Environmental Innovation and Environmental Policy: An Empirical Test of Bi-Directional Effects

The purpose of this paper is to study the empirical strength of the bi-directional linkages between environmental standards and performance, on the one hand, and environmental innovation, on the other and, hence, the role of policy in spurring environmental R&D and, in turn, ultimate environmental performance. We study these links using an alternative measure of policy stringency, namely, pollutant emissions themselves. Specifically, we examine 107 manufacturing industries at the three-digit SIC code for the period 1989 - 2002. In view of the joint determination of research and pollution outcomes, we estimate a system of simultaneous equations, using appropriate instruments to identify each endogenous variable. Our empirical results reveal that there is a negative and significant relationship between emissions and environmental patents, in both directions. Thus, environmental R&D both spurs the tightening of government environmental standards and is spurred by the anticipation of such tightening, suggesting that U.S. environmental policy (at least in the context of the manufacturing industries that we study) has been responsive to innovation and effective in inducing innovation. Preliminary results also suggest that a linear feedback model is appropriate in order to capture the dynamic nature of the links between environmental policy and environmental innovation.