The Effect of Within-Sector, Upstream and Downstream Environmental Taxes on Innovation and Productivity

The aim of this paper is to investigate the effect of environmental regulatory stringency on innovation and productivity using a panel of 8 European countries for 13 manufacturing sectors over the years 2001-2007. This research topic falls under the heading of the Porter hypothesis (PH) of which different versions have been tested. We consider both the strong and the weak versions of the PH, while also adding some peculiar features to the analysis. Firstly, we assess the role played by environmental taxes, that is an instrument rarely tested as a factor which can support the PH. Secondly, we analyse not only the effect of environmental taxes within a given sector (within-sector), but also the role played by environmental taxes in upstream and downstream sectors in terms of input-output relationships. Thirdly, we test these relationships also 'indirectly' by verifying whether innovation is one of the channels through which higher sectoral productivity can be achieved by imposing tighter environmental regulations. Our main findings suggest that downstream stringency is the most relevant driver of innovation and productivity while within-sector regulations only affect productivity but not innovation. Moreover, the effect of regulations on productivity is mostly direct, while the part of the effect mediated by induced innovations, as measured by patents, is relevant only for what concerns downstream regulations.