Environmental regulation can in fact increase worker productivity and overall capital accumulation, according to new research from Italian economists, with green taxes having the largest potential effect on productivity.

Their findings, published Jan. 12 in International Economics, confirm the Porter Hypothesis, an economic theory that predicts that environmental policy will lead to innovative growth and productivity, and counter previous theories that environmental policy is a burdensome cost to companies, the researchers noted.

“In the past, firms were somehow against the environmental stringency, the environmental policy stringency,” said Roberta De Santis, a senior economist at the Italian National Institute of Statistics and co-author of the research. “Adding this … might somehow incentivize firms to implement environmental policy.”

The Porter Hypothesis was first proposed by Michael Porter and Claas van Der Linde in the Journal of Economic Perspectives in 1995. The theory says — and De Santis’ research confirms — that when strict environmental policies are implemented, it forces companies to innovate, which in turn improves production techniques in an environmentally friendly way.

“So it is basically a win-win solution, because on the one side, firms improve their competitiveness,” De Santis said. “On the other side, it also adds to the environment.”

To conduct their research, De Santis and her co-authors examined 14 countries that are members of the Organisation for Economic Co-operation and Development, primarily those in Europe and North America that have closely followed OECD environmental guidelines, between 1990 and 2015. The researchers measured environmental-adjusted labor productivity as environmental-adjusted gross domestic product for pollution abatement in per hour terms, which allowed for the consideration of a country’s technological capabilities and economic structure.

The researchers found that both market- and non-market-based policy measures positively affect labor and multifactor productivity growth, a measure of economic performance that compares the amount of output to the amount of combined inputs such as labor, capital, energy and materials. 

Market-based policies include taxes, renewable-energy credits, energy-efficiency credits and feed-in tariffs, among others. Non-market-based policies include environmental standards, such as limits on emissions, subsidies for research and development and government expenditures.

Green taxes, or taxes levied on businesses and individuals in order to promote environmentally friendly practices, had the largest impact on multifactor productivity, though De Santis and her colleagues wrote that green taxes need to be paired with complementary redistributive policies, such subsidies and grants for companies transitioning to environmentally friendly practices, in order to avoid damaging productivity.

“What is clear is that you have to face this increasing environmental policy stringency, and as a firm, probably the best is if you try to create this win-win solution so it’s passed through an improvement in technology,” De Santis said.

This is the third paper De Santis has written about environmental policy; in addition to examining the Porter Hypothesis, she has also studied how environmental policy impacts international trade.

“I found it very interesting that starting from the [2007-08] financial crisis, many countries … were forced to find alternative economic growth sources, and the green economy was found among the most promising,” she said.

Other potential research avenues, De Santis added, include further study of how specific policies trigger productivity growth and the redistributive impact of new environmental policies implemented by the European Commission.

“According to what we found [in this paper], it will have a positive impact on productivity,” she said, “but what is not in the paper is what might be the redistributive impact,” such as the European Commission supporting EU countries that depend on fossil fuel and carbon commodities. 

The European Union has already allotted €150 billion to support these countries through its Just Transition Mechanism, part of the European Green Deal effort to create a climate-neutral economy in Europe by 2050.

“Basically, this is a very promising sector,” De Santis said. “Obviously because it will help the environment, but also because it might provide a lot of employment and GDP growth.”

The study “Environmental regulation and productivity growth: main policy challenges,” available online on Jan. 12, 2021, from International Economics, was authored by Roberta De Santis, Italian National Institute of Statistics and Luiss University; Piero Esposito, University of Cassino and Southern Lazio and Luiss School of European Political Economy; and Cecilia Jona Lasinio, Italian National Institute of Statistics and Luiss University.