Conflicting Views: Neoclassical, Porterian, and Evolutionary Approaches to the Analysis of the Environmental Regulation of Industrial Activity

By Hilliard, Rachel | Journal of Economic Issues, June 2004 | Go to article overview

Conflicting Views: Neoclassical, Porterian, and Evolutionary Approaches to the Analysis of the Environmental Regulation of Industrial Activity


Hilliard, Rachel, Journal of Economic Issues


The current European Union approach to environmental regulation aims to ensure that firms achieve continuous improvement in environmental performance and explicitly encourages firms to integrate environmental concerns into production technology. Such approaches to minimizing pollution often lead to economic as well as environmental benefits. The possibility that regulation can generate a "win win" solution, achieving both environmental protection and economic gains, is rejected by neoclassical environmental economists. Using the neoclassical model of a profit-maximizing firm with perfect information, neoclassical environmental economists argue that profit-maximizing cleaner technology will be adopted by profit-maximizing firms without requiring a regulatory stimulus: regulation can only act as a constraint on firms.

Both this argument and its underpinning theory of the firm have been challenged by Michael Porter and Claus van der Linde (Porter 1991; Porter and van der Linde 1995a, 1995b), who have argued that regulation can promote competitiveness-enhancing technical change. "Companies operate in the real world of dynamic competition, not in the static world of much economic theory. They are constantly finding innovative solutions to pressures of all sorts--from competitors, customers, and regulators" (1995a, 120). Porterian firms cannot pursue profit-maximizing behavior; they face problems of information, control, and organizational inertia. With this conception of the firm there is a role for regulation in directing the attention of firms: "strict product regulations can also prod companies into innovating to produce less polluting or more resource-efficient products that will be highly valued internationally" (Porter 1991, 96).

Porter's hypothesis has brought him into direct conflict with orthodox environmental economists who dispute his arguments. The debate is best exemplified in a pair of papers in the Journal of Economic Perspectives where Porter and van der Linde (1995b) presented the first detailed defense of their position and Karen Palmer, Wallace Oates, and Paul Portney (1995) responded with their theoretical and methodological objections. In this paper I use this debate to show how the divergent positions adopted are based on fundamental differences in assumptions about how firms innovate and compete. The arguments put forward by neoclassical environmental economists to dispute the regulation-innovation link are predicated on a neoclassical, profit-maximizing conception of the firm. Porter's argument is developed from a particular, non-neoclassical conception of how firms compete. I outline how this conception lies at the heart of the critique of Porter by environmental economists.

Porter's significant contribution has been to change the type of questions asked about the impact of environmental regulation, but his research fails to demonstrate robust theoretical evidence of a positive relationship between environmental regulation and firm competitiveness. The reasons for this lie in the original research in which Porter presented a richer and less abstracted conception of the firm but did so within the context of a mode[ which stresses the primacy of the external environment over internal firm characteristics as the factor of interest (1990). I argue the failure of both neoclassical environmental economics and Porter's theory to provide convincing analysis is because of their failure to look inside the black box. The evolutionary theory of the firm, with its emphasis on organizational capabilities as the driver of technical change in firms, provides a framework for the development of a coherent model of the relationship between environmental regulation and firm technical change.

Porter and Neoclassical Environmental Economics

The debate in the Journal of Economic Perspectives has a clear focus on the key question of the relationship between regulation and innovation within the firm. …

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