Environmental Regulation and Industry Dynamics

We examine the effect of more stringent environmental regulation on the dynamic structure of a deterministic competitive industry with endogenous entry and exit where firms invest in reduction of their future compliance cost. The level of regulation is exogenously fixed and constant over time. The compliance cost of a firm at each point of time depends on its current output, its accumulated past investment and the level of regulation. We outline sufficient conditions under which industries with more stringent regulation are associated with higher investment in compliance cost reduction and higher shake-out of firms over time; the opposite may be true under certain circumstances. Our analysis indicates that the effect of a change in regulation on market structure may be lagged over time.