Economics of Innovation and New Technology

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Revisiting the Porter hypothesis: an empirical

analysis of Green innovation for the Netherlands

George van Leeuwen & Pierre Mohnen

To cite this article: George van Leeuwen & Pierre Mohnen (2017) Revisiting the Porter
hypothesis: an empirical analysis of Green innovation for the Netherlands, Economics of
Innovation and New Technology, 26:1-2, 63-77, DOI: 10.1080/10438599.2016.1202521

To link to this article: https://doi.org/10.1080/10438599.2016.1202521

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ECONOMICS OF INNOVATION AND NEW TECHNOLOGY, 2017
VOL. 26, NOS. 1–2, 63–77
http://dx.doi.org/10.1080/10438599.2016.1202521

Revisiting the Porter hypothesis: an empirical analysis of Green

innovation for the Netherlands
George van Leeuwena and Pierre Mohnenb,c
a
Centraal Bureau voor de Statistiek, The Hague, The Netherlands; bDepartment of Quantitative Economics,
Maastricht University, Maastricht, The Netherlands; cUnited Nations University – MERIT, Maastricht, The Netherlands

ABSTRACT ARTICLE HISTORY

Almost all empirical research that has attempted to assess the validity of Received 30 August 2015
the Porter hypothesis (PH) has started from reduced-form models, for Accepted 15 April 2016
example, single-equation models for estimating the contribution of
KEYWORDS
environmental regulation to productivity. This paper follows a structural Porter hypothesis; Green
approach that allows testing what is known in the literature as the innovation; environmental
‘weak’ and the ‘strong’ version of the PH. Our ‘Green Innovation’ model regulation; complementarity;
includes three types of eco-investments to explain differences in the productivity
incidence of two types of eco-innovation, which are allowed to affect
labor productivity. We allow for complementarity between the two JEL CLASSIFICATION
types of eco-innovations. Using a comprehensive panel of Dutch H23; L5; O32; O38; Q55
manufacturing firm-level data we estimate the relative importance of
environmental regulations on eco-investment and eco-innovations. The
results of our analysis show a strong corroboration of the weak and a
nuanced corroboration of the strong version of the PH.

1. Introduction
The relationship between technological change and environmental policy has received a lot of atten-
tion from scholars and policymakers during the last decades. This is partly because the environmental
consequences of social and business activity are affected by the rate and direction of technological
change, and partly because environmental policies may create new constraints as well as new incen-
tives that may shape the path of future technological development (Jaffe, Newell, and Stavins 2003).
Environmental technological progress is a very broad phenomenon and every description of it
cannot be more than very incomplete. Some examples concern (1) technologies that reduce pol-
lution at the end-of-pipe, such as scrubbers for use on industrial smokestacks or catalytic converters
for automobiles, (2) technologies that increase user value for consumer products (e.g. medicines) by
introducing new production methods that use materials that are less harmful for the environment
and (3) implementation of technologies that are targeted to changes in production processes that
improve energy efficiency.
Environmental regulations (ER) in the form of carbon taxes, cap and trade or environmental stan-
dards have been put in place to solve two market failures: the lack of environmental innovations that
have positive spillover effects on other firms just like any other kind of innovation and the negative
spillover effects in the form of water and air pollution, noise, climate change and non-renewable
energy depletion connected to industrial activity. Let alone, firms innovate too little especially in
environmental technologies (see e.g. Jaffe, Newell, and Stavins 2002; Desrochers 2008; Cerin 2006).

CONTACT Pierre Mohnen mohnen@merit.unu.edu Maastricht University, P.O. Box 616, 6200 MD Maastricht, The
Netherlands
© 2016 The Author(s). Published by Informa UK Limited, trading as Taylor & Francis Group
This is an Open Access article distributed under the terms of the Creative Commons Attribution-NonCommercial-NoDerivatives License (http://
creativecommons.org/licenses/by-nc-nd/4.0/), which permits non-commercial re-use, distribution, and reproduction in any medium, provided the
original work is properly cited, and is not altered, transformed, or built upon in any way.
64 G. VAN LEEUWEN AND P. MOHNEN

Opponents to these ER argue that they increase costs and reduce the firms’ competitiveness. The
Porter hypothesis (PH) asserts that polluting firms can benefit from environmental policies, arguing
that well-designed and stringent environmental regulation can stimulate innovations, which in turn
increase the productivity of firms or the product value for end users (Porter 1991; Porter and van der
Linde 1995). The claim is that there is no trade-off between economic growth and environmental pro-
tection but a win–win situation instead. Environmental regulation would benefit both society and
regulated firms by triggering dynamic efficiency, and these benefits may partially or fully offset
the costs of complying with environmental restrictions.
As argued by Kriechel and Ziesemer (2009), the central issue behind the testing of the PH is the
question whether regulation drives innovation. This calls for a structural modeling approach in inves-
tigating the contribution of ER on green investment and of green investment on innovation and pro-
ductive efficiency.1 We will embark on this task by adopting a Green CDM (Crépon, Duguet, and
Mairesse 1998) type of model, similar to the model used by Lanoie et al. (2011), that allows testing
what Jaffe and Palmer (1997) called the ‘weak’ version and the ‘strong’ version of the PH, referring
to the effect of ER on respectively environmental innovations and economic performance. A
number of studies have found support for the weak version of the PH, little corroboration,
however, exists of the strong version of the PH (see Wagner (2003); Popp, Newell, and Jaffe (2010);
Ambec and Barla (2006); and Ambec et al. (2011) for extended reviews). This paper tries to shed
new light on the PH by using a rich unbalanced Dutch firm panel data set constructed by matching
firms from four different types of surveys.2
The plan of the paper is as follows. In Section 2 an overview of the literature is given. Section 3
discusses the model used in the empirical application. Section 4 presents the data. The results are
presented and commented in Section 5. Section 6 concludes.

2. Literature review
There is a vast body of literature devoted to appraise the seminal contributions of Porter (1991) and
Porter and van der Linde (1995). Originating primarily from empirical regularities found in the analysis
of cross-country differences in the stringency of environmental regulation and economic perform-
ance, the PH has triggered a lot of research both theoretical and empirical in nature. It has been cri-
ticized for being merely based on anecdotal stories and for the lack of a sound theoretical basis (see
Palmer, Oates, and Portney 1995; Cerin 2006).
Some research attempts to provide a theoretical underpinning of the PH. Mohr (2002) argues that
it is a feasible outcome if one allows for the possibility of endogenous technical change. More recent
theoretical contributions that link the environment to endogenous growth are given in Acemoglu
et al. (2012) and Gans (2012). Ambec and Barla (2002) raise the question whether regulation is
indeed needed for firms to adopt profit-increasing innovations, pointing to the first primitive of
the PH, that is, that firms systematically ignore opportunities for profit-increasing innovations, and
that ER can motivate firms to capture ‘low hanging fruit’ offered by environmental challenges to
their business. The literature of behavioral economics offers several explanations for underinvesting
in environmental innovations (see examples in Ambec and Barla 2006). Other studies have analyzed
the interaction between competition and innovation. A recent example is the introduction of organic
pharmaceutical products discussed in Constantatos and Hermann (2011). By avoiding the use of
environmentally damaging fertilizers there is less environmental burden as well as more user
value created because organic drugs are healthier. But a win–win situation between regulation
and innovation is not self-evident because of conjectural variations, consumer inertia or potential
first-mover disadvantages.
Another strand of research focuses on the second primitive of the PH, that is, the assertion that ER
should be well-designed and stringent enough to be successful also from an economic point of view.
An assessment of the instruments of environmental regulation and a judgment of their effectiveness
can be found in Wagner (2003). The myriad of environmental instruments can best be understood by
 ECONOMICS OF INNOVATION AND NEW TECHNOLOGY 65

distinguishing between command and control and market-based regulations. The instruments that set
emission limits and standards fall into the first class and are often labeled ‘end-of-pipe’ regulations.
Environmental taxes and tradable emission permits are examples of the second class of instruments.
Environmental effectiveness can be defined as the ability to achieve a predefined environmental
target. The general view is that this definition is more appropriate for the first class of instruments.
By contrast, the second class of instruments has a higher economic profile, because they are aimed
at triggering static and dynamic efficiency and internalizing environmental externalities.
Looking at the empirical evidence provided in the literature it can be concluded that the picture is
rather mixed (see also the meta-analysis of Cohen and Tubb 2015). The number of papers and articles
that have put the PH to the empirical testing is overwhelming but they do not to lead to a general
consensus. Much of this has to do with the different research strategies and the availability of data.
Compared to empirical evidence at the macro or industry level, the number of papers that use firm-
level data is rather scarce. Besides that, research is targeted at different measures of performance.
Cutting through different reviews of the empirical work testing the PH, it can be concluded that
many studies investigate the impact of environmental regulation on productivity or productive effi-
ciency in a reduced-form estimation approach and that the empirical evidence is mostly at the macro
or industry level. In many cases this type of research leads to the conclusion that environmental regu-
lation has a negative impact on productivity. This conclusion can be easily understood, because regu-
lation forces firms to invest in the environment and doing so increases production costs. If these
investments do not lead to the renewal of production processes then there is no reason for expecting
substantial gains in resource efficiency. There is, however, a measurement issue. ‘End-of-pipe’ invest-
ments may reduce pollution but this reduction is not accounted for in output. The same capital and
other inputs produce two types of output: bad and good output and it is hardly possible to value the
contribution of (reducing) bad output. This raises serious problems when investigating the relation
between environmental regulation and (productive) efficiency.3 An interesting solution to circum-
vent this problem is presented in Domazlicky and Weber (2004) and Weiss (2015). They use data
on toxic releases as bad outputs together with traditional output measures such as real value
added in a non-parametric analysis to identify technical change from efficiency change. Domazlicky
and Weber (2004) conclude that regulation has a negative impact on total factor productivity (TFP).
Weiss (2015) finds that Swedish ER do not affect conventional TFP growth but well green TFP growth
in the Swedish pulp and paper industry.4 Huiban, Mastromarco, and Musolesi (2014) find that the
elasticity of output with respect to pollution abatement capital stock is on average positive in the
French food industry.
More interesting is the research that looks into the impact of environmental regulation on inno-
vation. Notable examples of this type of research can be found in several papers based on the Man-
nheim Innovation Panel. The focus of research stretches from regulation driven innovation alone
(Rennings and Rexhäuser 2010) to the impact of regulation driven innovation on competitiveness
(Rennings and Rammer 2010), employment dynamics (Horbach and Rennings 2012) or profitability
(Rexhäuser and Rammer 2014). Support for the PH is provided by concluding that environmental
regulation does not harm competitiveness (Rennings and Rammer 2010) and that the contribution
of regulation induced innovation to profitability is larger than the contribution of other (more) volun-
tary innovations (Rexhäuser and Rammer 2014). On data from the Swedish pulp and paper industry
Weiss (2015) finds confirmation of the narrow version of the PH, according to which prescriptive regu-
lations are less efficient than incentive-based regulations. Dussaux (2015) on French data does not
find evidence in favor of either the strong or the narrow version of the PH but he finds that ER
lead to a change in the direction of innovation towards more green innovation efforts.
Ideally, a thorough empirical testing of the PH would rely on data of particular types of regulations
that would trigger innovations at the firm level. The most recent edition of Community Innovation
Surveys (CIS) contains new questions on environmental innovation. However, for the Netherlands,
this new module cannot be used to identify the role of different instruments of environmental regu-
lation properly. The only variable available on regulation in this research concerns firm responses to
66 G. VAN LEEUWEN AND P. MOHNEN

environmental regulation in general, either existing or anticipated regulations. By contrast, the

German CIS allows a distinction between types of ER. After matching the firm responses with external
data on the age of regulations, Rennings and Rexhäuser (2010) also investigated the long-term
impact of different types of regulation on the adoption of environmental innovation. Surprisingly
they find that command and control regulations of the end-of-pipe type can stimulate certain
types of long-term innovation.

3. A Green CDM model

The empirical model used in this paper is a modified version of the so-called ‘CDM model’ (following
the initials of Crépon, Duguet, and Mairesse 1998). A graphical presentation of our model is given in
Figure 1.5 The upper part of the figure points to the investment decision stage. In the traditional CDM
model this concerns the decision on how much to invest in R&D. In this paper we face another invest-
ment decision problem, that is, namely how much to invest in order to reduce the environmental
burden of the firm’s operations. The second block of the model describes the green innovation func-
tion with eco-R&D and other eco-investments as an input and eco-innovations, possibly of different
kinds, as outputs. The third block examines the link between innovation outputs and productivity as a
measure of economic performance. We shall now describe each block in detail.

3.1. The eco-innovation input decisions

We consider three types of eco-innovation inputs denoted by Iitk , where subscript i denotes the enter-
prise, subscript t the time period and superscript k the type of eco-innovation input. There are three

Figure 1. A ‘Green CDM model’.

 ECONOMICS OF INNOVATION AND NEW TECHNOLOGY 67

types of them : (1) eco-R&D, that is, research and development expenditure aimed at green products
or green technologies, (2) eco-investments in end-of-pipe facilities, those that reduce pollution but
do not fundamentally change the production process and (3) eco-investments that are ‘process inte-
grated’, that is, investments in new technologies that are less polluting. For each type of investment,
we assume that firms decide first whether to invest or not and then, if they invest, they choose the
investment intensity. Firms will invest in each of these types of investment if the latent value of
investing (denoted by a Dk∗ it ) exceeds some threshold value
ck , which for all practical purposes we
can put equal to zero. We can think of Dk∗ it as the expected return from such an investment.
The decision to invest in input k, Dkit , can be expressed as follows:

′
it = Zit a + h1it . 0 and zero otherwise.
Dkit = 1 if Dk∗ k k k
(1)

The vector Zitk in (1) collects the variables that determine the decision to invest in eco-innovation
input k. If firm i decides to invest in input k the amount that is going to be invested will be determined
by the following equation:

′
Iitk = Iitk∗ = Xitk bk + hk2it if Dk∗
it . 0 and zero otherwise. (2)

The vector Xitk in (2) contains all the variables that determine the intensity of eco-innovation input
type k. The unobservables that determine the decision to invest and the intensity of investment in
eco-innovation input k, respectively hk1it and hk2it are assumed to be jointly normally distributed
with mean 0 and variance-covariance matrix Vk . The system of equations (1) and (2) is a Tobit
type II selection model (Amemiya 1984). It can be applied to each of the three innovation input
decisions.
Although we are dealing in each case with a general investment problem, one can imagine that
the three types of investment are rather distinct. This is particularly the case if we compare eco-invest-
ment performed to comply with ‘control type’ environmental regulation with R&D that is aimed at
developing new goods. Not at least because of the difficulty of evaluating the output of ‘bad
goods’ or of ‘process integrated’ eco-investment, which by definition aims at reducing bad output
and increasing resource efficiency, it is impossible to use standard capital and investment theory
to derive formal investment models. At least, we consider such an exercise beyond the scope of
this research.
We let both the decision to invest and the intensity of eco-investment be a function of the size of
the firm. Larger firms are expected to have greater means and incentives to invest in eco-invest-
ments. It is less certain that the intensity is also affected by the size of the firm, but we do not
want to exclude a scale effect. Government can internalize the environmental externalities by impos-
ing environmental levies or by taxing the price of energy. The environmental levies in total environ-
mental exploitation costs are provided in the Environmental Costs of Firms (ECF) data set.
Constructing an energy price, and especially a marginal tax for energy, is feasible but would substan-
tially reduce the size of our sample. Therefore as an indirect measure of the incentive to save on
energy because of an energy tax we use the energy cost share in total cost in both equations. We
assume the relative size of the environmental levies to affect the decision to initiate eco-investments
but not the intensity of these investments as opposed to the energy cost share, which we let affect
both the decision to invest and the intensity of investment. In the intensity of investment equation
we also control for the presence of eco subsidies, the relative price of investment and labor,6 as well
as industry and time effects. Our central variable of interest, the importance of environmental regu-
lation (existing or anticipated), is inserted as an explanatory variable in each equation. Whenever
possible we use one-period lagged variables to minimize the possibility of endogeneity.
68 G. VAN LEEUWEN AND P. MOHNEN

3.2. Eco-innovation outputs

The middle part of Figure 1 indicates that eco-investment leads eco-innovation output. We consider
two types of eco-innovation output: pollution-reducing and resource-saving eco-innovations. The
former captures environmental innovations targeted at lower utilization of energy or materials and
can be seen as a form of end-of-pipe eco-innovation, aiming just at reducing pollution but not at
changing the production technology altogether. The latter captures environmental innovations tar-
geted at lower CO2 emissions, lower use of polluting materials, less pollution in the production
process and improvements in recycling, and can be considered as a deeper innovation that aims
at curbing pollution by improving the production technology itself. We observe dichotomous vari-
ables indicating whether a certain innovation has been adopted or not. The two types of innovation
are likely to be interrelated in the sense that the return to one innovation could depend on the adop-
tion of the other one for reasons of complementarity or substitutability between them. It is well docu-
mented in the econometric literature (see e.g. Heckman 1978; Tamer 2003; Lewbel 2007) that the
estimation of a bivariate probit with endogenous dummy variables raises severe problems of identi-
fication. There can be no solution (in which case the system is said to be incoherent) or multiple sol-
utions (in which case it is said to be incomplete). The empirical literature offers several solutions to
this problem. In general, these solutions boil down to imposing zero restrictions on the coefficients of
some of the binary endogenous explanatory variables or by relying on recursive or triangular systems,
in which one of the choices is assumed to be leading (see for a discussion of completeness and coher-
ency section 2 of Tamer (2003)). One way to avoid incoherency and incompleteness is to start from a
McFadden (1974) solution by considering a multinomial choice problem based on a random utility
model. This framework was proposed more recently by Lewbel (2007) and applied by Miravete
and Pernías (2006) and Kretschmer, Miravete, and Pernías (2012).
Let the total utility (in this case profit) be
′ ′
Vit = V(yit1 , yit2 ) = (b1 xit1 + a12 yit2 + 11it )yit1 + (b2 xit2 + a21 yit1 + 12it )yit2 . (3)

The dichotomous variables for the two types of innovation are given by yitl (l = 1, 2). There are in
total four possible combinations of innovation choices yielding respectively the following profit out-
comes:
V(0, 0) = 0, (4a)
′
V(0, 1) = b2 xit2 + 12it , (4b)
′
V(1, 0) = b1 xit1 + 11it , (4c)
′ ′
V(1, 1) = b1 xit1 + b2 xit2 + (a12 + a21 ) + 11it + 12it . (4d)

The ‘complementarity parameters’ a12 and a21 are placed in parenthesis because only their sum
can be identified.7 If (a12 + a21 ) . 0 (<0), the two innovations are complements (substitutes). The
model is complete because (latent) profitability is specified for all possible strategies and coherent
because every strategy should have a latent profit that exceeds the profits of all other strategies.
As pointed out by Lewbel (2007), the difference with respect to the traditional multinomial choice
framework is that we do not have a separate specification for V(1, 1) such as b′3 xit3 . Instead, we use
(4d) derived from the model for the total latent profit function. In the Appendix we give a more
detailed account of the construction of the likelihood function and its estimation for a somewhat
more general model, namely a trivariate simultaneous probit, of which the bivariate is just a
special case. The 1lit (l = 1,2), are random errors that are supposed to be jointly normally distributed.
The profitability of pursuing a particular eco-innovation output yitl 1 [ {1, 2} depends on the
adoption of the other eco-innovation output through the ‘complementarity parameter’. It also
depends on the magnitude of the three types of eco-innovation inputs – it is, indeed, interesting
to find out which investments affect which types of innovation. We also control for the size of the
 ECONOMICS OF INNOVATION AND NEW TECHNOLOGY 69

firm, a dummy for innovation cooperation, a set of industry and time dummies and especially the
environmental regulation dummy, which captures whether firms respond to either existing or antici-
pated ER. Since the three eco-investment intensities are endogenous, we replace them by the con-
ditional predictions of their latent variables estimated in the first step. In essence, the coefficient of
environmental regulation provides a test of the weak version of the PH in the terminology of Jaffe
and Palmer (1997).

3.3. Productivity
Finally, we investigate the strong version of the PH by relating ER to labor productivity (LP) via the
effects of eco-innovation output on the TFP component of LP. Suppose we have a Cobb–Douglas pro-
duction function. We can then write the expression for LP as follows:



 2
Qit Kit Mit ′
ln = g0 + gK ln + gM ln + (gL + gK + gM − 1)ln Lit + gl yitl + gw wit + mit , (5)
Lit Lit Lit l=1

where Qit is gross output, Lit is labor, Kit is the capital stock, Mit stands for materials, wit is a vector of
other control variables and mit is a random error term that captures the unobservables. Thus we
regress the log of LP on the log of the capital-labor ratio, the log of the materials-labor ratio and
the log of employment, the coefficient of which captures deviations from constant returns to
scale. We make TFP depend on the presence of the two eco-innovation outputs, pollution-reducing
and resource-saving environmental innovations. We control for industry and year dummies. Since the
innovation output measures are endogenous, we instrument them by the predicted latent innovation
variables from stage 2 (see e.g. Wooldridge 2002). As a robustness check we also account for the
endogeneity of the traditional inputs by instrumenting them by their lagged values.

4. Data
We have constructed a comprehensive data set by linking manufacturing firm-level data for 2000–
2008 from three different surveys:8

(1) The Survey on ECF: This yearly survey covers the period 2000–2008 and beyond. This is one of the
most important data sources for this research project. The survey collects (amongst others) data
on environmental current exploitation costs, environmental subsidies, expenses on environ-
mental R&D and two types of non-R&D environmental investments: ‘end-of-pipe’ eco-invest-
ments and those related to the renewing of production processes (so-called ‘process-
integrated eco-investment’). Because this survey only collects data for manufacturing, our empiri-
cal analysis will be restricted to this branch of the economy.
(2) The CIS survey that during our period of interest was conducted every two years, covering the
periods 2002–2004, 2004–2006 and 2006–2008. This survey contains data on the existence or
anticipation of environmental regulation and about a number of environmental innovation
targets: the reduced use of materials and of energy per unit of output (which we shall denote
as resource-saving eco-innovations) and the reduced CO2 footprint, the replacement of materials
with less polluting and hazardous substitutes, the reduced soil, water, noise and air pollution, and
the recycled waste, water and materials (all four of which we shall regroup under the heading of
pollution-reducing eco-innovations).9 Respondents were also asked whether they cooperated in
innovation.
(3) The Production Statistics Survey (PS): This yearly survey contains firm-level data on gross output,
turnover, value added, intermediate inputs, replacement investment and the total energy
costs. If the depreciation rate is constant, replacement investment can serve as a proxy for
capital stock.
70 G. VAN LEEUWEN AND P. MOHNEN

Table 1. Sample coverage (number of manufacturing firms).

PS CIS ECF
2002 5751 8782
2004 4966 2538 7867
2006 4300 2133 7296
2008 3808 2164 7230
PS, Production Statistics Survey; CIS, Community Innovation Survey; ECF, Survey on Environmental Costs of Firms.

Table 1 summarizes the coverage of different surveys for manufacturing before data linking and
before deleting ‘item non-response’ and/or implausible values (such as a recorded negative value
added). The ECF survey has the highest coverage and the CIS survey the lowest. To include as
many observations as possible we chose not to start with the data that are available after matching
all three available surveys. Instead, we tried to maximize the number of observations by taking all the
yearly data from the ECF and PS surveys and repeating the data from CIS for two successive years. For
the modeling of the three types of eco-investment we used essentially the ECF and PS panel. The only
variable that came from CIS was the environmental regulation. For that variable we put the values for
the years 2003, 2005 and 2007 equal to those for 2004, 2006 and 2008 respectively, which is not
unreasonable since the CIS surveys of 2004, 2006 and 2008 cover respectively the periods 2002–
2004, 2004–2006 and 2006–2008. The predictions from the eco-innovation investment equations
are then used for modeling the eco-innovation outputs. At this stage we absolutely need the CIS
data because it is the only source that collects data on the perception of ER. The dummy variables
that are taken from CIS, that is, the two eco-innovation choices, ER and innovation cooperation,
are again imputed for the years 2003, 2005 and 2007 as explained above. All other variables are
directly taken from the yearly surveys.
Table 2 presents some descriptive statistics for the variables used in the models. The means of the
variables do not change very much before and after merging datasets. It can be seen that about half
as much is paid on eco-R&D as on the other two types of (non R&D) eco-investments. The end-of-pipe
eco-investment is roughly twice as big as the process-integrated eco-investment. About 30% of the
firms responded to ER, either existing or anticipated. Approximately 30% of the firms in the sample

Table 2. Descriptive statistics.

Eco-investment equations Eco-innovation equations Productivity equation
N Mean Std N Mean Std N Mean Std
Employment in ftea 5989 132.6 292.3 6039 132.4 291.3 6581 143.1 293.8
Eco subsidies received (dummy) 5989 0.339 0.473 6039 0.340 0.474
Eco-R&D per fte (1000 Euro) in t 5987 0.106 0.256 6039 0.063b 0.043 6581 0.113 0.320
End-of-pipe eco-investment per fte 5987 0.137 1.487 6039 0.014b 0.019 6581 0.168 2.409
(1000 Euro) in t
Process-integrated eco-investment per 5987 0.070 0.571 6039 0.020b 0.026 6581 0.085 0.980
fte (1000 Euro) in t
Energy cost shares in total production 5989 0.017 0.024
costsa
Environmental levies/total 5989 0.081 0.121
environmental exploitation costsa
Existing and anticipated ER (dummy) 5989 0.285 0.451 6039 0.284 0.451 6581 0.300 0.458
Pollution-reducing eco-innovations (y31, 6039 0.321 0.467 6581 0.334 0.472
dummy)
Resource-saving eco-innovations (y32, 6039 0.287 0.453 6581 0.302 0.459
dummy)
Innovation cooperation (dummy) 6039 0.268 0.443
Gross output per fte (1000 Euro) 6581 229.2 311.3
Capital inputs per fte (1000 Euro) 6581 7.4 10.0
Material inputs per fte (1000 Euro) 6581 167.3 294.0
Value added per fte (1000 Euro) 6581 61.8 39.3
a
In the eco-innovation investment models and the eco-innovation output model we used one-year lagged variables.
b
Conditional predictions of eco-innovation investments per fte from tobit type II model for 2003–2008.
 ECONOMICS OF INNOVATION AND NEW TECHNOLOGY 71

underlying the productivity equation had introduced resource-saving eco-innovations and 3% more
had introduced pollution-reducing eco-innovations.10

5. Discussion of the results

We shall now present and discuss the estimation of each part of the model: the investment equations,
the innovation output decisions and the contribution of innovation to the productivity performance.
The focus of this paper is on the contribution of ER to innovation. We postulate that environmental
investment can be brought into the picture for obtaining a more in-depth analysis of the PH letting ER
affect the different stages of innovation and indirectly productivity.
We pool the data for the years 2003–2008. We control for industry effects and year fixed effects
(except for the investment selection equations). Some of the variables are lagged by one year to
partly circumvent an endogeneity problem.

5.1. Eco-innovation inputs

The selection and the outcome equations of the investment decisions were estimated simultaneously
by maximum likelihood using the tobit type II model. The results for the probit part of the estimates
(see Table 3) clearly indicate that selectivity is present in the data: the correlation coefficients
between the error terms in the selection and the outcome equations are statistically significant.
Larger firms have a higher propensity to invest in eco-R&D but lower propensity to invest in the
other two types of eco-investment. The intensity of eco-investments decreases with size. The
energy cost share, environmental levies and environmental regulation all push firms to invest in
eco-R&D and other eco-investments. Firms tend to invest more in eco-innovation when the relative
price of investment decreases, when the energy cost goes up, when they get innovation subsidies or
when they are forced to innovate because of environmental regulation. Almost all the firms do some
eco-R&D and therefore they are less responsive to ER for increasing their eco-R&D. The other two
types of eco-investments react more strongly to ER with semi-elasticities of 0.4 and 0.32.

Table 3. Eco-innovation input equations (tobit type II).

Eco-R&D Eco-investments
End-of-pipe Process integrated
N total 5987 5987 5987
N censored 28 3666 3829
Selection Coefficient SE Coefficient SE Coefficient SE
log(employment in fte) in t − 1 0.25*** 0.07 −0.06*** 0.02 −0.06*** 0.02
log(energy cost share) in t − 1+ 0.21*** 0.06 0.06*** 0.02 0.05*** 0.02
log(environmental levies share) in t − 1# 0.06 0.07 0.06*** 0.01 0.07*** 0.01
Environmental regulation dummy 0.36* 0.21 0.18*** 0.04 0.20*** 0.04
Constant 2.72*** 0.51 0.39*** 0.11 0.32*** 0.11
log(eco-investments per fte) Coefficient SE Coefficient SE Coefficient SE
log(employment in fte) in t−1 −0.14*** 0.02 −0.08* 0.04 0.03 0.05
Environmental regulation dummy 0.10*** 0.03 0.40*** 0.09 0.32*** 0.09
log(p_investment/p_labor) in t − 1 −0.49*** 0.06 −0.65*** 0.13 −0.34*** 0.12
log(energy cost share) in t − 1 0.10*** 0.02 0.41*** 0.05 0.36*** 0.05
Eco subsidies received dummy 0.81*** 0.05 1.04*** 0.11 1.25*** 0.14
Industry dummies Yes Yes Yes
Time dummies Yes Yes Yes
rho 0.45*** 0.06 0.80*** 0.03 0.51*** 0.16
Log likelihood −8619.4 −8228.8 −7908.9
Note: +In total costs; #In total environmental exploitation costs; *Significant at 10%; ***Significant at 1%.
72 G. VAN LEEUWEN AND P. MOHNEN

Table 4. Eco-innovation outputs (bivariate probit model, with and without simultaneity).
Without simultaneity With simultaneity
Pollution- Resource- Pollution- Resource-
reducing eco- saving eco- reducing eco- saving eco-
innovations innovations innovations innovations
MEa SE MEa SE MEa SE MEa SE
N observations (2002–2008) 6039 6039
log(fte) t − 1 0.01 0.01 0.02 0.01 0.12*** 0.01 0.00 0.00
Predicted log(eco-R&D per fte) −0.04 0.05 0.16*** 0.04 0.36*** 0.06 0.24*** 0.04
Predicted log(end-of-pipe eco-investment per fte) 0.13** 0.05 0.06 0.05 0.12* 0.06 0.04 0.04
Predicted log(process-integrated eco-investment per fte) −0.06 0.06 0.06 0.06 −0.37*** 0.07 0.10** 0.05
Environmental regulation (ER) 0.57*** 0.02 0.42*** 0.01 0.37*** 0.02 0.22*** 0.01
Innovation cooperation 0.15*** 0.01 0.13*** 0.01 0.50*** 0.02 0.24*** 0.01
Industry dummies Yes Yes Yes Yes
Year dummies Yes Yes Yes Yes
Synergy between both types of innovation output – – 0.47*** 0.03
Rho 0.68***b 0.01***b
Log likelihood −4591.41 −6898.96
a
The marginal effects are evaluated at the means of the covariates.
b
The rho parameter is calculated using ‘generalized residuals’ (see Gourieroux et al. 1987).
*Significant at 10%; **Significant at 5%; ***Significant at 1%.

Thus, already at the investment stage of innovation, there is a role for ER and market-based incen-
tives in the form of taxes, price and cost considerations in explaining differences in eco-investment
intensities.

5.2. Eco-innovation outputs

The main focus of this paper is on the innovation decisions of firms (i.e. the innovation output stage of
our ‘Green CDM’ model). Table 4 presents the results for the model that uses two types of innovations:
pollution-reducing and resource-saving innovations. The former can be assimilated with end-of-pipe
eco-innovations, the latter with process-integrated eco-innovations. We report two types of estimates,
those of a bivariate probit model in which the effects of common unobservable variables are captured
by correlations between the error terms of the three equations, and a simultaneous bivariate probit
model with endogenous dummies, our model (3) inspired by Lewbel (2007), in which we allow for com-
plementarity between the two innovation adoption decisions. In principle, the former model is nested
in the latter, but the programs used to estimate the two bivariate probit models are different in their
computations of the boundaries of the integrations and therefore not strictly comparable in terms of
achieved value of the maximum likelihood function. But, since the synergy coefficient, the only differ-
ence between the two models, is significant, we clearly prefer the model with simultaneity. We shall
therefore base the discussion on the estimates from that model.
Eco-R&D has a positive effect on both types of innovations. A 1% increase in eco-R&D increases the
probability of adopting a pollution-reducing innovation by 0.36 percentage points and the prob-
ability of adopting a resource-saving innovation by 0.24 percentage points. End-of-pipe eco-invest-
ments have a weak effect on eco-innovation: a marginal effect of 0.12, significant only at 10%, for
pollution-reducing innovations and an insignificant effect on resource-saving innovations. A one per-
centage increase in process-integrated eco-investments decreases by 0.37 percentage points the
likelihood of obtaining a pollution-reducing innovation but increases by 0.10 percentage point the
probability of obtaining a process-integrated innovation. These direct effects get magnified by the
synergy between the two types of innovations as the presence of one type of innovation increases
by 47 percentage points the occurrence of the other type of innovation. Consequently the total
effects of any exogenous changes in the determinants of innovation are roughly twice as large as
the direct effects.
 ECONOMICS OF INNOVATION AND NEW TECHNOLOGY 73

Table 5. Labor productivity (in log).

OLS GMMa GMMb
Coeff. SE Coeff. SE Coeff. SE
log(capital/labor) 0.05*** 0.00 0.05*** 0.01 0.06*** 0.01
Log(intermediate inputs/labor) 0.76*** 0.00 0.77*** 0.01 0.77*** 0.01
log(labor) −0.00 0.00 −0.01 0.01 −0.01* 0.00
Pollution-reducing eco-innovations −0.09** 0.04 −0.48*** 0.15 −0.52*** 0.17
Resource-saving eco-innovations 0.00 0.00 0.51*** 0.17 0.56*** 0.19
_cons 1.48*** 0.01 1.47*** 0.03 1.47*** 0.03
Year dummies Yes Yes Yes
Industry dummies Yes Yes Yes
R2 0.96
N 6581 4606 4516
a
The two types of eco-innovations are instrumented by all exogenous variables and the predicted occurrence of the eco- innovation
adoption obtained from the estimates reported in Table 4.
b
The two types of eco-innovations and the three inputs are instrumented by all exogenous variables, the lagged inputs and the
predicted occurrence of the eco-innovations obtained from the estimates reported in Table 4.
Significant at 1% (***), 5% (**), 10% (*). No Hansen test is reported since there is no overidentification.

Our results also show that innovation cooperation increases the incidence of both types of inno-
vation but that size only ‘matters’ for pollution-reducing innovation. Most interestingly, our results
show that ER influence the incidence of both types of innovation. The presence of ER increases by
45 percentage points the occurrence of pollution-reducing eco-innovation [0.45 = exp(0.37) − 1],
and by 25 percentage point the occurrence of resource-saving innovation. In other words, in addition
to the indirect effect of ER on innovation investment, there is also an important direct effect of ER on
the incidence of each type of eco-innovation. We consider this last result as a strong corroboration of
the weak version of the PH.

5.3. Productivity
This section looks at the productivity impact of different types of eco-innovations, that is, it examines
indirectly the strong version of the PH. The OLS estimates presented in the first two columns of Table
5 show that there are hardly any economies or diseconomies of scale: the coefficient of the logarithm
of employment is not different from 0. The direct effect of eco-innovation is negative for pollution-
reducing innovations and positive for resource-saving innovations.
A drawback of the OLS estimation is that the innovation dummies are not exogenous. To circum-
vent these shortcomings we have re-estimated the productivity equation using the GMM instrumen-
tal variables (IV) method. The GMM estimation presented in columns 3 and 4 uses the predicted
propensities derived from the innovation output model (3) as instruments for the two eco-innovation
outputs. In the last two columns of Table 5 we also let the traditional factors of production be
endogenous and instrument them by their one-period lagged values. The results of the GMM esti-
mation clearly show that the endogeneity of the innovation output dummies is an important
issue. Although the coefficients have quite different magnitudes, in essence they convey the same
story. Pollution-reducing assimilated to end-of-pipe eco-innovations are negatively correlated to pro-
ductivity whereas resource-saving assimilated to production-integrated eco-innovations are posi-
tively correlated to TFP. Whenever we introduced environmental regulation directly in the
productivity equation, it never turned out significant. In practice both types of eco-innovation
occur jointly: the frequencies of occurrence of resp. pollution-reducing and resource-saving eco-inno-
vations are 63% for (0,0), 6% for (0,1), 10% for (1,0) and 21% for (1,1). This high frequency of co-occur-
rence confirms the complementarity reported in the previous section. It also explains why the
environmental innovation is insignificant when not split into its two components: most of the
time the two innovations occur jointly, the chances of single occurrence are almost equal and the
marginal effects are also almost equal but of opposite sign.11
74 G. VAN LEEUWEN AND P. MOHNEN

Unlike most of the literature (see Ambec et al. 2011; Lanoie et al. 2011), we do come up with a
corroboration of the PH but only for process-integrated eco-innovations. As Horbach and Rennings
(2012) have found with German data regarding the employment effects of environmental inno-
vations, only process-integrated eco-innovations have a positive effect on economic performance.12

6. Conclusion
This paper presents a new attempt to investigate the validity of the PH using a more structural mod-
eling approach than mostly used up to now in the mainstream of empirical research on this topic. We
apply a ‘Green type of CDM’ innovation model to a very comprehensive data set built after matching
three Dutch firm survey data. We distinguish three types of eco-investments: eco-R&D, end-of-pipe
eco-investments and process-integrated eco-investments and two types of eco-innovation
outputs: pollution-reducing and resource-saving. We model the determinants of eco-investments,
eco-innovations and productivity, with eco-investments affecting innovation outputs and the latter
affecting productivity. We are particularly interested in testing the so-called PH that predicted a posi-
tive impact of ER not only on eco-investments and eco-innovations but also on economic perform-
ances like TFP.
Our empirical results strongly corroborate the weak version of the PH. There is a significantly posi-
tive contribution of existing or anticipated ER on eco-innovations, directly and indirectly via their
positive effect on eco-investments that in turn boost the propensity of introducing environmental
innovations. This driving effect is strengthened by the complementarity between the two types of
eco-innovations. Moreover the use of environmental levies seems to be an important element in
the decision making of firms to invest in eco-R&D and eco-investments and play indirectly a major
role in the introduction of eco-innovations.
Whereas many studies cannot corroborate the strong version of the PH we are able to detect one
way in which ER can boost TFP. Resource-saving eco-innovations, which can be assimilated to
process-integrated eco-innovations, increase TFP, whereas pollution-reducing, that is, end-of-pipe,
eco-innovations tend to reduce TFP. The marginal effects of both are almost equal, and in the Nether-
lands at least they occur mostly jointly and have about the same propensity of occurring individually.
Therefore eco-innovation globally does not turn out significantly. ER do not affect TFP directly. Eco-
regulations, if properly aimed at process-integrated eco-innovations, can have a positive effect on
TFP. And maybe if we allowed for more time between the inception of regulations, the occurrence
of innovations and their effect on productivity, we would get an even stronger result.

Notes
1. Green investment refers to investments aimed at reducing the environmental burden of production (see Kemp
2011).
2. The terms eco, environmental and green innovation will be used interchangeably, indicating each time an inno-
vation with a lower detrimental impact on the environment.
3. This problem is well recognized by statisticians and environmental accounting is an important avenue for
National Accounts. See Muller, Mendelsohn, and Nordhaus (2011) for a recent contribution to this problem.
4. The method used is the ‘directional output distance approach’ developed by Chung, Färe, and Grosskopf (1997)
for constructing the Malmquist–Luneberger index to decompose (changes in) TFP.
5. The figure is an adapted version of the one presented in Crépon, Duguet, and Mairesse (1998).
6. The investment deflator is specific to each type of investment but common for all firms in a given sector. The price
of labour, however, is firm specific and is obtained by dividing the cost of labour by the number of full-time
employees.
7. Notice that if theaij ’s are equal to zero, we are in the presence of a bivariate Probit model.
8. We could also have used the yearly Energy use Survey, which collects volume data on energy consumption of
different types. These could have been used to construct marginal energy prices at the firm-level after linking
them with the data on energy costs collected in the Production Surveys. Unfortunately, because of the poor cov-
erage when combined with CIS we would have faced a considerable loss of data.
 ECONOMICS OF INNOVATION AND NEW TECHNOLOGY 75

9. Since we concentrate on environmental regulations and firm performance, we do not exploit the data on environ-
mental benefits from the after sales use of a good or service by the end user.
10. Notice that we have constructed the predicted eco-investments per fte conditional on doing an eco-investment
also for firms for which some observations on environmental levies were missing. Therefore we have slightly more
observations for the eco-innovation output equations than for the eco-investment equations.
11. Our preferred specification is exactly identified, and therefore we cannot perform the test of overidentification.
But if we add the lagged values of the three predicted eco-investments, the Hansen test does not reject the test of
overidentifying restrictions attesting to the quality of our instruments. We do not report the latter specification
because the eco-innovation output effects are then no longer significant.
12. In a previous version of the paper we tried to examine the complementarity/substitutability between eco-inno-
vations and product or process innovations. Unfortunately we cannot separate the eco and non-eco product and
process innovations, and therefore product and process innovations partly contain eco-innovations. Contrary to
Marin (2012) who used a model similar to ours but patent counts instead of innovation occurrences as a measure
of innovation output on Italian data, we did not find that environmental innovations crowd out technological
innovations.
13. To simplify the exposition, we have ignored the i and t subscripts and replaced the choice superscripts by
subscripts.
14. We use superscripts to denote the sum ofaij anda ji . Thus, aij = aij + a ji .

Acknowledgement
This paper was presented at various seminars, conferences and workshops. We thank all participants for their critical
remarks. We are especially grateful to Andreas Stephan for his careful reading of the manuscript and to Mark Cohen
for his critical remarks.

Disclosure statement
No potential conflict of interest was reported by the authors

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 ECONOMICS OF INNOVATION AND NEW TECHNOLOGY 77

Appendix: The likelihood function for the simultaneous multivariate probit model
In this appendix we describe the derivation of the likelihood function for the simultaneous multivariate probit model,
suggested by Miravete and Pernías (2006) and Lewbel (2007), used to estimate the system of equations (4) in our model.
Suppose there are N = 3 types of innovation. The profit function is given by13
′ ′ ′
V(y1 , y2 , y3 ) = (b1 x1 + a12 y2 + a13 y3 )y1 + (b2 x2 + a21 y1 + a23 y3 )y2 + (b3 x3 + a31 y1 + a32 y2 )y3 .

Then there are eight possible combinations of the three types of innovation. Thus, for every adopted combination,
seven comparisons are at stake [(2N − 1)]. To keep things tractable we will focus on strategy (0,0,0), that is, no innovation
at all (thus all comparisons are against zero profits). The computational complexities are due to the derivation of the error
support over all possible combinations (strategy choices). The choice of strategy (0,0,0) yields the following set of
inequalities:14
′
V(0, 0, 0) . V(0, 0, 1) ⇒ 13 , −b3 x3 = UB3 ; UBd3
′
V(0, 0, 0) . V(0, 1, 0) ⇒ 12 , −b2 x2 = UB21 ; UBd21
′ ′
V(0, 0, 0) . V(0, 1, 1) ⇒ 12 , −b2 x2 − b3 x3 − a23 − 13 = UB22 ; UBd22 − 13
′
V(0, 0, 0) . V(1, 0, 0) ⇒ 11 , −b1 x1 = UB11 ; UBd11
′ ′
V(0, 0, 0) . V(1, 1, 0) ⇒ 11 , −b1 x1 − b2 x2 − a12 − 12 = UB12 ; UBd12 − 12
′ ′
V(0, 0, 0) . V(1, 0, 1) ⇒ 11 , −b1 x1 − b3 x3 − a13 − 13 = UB13 ; UBd13 − 13
′ ′ ′
V(0, 0, 0) . V(1, 1, 1) ⇒ 11 , −b1 x1 − b2 x2 − b3 x3 − a12 − a13 − a23 − 12 − 13 = UB14 ; UBd14 − 12 − 13 .

In the above inequalities we make a distinction between the deterministic part (indicated by UBdij ) and the stochastic
part of the right-hand side (RHS). Notice that, for N = 3, we have one inequality involving 13 , two involving 12 and four
involving 11 . Any coherency problem is lifted if we take the minimum of the upper bounds of the inequalities on the
right-hand sides.
So we replace the inequalities for 12 by 12 , min(UBd21 , UBd22 − 13 ) and similarly for the inequalities involving 11 :

11 , min(UBd11 , UBd12 − 12 , UBd13 − 13 , UBd14 − 12 − 13 ).

The (joint) probability for the case of no innovation at all is given by:
Pr{y1 = 0, y2 = 0, y3 = 0 }
= Pr{11 , min (UBd11 , UBd12 − 12 , UBd13 − 13 , UBd14 − 12 − 13 ) & 12 , min (UBd21 , UBd22 − 13 ) & 13 , UBd3 }
= Pr{11 , min (UBd11 , UBd12 − 12 , UBd13 − 13 , UBd14 − 12 − 13 ) | (12 , min (UBd21 , UBd22 − 13 ) & 13 , UBd3 )}
∗ Pr{12 , min (UBd21 , UBd22 − 13 ) | 13 , UBd3 } ∗ Pr{ 13 , UBd3 }.

Similar expressions can be derived for the other combinations of strategies. The expressions involve conditioning
upon unobservable variables to enable GHK simulation for evaluating the integration bounds in the likelihood function.
For example for choice P(0,0,0), the corresponding part of the likelihood function is given by
UBd3 min (UBd21 ,UBd22 −13 |13 )
f (13 )d13 f (12 |13 )d12 ,
−1 −1
min (UBd11 ,UBd12 −12 ,UBd13 −13 ,UBd14 −12 −13 |12 ,13 )
f (11 |12 , 13 )d11 .
−1

where f(.) stands for the density function of the normal distribution.
We estimate this model using maximum simulated likelihood. Methods for estimating such models are readily avail-
able (see Cappellari and Jenkins (2003, 2006) and Train (2003)). The number of draws we use in the simulation is 50.