Environmental Regulation, Induced Innovation, and Greener Transition: Firm-level Evidence

Abstract

This paper evaluates the impact of environmental regulations on the usage of hazardous chemical substances and the role of innovation activity during the adjustment process. Leveraging datasets that integrate firm-specific chemical usage, patent, and financial statements, in conjunction with the plausibly exogenous chemical safety Acts enacted in Korea in 2015, we find that firms facing more stringent regulations reduced their reliance on hazardous chemicals to comply with the Acts. Innovation turns out playing an important role in facilitating the shift towards more eco-friendly practices. First, our findings suggest that the imposition of stricter regulations induced more innovation activities at the firm level. Second, firms with greater product innovation following the introduction of these regulations disproportionately diminished their usage of hazardous chemicals. Third, this effect is particularly pronounced among firms that use hazardous substances as intermediate inputs, again through product innovation. Thus, the environmental regulations have served as crucial instruments for an economy-wide greener transition.

Keywords: Environmental regulation, Green chemistry, Porter hypothesis, Product innovation, Firm-level analysis JEL Code: K32, Green chemistry, Porter hypothesis, Product innovation, Firm-level analysis

JEL Classification: K32, O31, Q55, Q58, Q53