The paper, based on the literature review, discusses the interrelationship between the environmental regulations, eco-innovations and firm’s market performance. In particular, the paper reviews the main theoretical underpinnings and examines the empirical evidence of this interrelationship. The review shows that eco-innovation can be considered as a crucial factor that on the one-hand enhance environmental situation and on the other mitigate negative economic impact of environmental regulations, making market performance of individual firms more efficient. 

Keywords: eco-innovation, environmental policy, regulation, Porter Hypothesis, performance. 

Recent period, the role of eco-innovations in attaining sustainable development goals become widely acknowledged among academicians and policymakers. The term of eco-innovation (also regarded by some authors as green or environmental innovation) is defined, in academic literature, as the process of developing novel goods, services, systems, procedures which on the one hand provide competitive market value and on the other decrease environmental damage through minimized utilization of natural resources per unit of output or reduced pollution (Fussler and James,1996; OECD, 2009; Rennings, 2000; Arundel and Kemp, 2009). To say distinctly, eco-innovation can be considered as an important factor which mitigates the negative environmental impacts of economic growth and technological progress.

Though eco-innovation can take various forms and modes, five key types of eco-innovation can be distinguished according to Andersen’s taxonomy (Andersen, 2008):

• Add-on eco-innovations - i.e. pollution- and resource handling technologies and services that enhance the environmental performance of the customer.
• Integrated eco-innovations – cleaner technological processes and cleaner products that provide more eco-efficient products or processes compared to similar ones.
• Alternative product eco-innovations –  new technological paths that represent a radical technological discontinuity and offer a new technological trajectory which is more environmentally friendly compared to existing products.
• Macro-organizational eco-innovations – new organizational structures, which assume novelties for an eco-efficient way of organizing society.
• General purpose eco-innovations – include some general purpose technologies that have a substantial effect on the whole economy.

Despite the importance of eco-innovations in addressing environmental issues, there is an apparent underinvestment is such kind of activities on the side of private sector (Stucki et al., 2018). The neoclassical theory provides some explanations of the lack of investments to eco-innovations from the private firms. According to endogenous growth theory (Romer 1990; Aghion and Howitt. 1992; Acemoglu, 2009), eco-innovation like any other type of innovative activity, will be undersupplied by private companies due to technological spillovers. The latter arise from the fact that benefits from innovations are not appropriated solely by innovators in form of private rents, but rather spills over the whole society, since the knowledge advancements become publicly available to other economic agents. However, the spillovers related to the technological change are not the only obstacles for the emergence and diffusion of eco-innovations. The environmental externality, which is related to inability of the private company to appropriate all benefits from inventing environmentally friendly products, explains undersupply of eco-innovations along with technological spillovers (Carrillo-Hermosilla et al., 2009). To say distinctly, not like conventional innovations, eco-innovations are characterized by double-externality.

The market failures, caused by technological and environmental spillovers, calls for active governmental intervention to attain optimal level of private investments in eco-innovations. Generally, two broad categories of public policies that can promote eco-innovations are distinguished in economic literature: demand-pull and supply-push policies (Horbach et al., 2012).  The demand-pull policies usually rely on such instruments as: various regulations, norms and standards, energy taxes, as well as measures focused on creating market demand for new eco-products through public procurement policy or providing information and incentives for end-users. Supply-push strategies assume mainly general subsidies for R&D as well as tax cuts for eco-innovations. (Stucki et al., 2018; Peters et al., 2012; Rennings, 2000). These measures are aimed to stimulate private firms to invest in developing knowledge capital and infrastructure, introducing new process and organization innovations (Horbach et al., 2012).

Though public regulation is considered as a crucial factor for promoting eco-innovations among scholars (Brunnermeier and Cohen, 2003; del Rio Gonzalez 2009), there is still some controversy about the impact of such environmental regulations on market performance of private companies. According to neoclassical economic theory, environmental policy raises costs of compliance with regulations for individual firms and thus it may have negative impact on their market performance and competitiveness (Xepapadeas and De Zeeuw, 1999; Luken, 1997). Alternatively, Porter and van der Linde (1995, p. 98) argue that “…properly designed environmental standards can trigger innovation that may partially or more than fully offset the costs of complying with them.” Thus, according to so-called ‘Porter Hypothesis’ (PH) strict environmental regulations can improve market performance and competitiveness of firms, stimulating them to invest more in eco-innovations. Jaffe and Palmer (1997) further developed this concept by distinguishing between ‘weak’ and ‘strong’ versions of the PH. According to ‘weak’ version “…regulation will stimulate certain kinds of innovation” and “…the additional innovation must come at an opportunity cost that exceeds its benefits (Jaffe and Palmer, 1997; p.610). The ‘strong’ version assumes that environmental regulation will induce firms “…to broaden their thinking and to find new products or processes that both comply with the regulation and increase profits” (Jaffe and Palmer, 1997; p.610).

The empirical evidence, generally supports the ‘weak’ version of the PH, suggesting that more stringent environmental regulation stimulate innovation (Jaffe and Palmer, 1997; Arimura et al., 2007; Popp, 2006). Stucki et al. (2018), however, in the study of the effects of demand-pull and supply-push policies on green innovation for Austria, Germany, and Switzerland, find that taxes and regulations are negatively related with green product innovation if they don’t trigger additional demand. The same time, the results of empirical testing of the ‘strong’ version of the PH are not so obvious. A number of empirical studies show that tighter environmental regulations have negative impact on firms’ productivity and competitiveness (Rassier and Earnhart, 2010; Gray and Shadbegian, 2003; Dufour, Lanoie and Patry, 1998; Lanoie et al., 2011). For instance, Lanoie et al. (2011), in support of ‘weak’ version of the PH, find that stricter environmental regulation stimulates R&D activity. But the study failed to reveal any support for the ‘strong’ version. Yet, a bulk of empirical research proves the ‘strong’ version of PH (Endrikat et al., 2014; Lanoie, Lajeunesse and Patry, 2008; Marin and Lotti, 2017; García-Pozo et al., 2018). For instance, Endrikat et al. (2014) in their meta-analysis of relevant studies, find a strong link between environmental activities and market performance of firms. Lanoie et al. (2008), using lagged results, show that environmental regulations enhance productivity. Similarly, García-Pozo et al. (2018), reveal that reducing the environmental impact enhances both innovative process and labour productivity of transport firms in Spain.

The above review of the interrelationship between environmental regulations, eco-innovation and firm’s performance shows that eco-innovations can be considered as a crucial factor that on the one-hand enhance environmental situation and on the other  mitigate negative economic impact of environmental regulations, making market performance of individual firms more efficient. However, the strength and the direction of this interrelationship heavily depends on the specific settings or framework, within which it occurs. For instance, such factors as - the types and strictness of environmental regulation and other policy option mix chosen by the government; the existence of complementary industry development and innovation supporting policies; the level of knowledge and education; the soundness of market institutions and governance structures - can substantially moderate this interrelationship and affect the probability of occurrence of eco-innovation as well as its efficiency. We think that exploration of the moderating effects of the specific context on the environmental regulations/eco-innovation/firm’s performance link represents an attractive and promising direction for the future research.

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