The Porter Hypothesis (PH) states that well designed environmental regulation can benefit regulated firms by spurring innovation, leading to improved efficiency and enhanced competitiveness. This idea is controversial because the PH challenges a long-held paradigm in economics that presumes that, as profit-maximizing entities, firms are already using their resources in the most efficient way to achieve maximum profits, and that regulations merely restrict firms’ options, inevitably leading to sub-optimum profits.
The “Porter Hypothesis” proposes that well-designed environmental regulation can provide benefits for companies by encouraging innovation and boosting their competitiveness, which in turn can partially or fully offset the costs associated with regulatory compliance. A review of seven recent case studies from four industrial sectors provides real world evidence of “win-win” scenarios, in which environmental regulation can benefit both society (through an improved environment) and private industry (through the returns from innovation). Six of the seven studies reviewed in this Policy Brief found evidence of at least one form of the Porter Hypothesis.
There is emerging evidence that more stringent and flexible regulations promote more innovation. Canadian policy makers are increasingly adopting these market-based approaches, such as cap-and-trade systems and pollution pricing. The studies reviewed in this Policy Brief that differentiate more flexible regulations from other regulations generally found that the flexible regulations had a stronger track record of encouraging innovation.
Designing effective environmental policy can be difficult in the face of lobbying pressure from those being regulated. These examples presented in this Policy Brief show that some regulations can in fact deliver private benefits in the form of induced innovation. Understanding the conditions under which this is true can help governments and other regulators implement well-designed environmental regulation.
Further assessments of the private sector benefits of regulation should be made in order to better understand the conditions under which firms and sectors benefit from environmental regulation, as well as the sectoral and firm-level qualities that determine which sectors and firms will benefit. Increasingly, as newer policies incorporating market-based instruments are adopted, there is opportunity to further study and evaluate their advantages in promoting competitiveness relative to more rigid traditional regulatory approaches.