innovation.
Furthermore, the implementation of emission quota policy will also tend to freeze a
status quo. In this situation, firms will only comply with it reluctantly rather than
engage in environmental conservation willingly and consequently, the outcome may
be far behind the expectation. In contrast, if there are enough market incentives, firms
will have great enthusiasm to carry on innovation actively and the technological
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outcome achieved therefrom is likely to exceed current standards.
2.1.4, Cleaner production and end-of-pipe
Typically speaking, there are two different types of environmental technologies that
eliminate negative environmental impacts: cleaner production and end-of-pipe
technology. Cleaner production reduces the use of resources and pollution by using
cleaner products and producing procedures while end-of-pipe technology limits
pollution emissions by implementing add-on measures. Uncompetitive firms in the
first place are less able to innovate in response to environmental pressures, and thus
be prone to end-of-pipe solutions whose costs are easily measured, whereas
competitive industries are capable of addressing environmental problems in
innovative ways that have a lower compliance cost. Therefore, cleaner production is
considered in preference to end-of-pipe technology. In such a case, Porter and van der
Linde assert that “the environmental regulation should encourage product and process
changes to better utilize resources and avoid pollution early, rather than mandating
end-of-pipe or secondary treatment, which is almost always more costly” (Porter and
van der Linde, 1995, p.111).
2.1.5, Government plays a role of stimulator
Although the firm engages in pollution control activities and benefits from
technological innovation, however, because of information asymmetries, a lot of firms
hang back and ride the fence. Therefore, government regulation is imperative to
stimulate the firm to take actions without so much fear and hesitation (Porter and van
der Linde, 1995). In Porter’s opinion, he thinks that from a long run perspective,
although environmental regulation will positively affect firms, however, because of
sudden cost increase in the short run, firms can produce uncertain and unsafe feelings,
together with information asymmetries, they are likely to ignore some investment
opportunities and fail to make an optimal strategy. In such a case, government
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regulation is regarded as an intermediary to stimulate innovation. Porter points out
only in a statically optimized framework together with complete disclose of
information, can the strategy to seek for the profit maximization work. Nevertheless,
with the dynamic competition model in the real life, because technology is changing
over time, there is a potential space filled with endless innovation and improvement,
accompanying highly incomplete information and managerial inefficiency, firms
cannot make the actually optimal decision. As a result, once they improve technology
and enhance interior management, the potential improvement space will also be
enlarged, which creates more benefits. The role of the government is to implement a
strict environmental regulation to urge firms to recognize every potential
profit-making opportunity, revise the initial production combination and make an
optimal strategy for the profit maximization. Furthermore, taking the example of
American energy-saving plan, Porter illustrates a truth that the implementation of
environmental policy needs firm’s coordination to comply with its standards and
being aware of the profit-making opportunity to engage in pollution control and then
the environmental policy can be carried out efficiently.
2.1.6, Well designed regulatory criteria
Porter hypothesis is built on the basis of a “well-designed environmental regulation”,
which requires that the regulation has to be based on the market mechanism and have
a stimulation effect on firms. As is expounded, an environmental regulation, which is
helpful for the improvement of competitiveness, must have several criteria as follows.
First of all, it has to provide firms with a big innovation space so that the regulatory
objective can be achieved by flexible means. Secondly, the regulation should be able
to promote continuous innovations instead of focusing on a specific technology and
realize its objective through the stimulation on innovations. Thirdly, the regulation
should be implemented step by step in order to minimize uncertainties. Based on its
operational scheme and feature, the regulation can be classified into two types, which
are market-oriented stimulating regulation and command-and-control regulation. A
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well-designed regulation is mainly directed at the former that without market-oriented
regulatory measures, the further conclusion of Porter hypothesis cannot hold. In short,
a strict environmental regulation with appropriate design can enable the firm to
produce big-scale innovation and innovative compensation effects while a relatively
loose regulation can only increase pollution control costs without any innovative
effects: at most, it only uses the end-of-pipe approach or remedial measure afterwards.
Stricter regulation focuses on making the firm pay more attention to its pollution
emission, urge it to adopt radical solution starting from updating products and
producing procedures. Although the cost is increased in the short run, however, owing
to the offset effect of innovation, the firm will reduce its net costs and even obtain net
profits finally.
2.1.7, First-mover theory
Porter thinks that when the domestic regulation correctly foresees and represents the
international trend of environmental conservation, then firms in this country can get
competitive advantage from the initiative. At present, the international market demand
is trending towards environmentally friendly products. Germany takes the lead to
actualize product recycling standard, which creates a first-mover advantage for
German enterprises in the development of less packed products and enables them to
be leaders in the international market.
2.2, Opponents and proponents of the Porter hypothesis
2.2.1, Fundamental concepts:
It is a unanimous oppugn from almost all critics about Porter Hypothesis that there is
not a free lunch in the world (Jorgenson and Wilcoxen, 1990; Cropper and Oates,
1992; Jaffe et al., 1995; Simpson and Bradford, 1996). Palmer, Oates and Portney
(1995) do not agree with the viewpoint that some painful choices can be avoided
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when the environment objective is fixed; they warn the government of a “no-cost
paradigm” and argue that there is always a tradeoff between environmental regulation
and firm’s competitive power.
Porter thinks that as long as regulatory criteria are properly designed, then the
regulation can stimulate innovation, which will benefit firms instead of harming them.
However, on the contrary, according to the theoretical framework of neo-classical
economics, now that firms engage in activities to seek for the profit maximization, it
is impossible for them to give up any profit-making opportunities. If everything is
going on as Porter says, not only the compliance cost can be offset by the benefit
produced by innovation, but even a net profit can be created, then it doesn’t make
sense for the firm to give up the investment opportunity. Porter’s saying has
undoubtedly implied that there is not a tradeoff relationship between environmental
regulation and firm’s competitive power, that is to say, firms can get benefits
gratuitously without any extra inputs. If so, then the environmental regulation will
become a free lunch. Therefore, generic critics do not believe in Porter’s opinions and
think that even though enforcing firms to undertake pollution control can admittedly
internalize its external cost and improve the social welfare, however, it will also
deteriorate their productivity owed to the increase in private costs.
2.2.2, Practical feasibility
In Porter’s opinion, as long as the regulation is well designed, it will stimulate
innovation for sure to realize the effect of innovation offsets. This kind of regulation
concentrates on the outcome rather than the transitional process. In other words, there
must be some kind of environmental regulation that can stimulate innovation and
achieve a win-win situation of reducing pollution and benefiting firms simultaneously.
Directed toward this point, Jaffe and Palmer (1997) make a general survey into
current American environmental laws and regulations and they find that there is
indeed a positive relationship between growth in R&D and growth in PACE, whereas
“regulatory compliance costs have no detectable impact on patenting activity” (Jaffe
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and Palmer, 1997, p.617). Furthermore, Jaffe et al. point that the current information
is restricted to the exact standard of so-called stricter environmental regulation, which
leads to a trouble in the empirical analysis that it is difficult to assess the effect of
regulation on economy through regression analysis. Even though every country has
the information about firm’s PACE, some deviations still exist because of variances in
different measuring methods: even for the U.S, who always has perfect information
about the environment, its information about firms’ PACE is regarded not to be very
reliable either. Simpson and Bradford (1996) directly criticize that even though
Porter’s proposal is workable theoretically, it is really doubtful in practice if the
environmental policy is actually implemented as an instrument to achieve the
industrial objective. Although Porter cites varieties of successful examples in his
literature (Porter and van der Linde, 1995) to prove the positive effect of
environmental regulation on firm’s performance, there are also lots of failing
examples that he does not record. Moreover, the positive effect produced by those
successful examples is not necessarily big enough to offset the negative effect resulted
from failing examples that firms have to spend considerable costs to comply with the
regulation. Therefore, opponents concentrate on the doubt about the practical
feasibility of Porter hypothesis. According to their opinions, Porter’s proposal is too
unrealistic and even though the offset effect is really workable in theory, however, in
practice, there is still lack of enough information accordingly to prove its practicality.
2.2.3, Is regulation the only way to stimulate innovation?
According to Porter’s perspective, traditional analysis all ignores the stimulation
effect of environmental regulation, and then exaggerates the pollution-treatment cost
as a result. A properly designed regulation can stimulate innovation to partially or
completely offset the cost. Opponents think his statement implies that regulation is the
only instrument to stimulate innovation and make firms more competitive. Simpson
and Bradford (1996) doubt this argument that if it is true, then why firms do not
undertake R&D on products or processes directly, but must be restricted by such a
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cost-consuming regulatory strategy instead. If firms can really benefit from it, then
they will devote themselves into it voluntarily, even though in absence of government
regulation. Therefore, it does not seem very wise to use environmental policy to
stimulate innovation so as to achieve the industrial objective. It might be better if the
government subsidized firms on R&D directly. Although Porter asserts that only the
regulation can stimulate a comprehensive innovation with more cost-efficiency to
make resources be used more effectively. Nevertheless, shown by the study of
Sheridan (1992), if firms carry out a corporate total quality management program to
strictly monitor the producing process and remedy the quality problem in time to
confirm product’s quality and avoid the production of wasted materials, they can also
reduce pollution and benefit from the innovation-offset effect.
2.2.4, Is the strategy optimal?
Porter points out that due to the incomplete information in real life, firms cannot make
an optimal strategy. Furthermore, locating in a constant operational mechanism, firms
have no incentive to look for new technologies to update products or processes
voluntarily while being facilitated by the environmental regulation, they are urged to
start the searching and reconsider those constraints that are not considered before the
regulation in the process of seeking for profit maximization. As soon as they take
account of the restriction into the model of profit maximization, they will adopt a
different strategy and make investment in innovation, which can enable them to
satisfy the requirement at a lower cost. In this way, firms can comply with the
environmental regulation and get more benefits simultaneously. Palmer, Oates and
Portney (1995) don’t agree with that. They expound figure 1 about the correlation
between polluting firm’s cost and abatement level to see how the firm will be affected
by the innovation of abatement technology and whether its R&D investment is
optimal. The original MAC curve represents firm’s current marginal abatement cost,
which indicates the cost incurred by the firm to enhance the abatement level by an
additional unit. Its upward slope implies that the firm’s marginal cost of pollution
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reduction is rising. As the firm moves down its MAC to , the effect of its
marginal cost on pollution abatement is getting bigger. However, it also has to spend
more money on R&D about new technology, which is necessary for the shift. In this
model, market-oriented regulators use emission charges to encourage pollution
abatement. As long as the cost in pollution abatement is less than emission charges,
the profit-maximizing firm will do it willingly. However, after the point where the
abatement cost is more, the firm will make an opposite choice. In this model, it is
assumed that the firm initially faces an emission charge of P, and it chooses a
profit-maximizing level of abatement at A in accordance to B, where the cost is equal
to the emission charge. Besides the cost, this figure also depicts benefits to the
polluting firm from its R&D efforts, which are embodied by the cost reduction in
original abatement on one hand and new technology on the other hand. The total
benefits gained from innovation are represented by the area of OFCB, which cannot
offset the cost of R&D efforts that move the firm from MAC to if the firm is
operating at A. Now, a more stringent environmental standard is introduced and the
emission charge rises to
*MAC
*MAC
"P . No matter whether the firm will keep the old technology
and end up at H or invest in a new one and end up at D, generated profits are both
lower than B. Therefore, there is no ambiguity that a higher emission standard reduces
firm’s profits. Thus, they conclude that “in this model of innovation in abatement
technology, an increase in the stringency of environmental regulations unambiguously
makes the polluting firm worse off. Even if the firm can invest and adopt a new, more
efficient abatement technology, if that technology wasn't worth investing in before, its
benefits won't be enough to raise the company's profits after the environmental
standards are raised, either” (Palmer, Oates and Portney, 1995, p.125). In such a case,
it is not optimal for the firm to make R&D efforts into the technological innovation.
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Figure 1
Jaffe et al. think that Porter’s statement implies that firms are not operated in
production possibility frontier, which has to be thought about prudently. To invest in a
new technology, firms have to devote extra costs. Suppose initially, they do not find
any new technology that is more efficient and they do not adopt any new until the
regulation enforces them to do it, then their initial strategy before the regulation is still
efficient because in reality, there must be a lot of feasible and efficiency-improving
approaches. However, to look for them and put them into practice, firms have to make
more related investment. Suppose a firm has successfully invested in a
benefit-enlarging approach then its strategy, which has been sub-optimal before the
investment is still efficient. However, restricted by its limited resources, it does not
focus on whether it can find new production procedure to increase benefits, but
focuses on whether it can get more and better approaches to increase benefits resulted
from the searching job triggered by the stimulation of innovation than by other means,
whereas Simpson and Bradford (1996) think that in the real situation, firms
sometimes inevitably ignore many benefit-making opportunities at cost saving. They
cannot recognize them until a strict regulation urges them to be aware of them.
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Nevertheless, this fact does not say that the pre-regulation strategy is not optimal,
because no one can guarantee the uncertain benefits from innovation are big enough
to offset those extra costs induced by the increase in firm’s marginal cost and
investment in pollution control.
2.2.5, Is there any tradeoff between environmental regulation and competitiveness?
In Porter’s opinion, traditional analysis either exaggerates the real cost of regulation
or underestimates innovation’s benefit, which brings about a unanimous finding from
varied studies that environmental regulation will increase cost and make firms less
competitive. They all get a consensus that the environmental regulation brings firms
too high a cost that it has been a heavy burden on the industry. With respect to this
finding, Porter emphasizes that the tradeoff is undoubtedly inevitable if the innovation
factor is neglected. Besides, there is not sufficient evidence to show the negative
effect of environmental regulation on competitiveness based on the empirical analysis
of previous literature (Meyer, 1992; Leonard, 1988; Repetto, 1995). Porter shows that
proved by the practical evidence, the cost of environmental regulation is tiny relative
to GDP or total production cost, which only takes up 2-3% of GDP (Cropper and
Oates, 1993; Jaffe et al., 1995). In such a case, it will not cause an adverse shock to
the economy. As a proponent for Porter, Berman and Bui (1998) inspect the effect of
American air quality control Act in the petroleum refining industry between 1977 and
1993, during which period America gradually raises environmental standards. The
result reflects that firms in regions with stricter regulations improve productivity more
quickly than those ones in regions with relatively loose regulations. It is because the
former has adopted new technologies by force of pressure from environmental
regulations. However, Palmer et al., think that although the percentage is very small,
due to the diversity of different countries in labor, material cost, capital cost and
exchange rate fluctuation, such a small percentage can still be strong enough to affect
a country’s economic development, and even result in a recession. Furthermore, in
many countries, especially developing countries, some firms have undertaken
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environmental conservation overly, which consequently restrict their competitive
advantage. Additionally, some transnational enterprises are inclined to build facilities
with low pollution, even though in a region without any regulation. Therefore,
although a stricter environmental regulation does not affect the competitive status of
America, it is not enough to support Porter’s argument about the cost-offset effect.
Porter’s proposition implies that the environmental regulation is costless because
costs will be finally offset by benefits. With the example of American manufacturing
industry, Jaffe et al., make an empirical study into the relationship between the
regulation and firm’s competitive power. Based on the result, there is not clear
evidence to support the argument that the environmental regulation can facilitate the
promotion of international competitiveness. The cost of regulation is so high that it
will do harm to industrial competitive performance, which indicates a mutual-
tradeoff relationship between them.
2.2.6, Doesn’t the investment in innovation have a crowding out effect?
Porter thinks that in the production process, firms produce pollution emissions to
cause some inefficient use of production resources. In order to improve their
productivity, firms engage in some activities to comply with the environmental
regulation, which urges them to take a comprehensive innovation. As a result, their
costs of supervision, remedy and maintenance are reduced and they can achieve a
win-win outcome of reducing pollution and improving productive efficiency at the
same time. What is more, the investment in pollution control is only too small a part
of total investment to hinder them from engaging in other investment activities.
However, according to Simpson’s and Bradford’s opinion, granted that a strict
regulation can actually make the firm more competitive, the firm will be likely to
crowd out other investment plans that are more beneficial for them because of its
investment in pollution control.
2.2.7, Attitudes towards environmental problems
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According to Porter’s opinion, the regulation is appropriate only if it turns its
consideration of the environment into the requirement for competitive advantage.
Previous studies on the environment restrict firm’s abilities in technological
improvement and innovation and only concentrate on the pollution abatement and
elimination afterwards instead of the precaution in advance. In future, when the
related department implements the regulation, it should actively stimulate firm’s
technological progress and adopt an inducement mechanism to achieve the objective
of environmental conservation rather than only restrict firm’s pollution emissions
passively. If the method adopted is correct, then efforts into environmental
conservation will certainly bring about a positive effect on the competitiveness.
However, on the contrary, Simpson and Bradford criticizes that Porter’s proposition is
a something-for-nothing argument, which attempts to persuade the government to
implement a stricter environmental regulation by asserting the attractiveness of a
win-win outcome. Nevertheless, its feasibility is doubtful to use a phenomenon that
does not have a normal state as a suggestion for the implementation of practical policy.
The whole society should try to improve the environmental quality from a more
meaningful aspect and make a pragmatic research into how to allocate the heavy
burden of environmental issue in a realistic manner instead of prating about any
unconstructive proposition that arises so many disputes like Porter. Furthermore,
Palmer et al., also emphasizes that before the implementation, every proposal has to
be tested for its social value by means of cost-benefit analysis, which uses the
comparison between input cost and benefit arising therefrom to measure the economic
benefit rather than assume a wrong premise of cost-free regulation in advance.
Moreover, according to the perspective of Jaffe et al., what the government should do
is not to implement a strict environmental regulation that might lead to a high cost,
but to establish a preferential focus and objective of the regulation, which include
some inevitably produced tradeoff resulted from the regulation and try to carry out a
cost-effective policy instrument under the principle of cost-benefit balance.
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3. Case study: Haier
As the biggest developing country, China is confronted with an even bigger problem
about how to realize the balance between the environmental conservation and
industrial performance improvement. In this section, I have a look into a real life case
about the strategies that a world-famous Chinese manufacturer adopt in response to
the environmental regulation and test what kind of relationship exists between
regulation and their competitive performance. Haier, who has realized a transition
from compliance with criteria to setting up criteria owing to the independent
innovation. Its products successfully entered European and American markets, which
indicated that in the background of globally economic integration, enterprises from
developing countries had to cope with technological barriers implemented by
developed countries and only if by means of independent innovations, could they gain
the competitive advantage.
3.1, Two directives from the European Union: effect on exports of Chinese traditional
household appliances (WEEE and RoHS directive)
The European Union formally implemented WEEE directive in August, 2004, which
has caused a preliminary effect in exports of Chinese related products. Those products
involved in the directive include white goods, small household appliance, lighting
equipments, toys and other 6 types of products. Whereafter, it implemented another
directive called ROHS, which affected exports of Chinese traditional household
appliances and products with low added values, such as miniature measuring
instruments. The effect in the former is relatively smaller than the latter because
information, telecommunication and digital products have higher technological
standards and selected materials are always environment-protecting materials.
Therefore, most of them have cohered with EU criteria. Another reason is that those
products have high added values and 90% of them are exported by means of
processing trade. Therefore, they are affected less by recycling expenses. These two
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directives have a bigger effect on the latter mainly because recycling expenses of
waste products, new-material replacing and adoption of new environment-protecting
technics will all increase firm’s producing and managerial costs whereas traditional
household appliances have low added values. Therefore, increased costs will have a
bigger effect in this kind of products.
3.2, Technological innovation of Haier
In fact, Haier came across green barrier when it exported its electric refrigerators and
washing machines to America and European Union in 1999. Haier took it as an
opportunity, successfully passed the certification of ISO14000 and became Chinese
first enterprise that passed the certification. Additionally, the green refrigerator
developed by Haier in accordance with European environment-protecting legislation
and technical requirement became Chinese first household appliances product marked
with the environment-label.
Haier took the initiative to establish the firm-specific database system of domestic and
foreign patents, which was suitable for itself and build up pointed patent-document
base depending on product categories and technological fields. Attributed to the
development of database, Haier could dig for more technological innovation
opportunities from an international range and look for technological cooperators to
carry out strategic comparisons. Developers made searches and analyzed former
patents before getting down to the development of some product or technology in
order to keep away from and exceed existing patents. As a result, owing to its
effective innovation and establishment of new intellectual property rights, Haier was
able to improve its developing efficiency and capability. Additionally, it set up the
managerial institute of intellectual property right to guide all staffs to cultivate the
awareness of the right, providing the firm with a reliable guarantee to improve its
capabilities on the creation and application of the right.
With more and more products exported abroad, Haier has been gradually increasing
its foreign-patent application percentage as well as making efforts to apply for
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domestic patents. Till the first half of 2005, it had obtained 5469 Chinese patents
accumulatively, 582 of which were got in 2004. Shown from its sales report,
environment-protecting two-motor washing machine is the product sold most quickly
at the end of 2005. This innovative product was regarded as the fourth kind of
washing machine by the global market and had been exported to more than 10
countries. Its price in the international market was 3 times higher than other
conventional washing machines. It was also listed in the proposal of international
criteria by some related international organization. In this way, Haier started to lead
the formulation of washing machine criteria in the world. Furthermore, the
independent innovation schema explored through the process of developing the
environment-protecting washing machine enables Haier to obtain 70 more patents for
new products within 1 year. The washing machine series, which owned most patents
also earned the highest profit rate for the firm in 2005.
3.3, Transitions from innovative products to innovative international criteria
Haier realized a transition from innovative products to innovative international criteria.
After it obtained patent protections from technological innovations, it turned into the
competition for criteria from competition for patens. So far, it has participated in the
setting and modification of 86 Chinese national criteria accumulatively and possessed
5730 enterprise standards.
On the basis of continuous independent innovations, Haier achieved a breakthrough
development from a single technology to integrated innovations. The process of its
technological innovations indicates that technological innovations aim for the
possession of products with international competitiveness rather than for the
technology itself. Innovations broken away from products that can match the
requirement international competitiveness are valueless. Firm’s core competitive
power is not reflected by the difference in element resources. Instead, it is created by
the dynamic technological innovations, which is in accordance to Porter’s concepts.
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4. Data analysis
In this section, by means of data analysis, I will look into the real situation of China
about its implementation of environmental regulations and the effect arising therefrom
to test the feasibility of Porter hypothesis in China.
4.1, Data description
1) R&D: technological innovation is undertaken based on the capital investment. Its
level cannot be improved without the guarantee from strong capital power. Therefore,
R&D expenditure is an important index to measure the level of technological
innovation. In Porter’s opinion, a stricter regulation can stimulate more innovation
and finally result in an increase in profit. Here, we do not have any data about how
firm’s profit is changing over time but instead, we have data about R&D expenditures
collected from China S&T Statistics yearbook of 1998-2007. Its growth is a necessary
condition for the profit increase.
2) PACE: PACE is an important measurement about the regulation intensity. When
the regulation gets stricter, firms have to spend more money on pollution treatment
and the cost is increased with the improvement of regulation intensity. Therefore,
PACE is good indicator to well reflect the intensity that firms are confronted with. To
show the trend of PACE investment in China, I collect related data published in China
environment yearbook of 1998 to 2007.
3) Patent: different from R&D and PACE, patent is the output of technological
innovation instead of input. It is a good measure to reflect firm’s innovative capability
and level. Because there is a lag existing between patent application and authorization,
I use the quantity of patent application here instead of patent approval. The data about
patent application are also collected from China S&T Statistics yearbook of
1998-2007.
4.2, data analysis
22
With the help of excel, I do a simple statistical analysis into the data mentioned above
and make two scatter plot graphs to show the correlation between 3 variables. The
upward straight line can reflect a general trend about the effect of environmental
regulation in China from 1998 to 2007. From the result, we can see that in the long
run, environmental regulation has some stimulation effect on technological
innovations of Chinese enterprises: every 1% increase in pollution treatment
investment results in a 0.26%-increase in R&D expenditures and 0.3% in No. of
patent applications respectively. These statistical data tell us a truth that China has
been making more and more efforts into pollution abatement and control. In response
to government’s enhancing power in the environmental conservation, firms are aware
that they cannot stick with their old products or technologies any longer and go no
further. Instead, they have to think over what they should do to deal with those
potential challenges from the trend. Linear regressions above give the answer: they
make more investment in R&D aiming for product innovation and technological
progress. As a result, there is a continuous growth in patent applications. This finding
is consistent with the hypothesis that environmental regulation can stimulate
innovation. However, I cannot affirm whether this increase in R&D is only a
diversion from some other R&D efforts of the firm or the evidence to prove that
regulation can awake firms to think in new ways about their productions. Moreover, it
is also ambiguous how this finding will change cost-benefit analysis of regulation.
Furthermore, because of the difficulty in classification by industries and shortcomings
of using pollution treatment expenditures as a measure of regulatory stringency, there
is still a long way to go before this result can be summarized into a definite
conclusion.
23
y = 0.2609x + 0.2526
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
0.0% 10.0% 20.0% 30.0% 40.0%
growth of investment in pollution treatment
growth of R&D expenditures
y = 0.3948x + 0.2289
0.0%
5.0%
10.0%
15.0%
20.0%
25.0%
30.0%
35.0%
40.0%
45.0%
50.0%
0.0% 5.0% 10.0% 15.0% 20.0% 25.0% 30.0% 35.0%
growth rate of investment in pollution treatment
growth rate of No.of patent
application
5. Conclusion
Based on the analysis above, it can be seen that even though Chinese environmental
regulatory policies cause some cost burden on firms, they can also spur on firms to
recognize challenges and opportunities in front and carry on innovation willingly. In
this way, firm’s competitive performance is improved, which is reflected in growing
patent applications. It seems that this causal relationship partially proves the validity
of Porter hypothesis in China. However, there are still some ambiguity remaining in
the data analysis and many unanswered questions, such as whether the R&D efforts
24
inspired by regulation can reduce production costs or bring about new products and
finally increase firm’s profits. In such a case, we cannot be so subjective to conclude
that as long as there is a positive relationship between growth in compliance costs and
R&D, Porter hypothesis is completely valid. Instead, we need to take a critical attitude
towards the result of data analysis and think over how the data should be improved in
order to be more reliable.
6. Recommendations
With the acceleration of industrialization, industrial pollution is more and more
deteriorated day by day and simultaneously, regulatory intensity is increasingly
enhanced. As China is experiencing considerable economic development, there is a
big dilemma between environmental conservation and economic development;
pollution control and firm’s performance. Therefore, it is imperative for the industry
to try its best to reduce the adverse effect of environmental regulation on its
performance together with its compliance with the regulation so that a win-win
objective of pollution abatement and performance improvement can be achieved.
Based on the conclusion of this paper, there are some recommendations I would like
to put forward.
First of all, the government should appropriately improve the standard and intensity of
environmental regulations to further stimulate technological innovations. Through the
compensation effect of innovation, those negative effects on firm’s performance can
be offset and exceeded. According to the empirical analysis in the paper, at present,
the intensity of stimulation in China is small. Therefore, the compensation effect of
innovation is not big enough to completely offset all adverse effects. In such a case, it
is suggested that China should improve the regulatory intensity in order to enhance
the stimulation and take full advantage of innovation’s compensation function to
realize a win-win situation.
Secondly, we should choose a best policy instrument that can stimulate the
technological innovation to a biggest extent. Although enhancing the regulatory
25
intensity is important, the improvement cannot be endless. With the intensity fixed,
the government should choose a policy instrument to maximize the stimulation. For
example, seen from the research, some instruments based on the market, such as
pollution taxes and the tradable pollution permits system can greatly promote the
innovation. Therefore, China should actively and stably push on the revolutionary
practice of environmental regulatory policy instrument so as to maximize the
innovative effect as well as achieving the objective of pollution control.
Finally, regulated firms should adopt active strategies in response. They can carry out
clean production, develop ecological industry, undertake recycling economy, and
make full use of compensation effect of technological innovation to eliminate
regulations’ negative effects on firm’s performance. The effect of regulation not only
reflects the quality and validity of policy itself, but also reflects the industrial
capability and level in response to the regulation. As parties being regulated, firms
should have the awareness that environmental regulation is not only the arch-criminal
for the deterioration of industrial performance; it is also the opportunity, by which
they can improve economic performance and obtain the competitive advantage.
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7. Appendix
Comparison between proponents and opponents of Porter hypothesis
Proponent Opponent
Assumptions Dynamic model:
technology is changing
over time
High information
asymmetries
Failure of firm’s interior
organizations
Static model:
Technology is fixed
Products and producing
process are fixed
Consumer demands are
fixed
Complete information
Model Profit-maximization Cost-minimization
Restrictions from
environmental regulations
Regulations-stimulate
innovations-reduce
costs-improve competitive
advantages
Regulations-internalize
external costs-increase
costs-destroy
competitiveness
Regulation player Media that stimulates
innovations
Extra costs imposed on
firms
Suggestions
Do not passively engage in
remediation after
something bad has
happened; actively
participate in the pollution
abatement and control
Do not only put forward
instigating theories; take
some pragmatic actions to
allocate the burden of
environment
27
8. List of references
Baumol, W. J. and W. E. Oates, 1971, "The Use of Standards and Prices for
Protection of the Environment". Swedish Journal of Economics 73: 42-54.
Cropper and Oates, 1992, “Environmental Economics: A Survey,” Journal of
Economic Literature, in Stavins, Chap. 4
Eli Berman & Linda T. M. Bui, 2001. Environmental Regulation And Productivity:
Evidence From Oil Refineries. The Review of Economics and Statistics, MIT Press,
vol. 83(3), pages 498-510.
Jaffe, Adam B. and Palmer Karen, 1997. "Environmental Regulation And Innovation:
A Panel Data Study," The Review of Economics and Statistics, MIT Press, vol. 79(4),
pages 610-619, November.
Jaffe, Adam B., Steven R. Peterson, and Paul R. Portney. "Environmental Regulation
and the Competitiveness of U.S. Manufacturing: What Does the Evidence Tell Us?"
Journal of Economic Literature, March 1995
Jorgenson, Dale W. and Peter J. Wilcoxen (1990), “Environmental Regulation and
U.S. Economic Growth,” The Rand Journal of Economics, 21(2), pp. 314-340,
Summer.
Leonard H. J., (1988), Pollution and the Struggle for the World Product: Multinational
Corporations, Environment and International Comparative Advantage, Cambridge
University Press.
Meyer, S. (1992), ‘Environmental and economic prosperity: testing the environmental
impact hypothesis’, unpublished manuscript, MIT.
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Palmer, K., W.E. Oates and P.R. Portney, 1995. “Tigthening environmental standards:
The benefit-cost or the no cost paradigm.” Journal of Economic Perspectives, 9:
119-132.
Porter, M.E ”America’s Green Strategy”. Scientific American, No. 168, April 1991.
Porter, M.E & C. van der Linde, 1995, Toward a New Conception of the
Environment-Competitiveness Relationship, Journal of Economic Perspectives 9,
97-118.
Repetto, R. 1995. Jobs, Competitiveness, and Environmental Regulation: What are
the Real Issues? World Resources Institute, Washington, D.C.
Simpson, R. D. and Bradford, R. L., III. 1996. Taxing variable cost: Environmental
regulation as industrial policy. Journal of Environmental Economics and Management.
30 (3): 282-300.
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