Environmental Regulation and eco-innovation: Insights From Diffusion of Innovations Theory

The paper analyses the relationship between environmental regulation and environmental innovation based on the diffusion of innovations theory. The relationship is tested using a German firm-based panel and a Count Data model, over a short period of time with a large number of observations. We estimate the propensity of firms to innovate in response to five initiating factors, namely the fulfilment of legal requirements, expectations towards legal requirements, public funding, demand for environmental innovations and self-commitment. We also control for R&D intensity, the region and the sector of the company and filter for companies that account for their environmental impact. The results answer the central question concerning the design of environmental policies in order to foster innovation. Comparing a static model to a dynamic one, we show that only dynamic and market-based policies are positively associated with environmental innovation. Conventional regulatory tools, namely technology-based command and control, are not effective for triggering innovative behaviour at the firm level. Lastly, we show that environmental regulation is a necessary condition for eco-innovation.