# ENVIRONMENTAL INNOVATION AND REGULATION: SIFTING REALITY FROM RHETORIC

# 

# MAIN REPORT

> *Authors: Antony Scott, V. J. Lein, and E. L. David, Wisconsin
> Department of Natural Resources, Madison, WI; and Donna M. Downing,
> USEPA, Washington, D.C.*
>
> *Inquiries: E. L. David, MB/5, Department of Natural Resources, Box
> 7921, Madison, WI 53707. E-mail: davide@dnr.state.wi.us; Phone: (608)
> 266-8299; Fax (608) 267-3579.*

**Environmental Innovation and Regulation: Sifting Reality From
Rhetoric**

**µCHAPTER 1. INTRODUCTION 3**

I. Purpose of Study, and Principal Findings 3

II\. Focus Of Study 5

Innovation Defined 5

A Model of Innovation 5

Firms and Regulations of Interest 5

Issues and Areas *Not* Addressed by the Study 7

III\. Methods 8

Interviews 8

Mail Survey 9

IV\. Findings and Policy Recommendations 9

V. Structure Of Report 13

**CHAPTER 2. MOTIVATION FOR INNOVATION 15**

I. Introduction 15

II\. Regulatory Compliance 16

A\) Compliance with Existing Regulations 16

B\) Anticipating More Stringent Requirements 21

III\. Direct Production Costs 24

A\) Direct Production Inputs 25

B\) Inventory Management 27

C\) Waste Disposal 27

D\) Production Down-time 29

IV\. Indirect Production Costs 30

A\) Financial Exposure From Liability 30

Liability for Hazardous Waste 31

Liability for Accidental Releases 32

Liability for Noncompliance Penalties 33

B\) Regulatory Burden 34

C\) Employee Exposure 38

V. Product Quality / "Green" Market Niche 40

VI\. External Relations, Firm Ethics 41

VII\. Conclusion 43

**CHAPTER 3. HURDLES TO INNOVATION 45**

I. Hurdles That Affect Incentives for Innovation 49

A\) Industry Expertise Not Incorporated in Standard Drafting 49

B\) Regulations Specify Performance Not Technology 50

C\) Permits Limit Production as Surrogate for Pollution 52

D\) Short Compliance Timeframes 53

E\) Enforcement 56

F\) Differential Regulatory Treatment of Old and New Sources:
Grandfathering and New Source Performance Standards 58

G\) Permit Limits That Do Not Affect Firm Behavior 62

H\) Monitoring and Recordkeeping Costs 64

I\) Regulatory Thresholds: Reclassification That Increases Regulatory
Burden, A Lost Opportunity 67

II\. Hurdles That Affect Firm Sensitivity to Incentives 68

A\) "Culture of Compliance" 68

B\) Costs and Benefits of Industrial Releases Not Tracked 71

**CHAPTER 3. HURDLES TO INNOVATION *(continued)***

III\. Hurdles That Affect Idea Formation 74

A\) Employees Do Not Appreciate Benefits of Innovation 75

B\) Communication Limitations Within the Firm 77

C\) Environmental Quality Managers Lack Time, Training, or
Responsibility 80

IV\. Hurdles That Affect Implementation 81

*i. Internal Firm Hurdles to Implementation 82*

A\) Product Quality Concerns 82

B\) Capital Constraints 84

C\) Non-Depreciated Equipment 86

D\) Employee Resistance to Change 87

E\) Risk Aversion \-- Fear of Going First 91

*ii. Regulatory Hurdles to Implementation 92*

A\) Agency-Preferred Approaches 92

B\) Distinguishing Between Agency Suggestions and Requirements 97

C\) Obtaining and Modifying Permits: The Costs of Delay 98

V. Conclusion 100

**CHAPTER 4. ENHANCING INNOVATION IN WISCONSIN: POLICY RECOMMENDATIONS
105**

I. Regulatory Hurdles that Appear in Practice to Discourage Innovation
106

A\) Performance Standards Applied Too Narrowly 107

B\) Permits Limit Production as a Surrogate for Pollution 107

C\) Differential Treatment of Old and New Sources \-- Grandfathering and
NSPS 108

D\) Permit Limits That Do Not Affect Firm Behavior 110

E\) Regulatory Thresholds: Synthetic Minor Status a Lost Opportunity 110

*II. Theoretical Regulatory Hurdles That Have Limited or No Practical
Effect* 111

A\) Requirements Do Not Specify Technology 111

B\) Enforcement: Firms *Not* Risk Averse to Penalties, but Dislike Being
Considered "Bad Actors" 112

C\) Information Access for Small Firms 113

D\) Little Confusion About Requirements versus Permit Writer Suggestions
114

E\) Permitting Delays Occur, But Do Not Appear to Inhibit Innovation 115

F\) Monitoring and Reporting Environmental Data: Net Effect Uncertain
115

III\. What Works Well: Creating the Right Kind of Incentives 117

A\) Environmental Requirements that Limit Environmental Releases 117

B\) Anticipation of Stricter Future Standards 118

C\) Liability for Environmental Releases 118

D\) Regulatory Thresholds: Reclassification that Reduces Regulatory
Burden 119

E\) Public Information on Environmental Releases 119

IV\. Conclusions 120

Environmental Innovation and Regulation:\
Sifting Reality From Rhetoric

> *"\[O\]ur laws and regulations often end up hindering innovation by
> making it difficult for polluters to try out new technologies. \...
> These barriers to innovation take many forms. For example, most
> environmental standards serve to 'lock in' the use of existing
> technologies. Companies receive neither rewards for trying something
> new nor protection against failure. ... Traditionally enforcement
> personnel have been reluctant to grant exceptions for businesses that
> make bona fide attempts to comply using an innovative approach but
> need extra time or fall short of the regulatory mark. ... Often, the
> promulgation of a new environmental standard takes many years to
> develop. Only at the end ... do companies find out what will be
> required of them. At that point they may be required to meet the new
> standards within a relatively short period of time. ... EPA is
> striving to make our regulatory program more friendly towards
> innovative technologies."*[^1]
>
> > Carol M. Browner, Administrator, Environmental Protection Agency
>
> *"\... We have heard from both users and developers that EPA's
> policies can inhibit the introduction of new and innovative
> technologies into the marketplace. ... A good example is that many of
> the most innovative ideas that might be applied in a particular
> facility have to work their way through a permitting process. And many
> times, the permit writers themselves, or indeed the people who might
> buy these technologies, aren't sure they work."* [^2]
>
> > David Gardiner, Assistant Administrator for Policy, Planning &
> > Evaluation, Environmental Protection Agency

# **Chapter 1. Introduction**

## I. Purpose of Study, and Principal Findings

The above comments by the leaders of the Environmental Protection Agency
(EPA) reflect a prevailing conviction that the current regulatory regime
erects barriers to technology and process innovations that could benefit
the environment. These barriers are thought not to be limited to a
narrow subset of environmental regulations. Rather, they are held to be
embedded in both regulations and regulatory implementation of our
nation's major air, water and hazardous waste legislation. The
implication is that we need significant reform of our major
environmental laws and regulations to prevent them from discouraging
innovation. It is striking, however, that complaints about how the
current regulatory regime affects innovation are based largely on theory
with little empirical basis.

The principal purpose of this study was to determine the extent to which
the current regulatory system does, *in* *fact,* create barriers to
environmental innovation. Our research asked how environmental
regulations actually affect manufacturing firms\' decisions to innovate
in their control or prevention of environmental releases. In addition,
we sought to better understand the full range of hurdles to innovation
that manufacturers face, so that we might put in context the relative
importance of regulatory-induced innovation barriers.

We focused on how firms experience regulatory hurdles to innovation, the
nature and extent of perceived hurdles, and the relative importance of
hurdles in preventing innovation. In both structured interviews and with
survey tools, we looked for instances where manufacturing firms had
wanted to do something innovative but were prevented or hindered from
doing so by the environmental regulatory regime. We analyzed firms\'
experiences to provide direction to policymakers for how they might
remove or lower the regulatory hurdles to innovation.

In stark contrast to the impression of EPA administrators, and the
literature more generally, we found no instances where firms perceived
that the environmental regulatory process erected outright barriers to
innovation. No interviewed firm could identify a specific instance in
which they sought to use an innovative approach for controlling or
preventing pollution but were *prevented* from doing so by environmental
regulations, how those regulations were implemented, or how they were
enforced.

The following questions and responses were typical:

> \[Q: Can you think of any areas in which regulation has gotten in the
> way of doing something that would have been environmentally nifty, or,
> \[would have achieved\] same level of compliance but less expensive?\]
> *"I can\'t think of anything \... If anything, it\'s becoming more
> flexible in terms of what you have to submit if you want to try a new
> technology or something like that."*
>
> \[Q: There\'s a certain amount of talk out there, that regulations are
> counter-productive, and that they hinder environmental improvement,
> that you can\'t go beyond compliance, because the regulations get in
> the way. Do you have any examples, and if you don\'t have any here, of
> other people who have run into this kind of problem?\] "*Well, I\'ve
> just\... I\'ve been around a lot of different projects, waste min
> projects, \[waste min\] philosophies, but I\'ve just, I can\'t think
> of anything where the regulations really have hindered anything. I
> can\'t even think of something\... I can\'t think of an example, no."*
>
> \[Q: Do you see any ways in which the regulations are inhibiting you
> from being innovative at this facility? Doing something new to reduce
> pollution, or - ?\]
>
> 1: "*No."*
>
> 2: "*No."*
>
> 3: "*No, I don\'t think so."*

In this chapter we lay out the focus of study and the research methods
used. We then summarize our findings and policy recommendations.
Finally, we provide readers a roadmap to the rest of the report.

## II. Focus Of Study

The object of our inquiry \-- innovation, and the forces that inhibit it
\-- is fairly complex. We started by defining what we meant by
"innovation," generating a model for how innovation might be curtailed,
and determining which firms and which regulations we would investigate.
The rest of this section outlines our approach, and concludes with a
discussion of issues and areas that are *not* addressed.

### Innovation Defined

Working definitions of "environmental innovation" abound. This can cause
confusion on what is included in \-- or excluded from \-- the
discussion. Innovative actions could include the development of a new
process, the substitution of cleaner inputs, or the adaptation of an
existing approach to the particular circumstances of the facility.
Interviews revealed that most manufacturing firms consider "innovation"
to mean the adaptation of an existing approach to their facility, not
the development of something entirely new. Interviewed manufacturers
explained that they could rarely take an approach off the shelf and
easily apply it to their facilities. Firms know that to get a new
approach to work at their particular facility a great deal of testing
and tweaking must be done. Using firms\' perceptions as a guide, we
defined environmental innovation to be *any change by a facility that
reduces or prevents an environmental release at the same or lower cost
to the facility; or any change that reduces a firm\'s costs but results
in the same or lower level of environmental release*. Our definition
accommodates firms' actions that produce benefits that are difficult to
quantify \-- such as reducing liability for hazardous waste.

### A Model of Innovation

Innovation occurs only after a chain of events: there must be incentives
to innovate, the firm must recognize and respond to those incentives,
the firm must then develop innovative ideas, and finally, must adopt the
innovative approach. Innovation can be hindered at any point in this
process. A hindrance earlier in the process will preclude subsequent
actions. Thus, if the firm does not have or feel incentives to innovate,
none of the other steps will be relevant. The regulatory system affects
the innovation process at many points, and in many ways. Regulatory
hurdles could be erected by laws or rules, by how permit writers
interpret those laws and rules, or by how compliance staff enforce them.

### Firms and Regulations of Interest

Manufacturing firms \-- those firms with Standard Industrial
Classification codes between 20 and 39 \-- are by far the most numerous
type of firm affected by this nation's major environmental laws. There
are roughly 10,000 manufacturing firms in Wisconsin, of which over 5,000
report to the state's environmental protection agency \-- the Department
of Natural Resources. From the list of firms regulated by the
department, we used a multi-stage process to select the firms to study.

Since we wanted to understand the extent and manner in which regulations
erect hurdles to innovative environmental approaches for manufacturing
firms, we wanted to find firms that might have encountered obstacles in
their efforts to develop or implement such approaches. We reasoned that
firms were more likely to encounter hurdles to innovative efforts if
they were in the *process of innovating*. We reasoned further that firms
were more likely to engage in innovative efforts *if they had incentives
to do so*. Firms subject to new regulations are likely to have these
incentives, since to comply with the regulations they may need to change
or modify their production processes. Firms subject to new regulations
are more likely to try to innovate \-- and thus more likely to run into
regulatory trouble while attempting innovation \-- than firms who have
had no recent external incentive to innovate. Finding firms subject to a
relatively recent regulatory push seemed a reasonable way to turn up
examples of firms that have faced hurdles in their efforts to develop or
implement innovative approaches to controlling their releases. For a
great many firms, the 1990 Clean Air Act (CAA) Amendments has provided
just such a regulatory push.

For our research, we selected manufacturing firms to interview and
survey that had *processes* for which innovative pollution prevention or
control technologies had been or were being developed. We chose
"process" as the relevant criteria because innovative efforts are often
directed towards improving specific processes. This selection criterion
contrasts with most regulatory studies that select firms by their
Standard Industrial Classification (SIC) code. For the most part, there
is no neat way to relate SIC codes and manufacturing processes. The
particular processes were selected because they had also been subject to
recent tightening of regulatory standards, as noted above. Processes
chosen as selection criteria were:

> Adhesive Application
>
> Degreasing
>
> Vapor Degreasing
>
> Fiber Reinforced Plastics
>
> Leather Tanning
>
> Metal Pickling
>
> Paint Application
>
> Printing
>
> More than 450 Wisconsin firms use one or more of these processes.

We studied how the environmental regulatory regime affects firms\'
decisions regarding pollution control or prevention. Regulations
affecting releases to all media \-- air, water, and land \-- were
investigated.

### Issues and Areas ***Not*** Addressed by the Study

There are many ways in which the environmental regulatory system might
be burdensome to firms, but yet have little effect on firm innovation.
For example, some firms believe certain regulatory standards are
inappropriate, given the goal of protecting public health. Others take
issue with being regulated at all, viewing it as an invasion of their
privacy and a curtailment of their rights. We do not address such
complaints in our study. Our goal was to address the relatively narrow
problem of environmental innovation.

The study's working definition of "innovation" excluded innovation
directed towards reducing a products\' in-use emissions. We were
interested in releases during the product *manufacturing*, not releases
caused by the products\' *use*. Of course, environmental regulations do
affect innovations in product design. For example, regulations might
cause a small-engine manufacturer to re-engineer its engines to reduce
emissions from when consumers use the engine. Regulations could also
cause paint manufacturers to change paint constituents to reduce
emissions when other manufacturers use their paint. Such innovation was
not the focus of our study. However, in the latter example, we *were*
interested in how regulations might prompt secondary manufacturers to
use innovative paints in the manufacture of their products or to work
with paint suppliers to develop these paints. We examined how
regulations affected innovation by manufacturers in the manufacturing
process, not innovations in the products they manufactured.

Importantly, the study specifically excluded from consideration how the
environmental regulatory system affects innovative efforts of firms that
specialize in *treatment of hazardous waste.* Most manufacturers do not
treat their own hazardous waste; rather, they ship it off-site to be
treated by special treatment facilities. Given the extreme liability
issues associated with hazardous waste treatment and disposal, it seems
likely that such facilities may face special issues that differ from
those affecting the average manufacturing firm. While some manufacturers
do treat their own hazardous waste, and so share the special concerns of
hazardous waste treatment facilities, these issues were not discussed in
this report.

We also did not investigate how the environmental regulatory regime
directly affects innovation by suppliers of pollution control
technologies. Environmental regulations may well affect whether these
firms develop innovative, cleaner, or less costly approaches to
controlling releases. These supplier issues were addressed only to the
extent that the regulatory regime affects manufacturing firms in their
relationship with control technology providers. For example, the study
did include instances in which regulations influenced manufacturers\'
decisions to test or develop innovative approaches in concert with
suppliers of control technology.

The study did not address how *solid* waste regulations, as distinct
from hazardous waste regulations, affect environmental innovation.

##   {#section-1 .unnumbered}

## III. Methods 

We started by generalizing hypotheses derived from our own experience
and a literature review. This provided an understanding of the
prevailing rhetoric about regulation and innovation, and of the common
theories about how and why innovation gets thwarted. As part of this
hypothesis development, we interviewed academics and practitioners
familiar with manufacturing firms and the ways in which regulations
affect manufacturing.

We interviewed technical assistance providers at the University of
Wisconsin - Extension's Solid and Hazardous Waste Education Center
(SHWEC); members of environmental groups; environmental consultants;
representatives of business associations; and state agency staff in
Wisconsin, New Jersey and Massachusetts. Interviewed agency staff
included policymakers, permit writers, and compliance and enforcement
personnel in all media. We solicited perceptions of how the regulatory
regime might hinder or prevent firms from developing or adopting
innovative approaches to pollution prevention or control; where we might
find such instances; and how best to discover these instances.

After selecting our universe of firms \-- the 450 Wisconsin firms that
used one or more of the criteria processes \-- we characterized each
firm by size, relative position and movement on the state Toxic Release
Inventory (TRI) list, awards won for environmental performance, and
enforcement history. We then used a two step process to search for
barriers to innovation. First we interviewed a cross-section of firms,
chosen to represent all processes and multiple firm characteristics.
(Additional firm-selection details are contained in Appendix A.) The
interviews were our major source of information on how the regulatory
process motivates firms to innovate and how it stands in their way. Next
we surveyed all Wisconsin firms that use one or more of the target
processes, using a mail questionnaire, to test interview findings about
(the lack of) specific barriers to innovation.

### Interviews

We conducted in-depth interviews with thirty-eight (38) manufacturing
facilities. Firms of each size, of each type of movement on the TRI
list, of each type of enforcement history, and that both had and had not
won environmental awards were interviewed. We made no attempt to
randomly sample from our list of 450 firms. Our qualitative interviews
cannot be interpreted in any statistical sense, and we made no attempt
to generate statistical data from them. Rather, we wanted to learn about
the experiences of a wide variety of firms. Interviews allowed us to
probe further into the issues specifically relating to innovation and to
explore the multiple points at which innovation might be hindered.

Interviews lasted two to four hours. Each interview was taped and
transcribed. Quotes are verbatim although not attributed to the
individuals or firms to preserve confidentiality. Interviews were guided
by a list of questions, which can be found in Appendix B. Questions were
tested both internally and in facility interviews, then reviewed and
revised. Since interviewed firms differed in many respects, questions
were tailored to each facility.

We asked firms whether they had taken actions to reduce their
environmental releases in the last five years. Each such effort
recounted was followed up with questions to elicit what had motivated
action, how the decision to act had been made, and what had hindered
their efforts. If a firm had done nothing to reduce releases we
attempted to determine the reasons for inaction.

We also asked firms about their experiences with the state environmental
regulatory agency, the Wisconsin Department of Natural Resources (DNR.)
We asked specifically whether efforts to innovate had been adversely
affected by the regulatory regime. When firms said they had not been so
hindered they were prompted further. We asked, for example, whether they
had experienced difficulty innovating or had failed to innovate because
of delays in permitting; a fear of triggering stricter standards; a
sense that their permit writer preferred a certain approach for their
environmental compliance; or a problem in having enough time for testing
an innovative approach.

### Mail Survey

When in-depth interviews of environmental quality managers at the
manufacturing facilities failed to produce *any* examples of regulatory
barriers to innovation, we decided to confirm these findings. We did
this by developing and conducting a mail survey. The survey was sent to
450 manufacturing facilities in Wisconsin having production processes of
interest. Seventy percent of the firms responded. The survey instrument
asked CEOs and environmental quality managers three questions. The first
question was designed to elicit problems with the environmental
regulatory regime that are unrelated to innovation, as defined in our
study. The second question defined innovation and asked firms if the
regulatory system kept them from innovating. If firms thought they had
been prevented from innovating, they answered the survey's third
question, which asked for the specific barriers encountered. Firms were
given a list of seven hypothesized barriers to innovation; they were
also asked to explain their responses. The survey instrument is
contained in Appendix C.

The survey was meant to elicit concrete examples of where environmental
regulations or their implementation had prevented innovation. It did not
uncover any examples of environmental regulations preventing
facilities\' innovative control of pollution. While many firms reported
having problems with the environmental regulatory regime, none were
related to innovation as defined in this study.

## IV. Findings and Policy Recommendations

We found a few instances where the environmental regulatory system can
make it more difficult for firms to innovate than to use conventional
approaches to pollution control. We found a few other situations where
the regulatory system fails to provide firms a strong incentive to
innovate.

We were interested in hurdles that might cause firms to choose
conventional approaches in preference to innovative approaches to
pollution control, or that might cause firms to forgo pollution
reductions altogether. Some regulatory requirements hinder firm action,
but they do not hinder the use of innovative approaches any more than
conventional approaches to pollution control, and thus do not concern us
here. We did confirm some hurdles that could dissuade firms from
innovating. Of note, surprisingly few of the identified hurdles stemmed
from the regulatory system. More typically, hurdles arose because of
internal corporate characteristics, such as capital constraints or the
firm's corporate culture.

We did find instances in which the environmental regulatory regime
*does* appear to hinder innovation, either by making it more difficult
to innovate or by failing to provide strong incentives for innovation.
We summarize these regulatory hurdles and our policy recommendations
below. We then note the various barriers to innovation that the
theoretical literature considers important, but that appear in practice
not to importantly hinder innovation. Finally, we review motivations to
innovate that are generated or augmented by current environmental
policies and attempt to underline areas in which existing policies and
practices might be strengthened.

Regulatory hurdles are of two types; they discourage innovation or fail
to encourage innovation. The regulatory hurdles that could discourage
innovative approaches, and therefore merit immediate attention include
the following:

> · Permits that limit production or production inputs, in addition to
> pollution, can blunt firms' incentives to consider creative ways to
> reduce emissions per unit of product. EPA requires such production
> limits, in response to a court order; so short of challenging the
> court decision, state and federal agencies can not directly address
> this problem. Nevertheless, agencies should make certain that firms
> understand that their production cap is *based* on their releases and
> that it may be recalculated if the firm demonstrates that it has
> reduced its releases. Expedited permit review for such changes may
> lessen this hurdle to innovation.
>
> · Performance standards that apply to the content of the input
> material, rather than to environmental releases from production
> activities, can hinder innovation. While it doesn't appear that this
> application of performance standards has deterred much innovative
> activity, it remains possible. Either such standards themselves should
> be revisited, or an expedited variance process should be developed for
> innovative approaches that run into conflict with these standards.

The instances where the regulatory system fails to create or enhance
incentives to innovate, and therefore should be remedied where possible,
include the following:

> · Existing sources and new sources are treated differently; existing
> sources are subject to less stringent requirements than are new
> sources. This reduces the incentive existing sources feel to innovate
> to reduce releases. Further, grandfathered equipment is subject to
> less stringent requirements and can retain its preferred status in
> perpetuity, regardless of its depreciable life. This can curtail or
> slow the replacement of equipment with cleaner, innovative approaches.
> To the extent possible, grandfathering in legislation and regulations
> should include sunset provisions. In addition, new source performance
> standards could be written to apply to all equipment and firms after a
> number of years. The point would be to encourage creative replacement
> or upgrade of older polluting equipment with cleaner approaches to
> production.
>
> · Permit limits sometimes do not affect firm behavior, but rather are
> so easy to meet that firms do not feel this incentive to innovate to
> reduce environmental releases. There is a clear tradeoff between
> policy objectives that should be explicitly considered and balanced as
> regulations are developed and permit limits are calculated.
>
> · Synthetic minor status, allowed under the Clean Air Act Amendments
> Title V program, fails to create a threshold of reduced regulatory
> burden for many firms. This represents a lost opportunity to motivate
> innovative activity. This situation should prove instructive to
> Congress and the EPA in future legislation and rulemaking.

There are various barriers to innovation that the theoretical literature
considers important, but that appear in practice not to importantly
hinder innovation. These theorized regulatory hurdles appear to have
limited or no practical effect on innovation. Findings include the
following:

> · Regulations do *not* specify the technologies firms must use.
> Rather, both in the regulations and in firms\' experiences,
> requirements specify the level of environmental performance to be
> achieved.
>
> · Firms do *not* appear *unable* to distinguish agency requirements
> from agency suggestions. No interviewed firm felt that their permit
> writer had a preferred approach to compliance.
>
> · Fear of noncompliance penalties is *not* a factor in deterring
> innovation. However, firms dislike being treated like "bad actors" if
> attempts to innovate run into difficulty, as happened to one
> interviewed firm. Firms were largely unaware of available variances
> that would prevent compliance problems by allowing them more time to
> get their innovative approach up and running. Agencies should consider
> ways of better publicizing the existence of variances for innovative
> endeavors. Agencies should also consider addressing issues of
> enforcement style in training programs or review for enforcement
> staff.
>
> · Information *is* *available* for small firms. It does not appear
> that small firms have significantly less access to information about
> innovative approaches than large firms. However, environmental
> managers at smaller firms are more likely to have multiple
> responsibilities and so are less likely to have time to avail
> themselves of the information. Unless small firms feel that the
> potential benefits of tracking emerging requirements and researching
> alternative approaches is worth the investment in time, providing
> *more* information and seminars is unlikely to have the desired
> result.
>
> · Permitting delays occur, but do *not* appear to favor conventional
> over innovative approaches to pollution prevention and control.
>
> · Time *is* required to monitor, record, and report environmental
> data. Some firms said that time spent on fulfilling reporting
> requirements *might* otherwise have been used for innovative efforts.
> Nevertheless, innovative firms noted that they often used the
> environmental data generated to support their environmental
> decisionmaking. Moreover, firms indicated that having to take time for
> required reporting acted as an important incentive to change processes
> and thereby avoid the reporting burdens of the regulatory system.
> Therefore, the net effect of required reporting on innovation cannot
> be ascertained.

Even while the environmental regulatory system erects some hurdles to
environmental innovation, it also provides important incentives for
firms to innovate. Policymakers concerned about innovation should use
care when considering proposals that would dilute these regulatory
incentives. Firms must comply with environmental requirements.
Frequently, they pay attention to the actual and potential costs
associated with releases and their control. The following regulatory
motivations, found to be especially effective at motivating innovative
approaches to pollution control, should be enhanced or strengthened
where possible.

> · Environmental requirements that limit firms\' releases. One example,
> product bans, motivates considerable innovative activity. Stringent
> regulations that require firms to reduce or watch their releases also
> motivates innovative behavior.
>
> · Future standards anticipated to be more stringent. Firms innovate to
> stay ahead of the regulations.
>
> · Liability for process wastes. The potential for uncertain liability
> prompts firms to innovate to eliminate their use of hazardous
> substances altogether.
>
> · Reduction in regulatory burden when releases fall below a threshold.
> Thresholds can motivate innovation if the regulatory burden is
> substantially lessened for firms that reduce their releases below the
> threshold, i.e., the firm is subject to less burdensome recordkeeping
> or reporting requirements or is no longer subject to a regulation.
>
> · Public release of firms\' pollutant information. The Toxic Release
> Inventory status appears to provide a powerful motivation to innovate.

## V. Structure Of Report

The report is structured as follows.

Chapter two addresses the range of factors that motivate firms to launch
innovative efforts. Some innovation occurs in response to regulatory
incentives. Other innovation occurs in response to market incentives. By
exploring *why* firms innovated, the chapter provides a basis for later
discussion of how and why innovation gets discouraged. It thus helps to
clarify the policy choices available to policy makers who seek to
unleash further innovative efforts.

Chapter three addresses the hurdles to innovation that firms experience.
These hurdles arise from the environmental regulatory system and from
internal firm characteristics. The chapter seeks to place the effects of
environmental regulations in context, by addressing more broadly why
innovation sometimes fails to occur. It is intended to provide an
understanding of the relative impact of regulations \-- as opposed to
internal firm restrictions \-- on innovation. Understanding the size of
the regulatory-induced problem should facilitate better decisionmaking
and solutions.

Chapter four addresses potential policy responses to regulatory hurdles
to innovation. This chapter has three sections. The first section
focuses on instances in which the environmental regulatory regime *does*
appear to hinder innovation, and discusses policy options for addressing
them. The second section addresses various barriers to innovation that
the theoretical literature considers important, but which in practice
appear not to importantly hinder firms' innovation efforts. Finally, the
last section reviews motivations to innovate that are generated or
augmented by current environmental policies. This section attempts to
underline areas in which existing policies and practices might be
strengthened.

A number of appendices follow. They include:

A\) the method and selection criteria for choosing firms to interview or
survey;

B\) the interview question template;

C\) the survey method and summary statistics;

D\) a review of current environmental regulations that provides the
context for the study;

E\) the conceptual model used to think about and organize hurdles to
innovation.

#   {#section-2 .unnumbered}

# CHAPTER 2. MOTIVATION FOR INNOVATION

> *"\[T\]he reason they are regulating us is because we are stupid
> enough not to regulate ourselves. If industry would have regulated
> themselves from the beginning, the government wouldn't have had to do
> it. That's the only reason the government is doing it. It's because we
> didn't do it ourselves. \... they can't trust us because we didn't do
> it in the first place."*
>
> An Environmental Manager at a manufacturing firm

## I. Introduction

Firms face a variety of incentives to innovate. This chapter looks at
the factors that motivate firms to try to control pollution, prevent its
generation, and dispose of it in innovative ways. By exploring *why*
firms innovate, the chapter provides a basis for later discussion of how
and why innovation gets discouraged. It will thus help to clarify the
policy choices available to encourage further innovative efforts.

Firms respond to four broad categories of motivation. First, they want
to *comply with environmental regulations.* Second, firms may innovate
to curtail *direct production costs* \-- by reducing costs of material
inputs, waste disposal, or inventory. Third, firms may innovate to
reduce *indirect production costs:* pollution control equipment costs,
personnel and paperwork costs of compliance; liability for hazardous
wastes; and employee exposure. Finally, *non-cost factors* can prod
firms to improve their environmental performance. These include being a
good environmental citizen, cultivating a positive public image, or
meeting customer demands for "greener" production.

Firms usually have multiple and complementary reasons for innovating.
Switching to non-hazardous inputs can reduce both employee exposure and
the firm's liability for hazardous wastes. Similarly, firms that
establish excellent compliance records can both reduce the likelihood of
suffering fines for noncompliance, and also generate a positive public
image. In consequence it may be difficult, if not impossible, to isolate
which motivations are most important. Thus the basic purpose of this
chapter is to explore the types of motivations that encourage action. In
general, we do not evaluate the relative effectiveness and importance of
different types of motivations.

However, it must be stressed that the need to get into and remain in
compliance with environmental regulations is a primary driver of firm
efforts to reduce industrial releases in an innovative fashion.
Interviews suggested that environmental regulations create incentives to
innovate in at least three ways. First, existing regulations, new to the
firm, stimulate innovation to achieve compliance. While some firms
choose to get into compliance using conventional approaches, others
respond by trying to innovate. Second, the credible threat of future,
more stringent regulatory standards causes many firms to think
dynamically about compliance options. In anticipating future regulations
such firms look beyond needing to comply with existing law and instead
plan their capital expenditures with an eye towards likely more
stringent regulations. Finally, since environmental regulations -- such
as hazardous waste disposal regulations -- impose costs on firms which
they otherwise could avoid, the desire to reduce such costs is an
important incentive to develop and adopt innovative pollution prevention
and control technologies. Together, these three motivations powerfully
suggest that while environmental innovation may flourish, given a
certain degree of regulatory flexibility, flexibility should not be at
the expense of clear and enforceable requirements.

## II. Regulatory Compliance 

### A) Compliance with Existing Regulations

"\[Environmental regulation\] is a constraint, and everybody recognizes
it."

The need to stay in compliance with environmental regulations is a
constraint within which businesses operate. Firms found not to be in
compliance not only face fines; ultimately, non-compliant firms can be
shut down by the regulating agency. Many interviewed firms believe that
stringent regulations provide strong incentives to search for new
compliance methods.

> "We're not disputing the fact that regulatory requirements are needed.
> They absolutely are. Some people would never change if they weren't
> forced to do it."

Environmental regulations are an important source of motivation. For
innovative firms, regulatory requirements tend to provide what firms
consider to be a floor for acceptable environmental performance. This
innovative firm\'s environmental manager explained that environmental
requirements prompted them to consider the metals in their discharge
water, but that they then attempted to go beyond regulatory requirements
by eliminating chrome used in their metal plating process:

> "When regulations came into effect that said we had to limit the
> metals that we were putting into our discharge water, we knew we had
> to treat. \... And we knew that we would like to get rid of any of
> that that we could. So we are looking at ways of either reducing the
> amount of chrome that we use, or eliminating it entirely. \[Although\]
> we aren\'t producing enough chrome in our sludge now that it\'s
> \[classified as\] hazardous anymore, \... we would like to get it out
> of the plant entirely."

Another firm\'s environmental manager explained that the regulations
helped them focus on important pollutants.

> "I consider any chemical that has a regulation or requirement as
> something that you have to control. \... So we will control it. We
> will put engineering controls in, if necessary, and we will find a
> lower, suitable substitute. In reference to methylene chloride, we\'ve
> been looking for 3 years and we\'re still continuing looking. If you
> run across anybody\'s got some ideas, please call me!"

Some standards effectively cap a firm's total pollutant releases,
thereby encouraging firms to innovate to reduce emissions per unit of
product. An environmental manager of a firm located in a non-attainment
area for VOCs explained that the need to stay under the firm's emission
cap of 25 tons \-- and simultaneously meet customer demands for new
product \-- had initiated a search for innovative ways to reduce
emissions:

> "\[We are\] in the process now of working on installing a color
> flexographic press ... A lot of our customers are wanting it. ... I
> have got to try and figure out how to fit it into 25 tons. Right now,
> normal operations, it calculates out to roughly 50 tons. So, I have to
> go come up somewhere with 25 tons of offset. ... We are going to make
> the shift in a couple of other areas by changing our processes. In
> some of the other areas in the plant, shifting the materials that we
> are using there to go to lower-emitting materials."

Firms motivated to innovate by pollution caps are often concerned with
losing operational flexibility. If a firm's emissions start to approach
its legal levels, then production -- the firm's life-blood -- may be
effectively capped. The desire to avoid production constraints functions
for some firms as a powerful motivation to innovate.

> "It's no secret that we need to get away from solvents. ... The
> regulations say that if you get to where you're doing too much of
> this, you're handcuffed. And we need to be very flexible. We need to
> be able to move quickly. We need to be able to move without a lot of
> encumbrances. And if you get to the point where you're running 200
> tons of stuff, or even get much over 100 tons you're talking
> incineration ... So you have this play of the regulatory world
> pressing down on us, keeping the pressure on, and internally us
> working very hard to remain flexible."

Because innovation takes time, and because they view the risk of
production constraints as unacceptable, some firms adopt innovative
approaches long before they are in any danger of bumping into production
bottlenecks created by emissions caps.

> "With the things we've done recently, we're within our permits and I
> could run seven days a week if I wanted to."

Similar reasons were given by a firm explaining why it had recently
installed an innovative coating technology:

> "Real simple. I can increase my capacity without generating more VOCs.
> ... It can be used to increase overall capacity, it can be used to
> reduce VOCs should more stringent regulations come about ... it can be
> used in any of a number of ways to offset. ... You're only limited by
> creativity on that stuff, I guess."

Regulations that ban a product or compound are the ultimate emissions
cap, and are particularly strong motivators of innovation. Since every
facility using the product or compound has to change their product or
processes, innovative activity flourishes. For example, the number of
new aqueous cleaning processes exploded in the wake of the 1990 Clean
Air Act Amendment's ban on CFC cleaners.

> \[Q: You got rid of 1,1,1-trichloroethylene (a banned chemical),
> right?\] "Well, yeah. But I think we wouldn't have if there wasn't a
> law there."

One firm made a number of innovative changes to its production processes
to eliminate 1,1,1-trichloroethylene. Although a product ban was the
ultimate motivator, the cost savings that arose from an escalating tax
on the product helped direct the firm's attention to innovations that
would facilitate a rapid phase-out.

> "In \'93, we eliminated the use of all 1,1,1-trichloroethylene because
> of its impact. It\'s considered ODC, \"ozone depleting compound.\" At
> least, it tears up the good ozone. So we completely eliminated,
> eliminated that. And this was a good \-- I don\'t know if that\'s the
> right term \-- this was, I would have to say, a positive thing because
> we can justify savings here. You know, the price went up for everybody
> using trichlor. Yeah, okay, it was a mandated kind of a deal, but it
> got everybody\'s attention."

Some firms respond to product bans by changing decisionmaking structures
and adopting a wider pollution prevention approach. Once established,
such institutional innovations can foster further production
innovations.

> "The \[mandated\] elimination of ODCs obviously sparked that activity.
> We put together a multi-functional group of people; we had everybody
> and his brother working on that project, it seemed like. We had
> purchasing people, product engineering people, manufacturing
> engineering people, ourselves, and eventually marketing people got
> involved."

Stringent regulatory standards[^3] can induce firms to change their
operations in a number of ways. Firms may respond by changing their
production equipment. Or they may substitute less polluting inputs to
production, such as water-based instead of solvent-based cleaners. Often
this creates pressure for suppliers to develop new, less polluting
inputs. Larger firms work with their suppliers to develop satisfactory
substitutes. In the following quote, the firm's paint supplier not only
created a lower-polluting paint, but also came up with a new product in
the process.

> "And we\'ve had some \[paint\] that came close to the limits and we
> said, 'We won\'t accept this for our plant; you\'ll have to
> re-formulate, it\'s too close \[to the legal limit\]'." \[Q: Did your
> supplier reformulate when you asked them to do that?\] "Yes, they did.
> \... \[O\]ur current supplier made a reformulation and actually came
> up with a new name for the product as well."

Frequently firms do more than just ask their suppliers to reformulate.
Manufacturers often work actively with suppliers to be sure that
substitute inputs meet both environmental and product-quality needs.

> "And it\'s like the painting. We went from the regular VOC to the high
> solids. And it took some \[doing\] to get there. You had to work with
> \[paint supplier\]. \[The new paint\] didn\'t really change our
> process a whole lot, and it satisfied the requirements. \... But the
> first step was getting the lead out \[of the paint\]. Then it was
> reducing the VOCs, down from basically 7 lb/gal to 3.5, that was the
> magic number. So, then it was a matter of working with the paint
> manufacturer more than just us saying: 'Hey. This is my regulation,
> this is what we got to do, what do you offer?' "

Innovation seems particularly common where new regulatory standards are
imposed on an industry sector. By reducing limits, new standards clear
the field of well-accepted and proven approaches to achieve compliance.
This firm explained how new standards unleashed a multitude of ways to
comply with new chromium standards for tanneries:

> "There's some people that have chrome recovery. \[Company name\] do, I
> think. At least they did; I don't know if they still do chrome
> recovery. There are tanneries that settle rather than float. There are
> people that float, like we do. ... And none of it is 100%, so a few
> places I guess may even have both. But everybody was pretty new on the
> block at the time. I mean, we all were hit about the same time."

Compliance concerns can be a strong motivation for innovation. This firm
was motivated to move to an innovative environmental technology because
it was bumping up against its emissions cap and wanted to avoid
compliance problems:

> "There were compliance concerns, because we were bumping the ceiling".

An existing compliance problem motivated this firm to actively search
for innovative approaches to get back into compliance:

> "We have to tighten up our sewer treatment program. We have had some
> excursions from our limits, and we are now under an order to make it
> all right. \... We\'re constantly asking people about our sewage
> treatment."

This environmental manager explained that an incident of noncompliance,
in which they had violated their limits, had pushed the firm to innovate
to eliminate a hazardous waste.

> "\[T\]here\'s a way of doing it, I guess, when you\'re pushed to do
> it. We had a 6 month window, okay. In other words, from the time I did
> the test and I violated, then you had to do three consecutive
> \[clean\] tests in a row to be in compliance. So we struggled like
> heck and got there; but he \[DNR agent\] says, hey, he\'s going to be
> back in 6 months to do his test again. Either we\'re going to spend
> this money to put in a treatment plant or, let\'s see what we can do
> to get out of it. And so in that 6 month period we were able to come
> in and basically eliminate zinc phosphate."

Some firms innovate, hoping it will generate a positive relationship
with the regulating agency, and thereby help them to avoid compliance
problems. As one firm put it, taking actions to reduce or eliminate
pollution may persuade the Agency to be more lenient if permit limits
are exceeded.

> "If you\'re only one foot over the line in compliance, if there\'s a
> 'whoops', you\'re in trouble. If you go the extra \[mile\], and
> there\'s a 'whoops', you, and I say you, your department comes in and
> says, 'Boy, you really did a lot, you know, we\'re not going to beat
> the snot out of you.' But if you\'re just that inch over, just getting
> by all the time, then someone comes in and says, 'Hey, you\'re not
> doing a very good job.' So we\'re trying to do that extra ... we\'re
> looking at zero discharge, totally, okay. ... So that\'s \-- it\'s a
> self-motivation \[my colleague\]and I have to get there".

Firms innovate to maintain or achieve compliance. Firms may also adopt
innovative environmental approaches to reduce the likelihood of
enforcement penalties: reducing pollution reduces the probability of
exceeding permit limits and therefore the probability of getting
severely fined. The issue of enforcement activity does not always
originate with the environmental protection agency. One firm explained
that action to reduce its VOCs was prompted by a citizen suit.

> \[Q: So you said earlier that you had been bumping up against VOC
> limits, and that, ultimately I guess, affected how much you could
> produce. When did that happen?\] "Oh, when I got here in the early
> \'90s, in 1992, that\'s kind of what I found. The manager at that time
> had been here for 25 years. He came from a different school of
> thought, and it \[regulation\] was just something that was an
> inconvenience, a pain in the ass to him. And in fact, we got in
> trouble with \[a non-governmental organization\]. When I walked in, it
> was my job to clean up that mess. We got sued by \[a non-governmental
> organization\]."

In summary, regulatory requirements can prompt firms to change their
production processes. Some firms respond to the challenge by developing
or adopting innovative approaches. Regulations that effectively cap a
firm's emissions of a given pollutant create a number of incentives to
innovate: to stay in business; to reduce exposure to fines and
penalties; to ensure production flexibility; and to foster a positive
relationship with the regulating agency. Product bans serve as the
ultimate emissions cap, and as such they can be particularly good at
encouraging innovative efforts. Some firms determine what innovative
steps to take by first forming novel collaborations within the firm. In
these and other ways, the need to modify operations that is induced by
new regulatory requirements tends to unleash a burst of innovation, as
firms search for sensible ways to comply with these requirements.

### B) Anticipating More Stringent Requirements

Regulatory requirements are not static; they change over time. Typically
they become more stringent in response either to advances in
understanding of environmental problems or to new cheaper pollution
prevention and control techniques. This section addresses how
anticipating stricter environmental regulations can motivate firms to
innovate.

A quick glance at major pieces of federal environmental legislation
reveals that many regulatory standards are intended to evolve and become
more stringent. The Clean Water Act requires the EPA to periodically
evaluate whether existing limits remain appropriate: the agency "shall"
amend limits where engineering advances have resulted in "best available
technology" becoming better, with the tighter limit corresponding to
what the new technology can achieve.[^4] "Reasonably available control
technology" (RACT) under the Clean Air Act also may become more
stringent as engineering, economic, and environmental factors change
what is determined to be "reasonably available."

Standards may also become more stringent if the EPA concludes that
existing limits are insufficient to meet environmental goals. For
example, the Clean Air Act requires "maximum achievable control
technology" (MACT) for control of air toxics, but calls for stricter
health-based controls if the MACT standard does not reduce the human
health risk within eight years to less than one in one million.[^5]

The credible threat of more stringent future regulations encourages
firms to think creatively about compliance strategies, for many of the
same reasons that firms respond to existing standards. Further, firms
considering future, more stringent standards in their decisionmaking may
have greater opportunities for innovating than firms concentrating only
on compliance with existing regulations. Potential benefits of
anticipatory innovation include reduced compliance costs compared to
non-anticipating firms, increased flexibility in choice of ultimate
compliance strategy, and reduced regulatory uncertainty.

Many firms said they anticipate future requirements:

> "\[W\]hen the VOC limits were first established ... we were in
> compliance at that point with the rules. But I think since then we've
> probably cut VOCs at least in half, \... maybe even in thirds from
> what we used to be using. You know, because it's prudent ... you know
> that the direction of the environmental laws are going to get stiffer,
> and it only makes sense; as the technology develops towards the
> water-based it just makes sense to go in that direction."
>
> "\[W\]e knew at some point we would have to be doing it, didn't know
> if it would be this year or next year or the year after that but, it
> seemed like it was coming soon. And it was, again, one of those things
> that felt like the right thing to do..."

Anticipating future environmental requirements in decisions about the
installation of new capital equipment -- purchased for non-regulatory
reasons -- can save firms money in the long run. Several interviewed
firms explained that anticipating regulatory changes enabled them to
enjoy cost savings by being able to avoid making multiple process
changes.

> "Well, I mean, there was a realization that at some point down the
> pike you're not going to be able to use solvents anymore. So why start
> with solvents and have to change, when you can start without them
> initially? So, if you're designing a process from scratch, you might
> as well take the most friendly path long-term. Yeah. Actually, we
> started this project before the ban, before we essentially had to do
> it."

The following firm installed equipment that can be readily adapted to
meet tighter environmental standards in the future, so as to avoid
additional capital expenditures.

> "So there's a lot of things we've got in there for production, for
> flexibility. Like being able to add clear-coat later. ... But we've
> also put in things so that we can put in environmental improvements
> when the technology is available later on. The booths will be able to
> handle lower VOC paints when they are available. The ovens, I guess,
> will be able to handle some of the powder coatings ..."

For some firms, the benefits of anticipating more stringent requirements
derive from having additional time and flexibility to develop innovative
solutions. This gives firms more control over the strategy they
ultimately use to comply with future regulations once the regulations
are promulgated. When asked about the motivation for dramatically
reducing VOC emissions, one firm\'s environmental manager explained:

> "Well, we felt that the rules and regulations were leading us in that
> direction, and we wanted again not to be playing with these things at
> the end of the tunnel, we\'d rather be at the beginning of the tunnel
> and be a leader if we could find ways to do these things."

Other firms are prompted to eliminate certain chemical emissions on the
basis of their experience with past regulatory change. This suggests
that a certain degree of "institutional memory" within a firm can help
strengthen a firm's ability to recognize and respond to regulatory
trends.

> "You know, it\'s kind of self-driven. I started out in the foundry 25
> years ago, when if you got to 90% of air particulates you were doing
> good. Then it went to 95, then it went to 97, then it went to 99.
> Pretty soon we were spending 50% of every dollar for emission control.
> Well, I saw it with PCBs, 'Just put a tag on it, you\'ll be okay.'
> Well, then it got a little, now it got to the point that you can\'t
> even have PCBs. ... See, so, historically, the regulations have always
> gotten stiffer. If I get rid of the process, I don\'t have to face the
> regulation. Okay. So, that\'s part of the driving force. Maybe it\'s
> from that time on, but if you get to zero discharge you don\'t have to
> contend with things."

Given the increasing stringency of regulatory requirements, many firms
have reduced their exposure to the risk of expensive regulations by
completely eliminating their use of various polluting chemicals. Once
facilities start thinking about how to creatively reduce their emissions
a problem-solving mentality can be fostered in which complete
elimination of some pollutants appears both possible and desirable.

> "We kind of carried 33/50 out to total elimination. For example,
> methyl ethyl ketone. It used to be the biggest solvent that we used,
> not only in this plant but in a lot of our plants. ... MEK is gone.
> Trichloroethelyne, 1,1,1-, that one's gone ... Toluene ... was also on
> the 'extremely hazardous chemicals list,' the list of 100 extremely
> hazardous. So we targeted not only 33/50, but anything that was on
> that list, 100 chemicals list. Cellusol acetate is another one that's
> history; that one used to be a big, big solvent here."

In anticipating stricter requirements, firms may find themselves moving
toward a source reduction mentality so that they do not have to worry
about future standards.

> "\[V\]ery early on \... in 1990, when the Clean Air Amendments were
> still being finalized we were getting together and saying 'the hand
> writing is on the wall, we\'ve got to be out, we\'ve got to do
> something'. And so we chose to go to source reduction as the method.
> As long as we were doing it, that\'s the way we decided to go."
>
> "Yes, it was more an anticipation, there was really not 'you have to
> get out of this.' And then it started to snowball."

One firm looked at potential MACT standards for air toxics and decided:

> "We just want to be out of it, and now is the time to do it."

Firms that eliminate industrial releases reduce their exposure to
regulatory risk. In so doing they reduce their costs, even if
quantifying the magnitude of such reductions is not practical.

Some firms anticipate stricter environmental requirements and attempt to
forestall them by voluntarily improving their environmental performance.
For example, several interviewed firms participated in EPA's 33/50
program, which called for companies to voluntarily reduce emissions of
17 high-priority toxic chemicals by 33 percent by 1992 and 50 percent by
1995. When announcing the voluntary 33/50 program, EPA suggested that it
was thinking about issuing regulations to control emissions but wanted
to see how far industry could go on its own.[^6] Firms took the hint.

> "We just sort of saw the handwriting on the wall. It was only a
> question of time ... The handwriting said 'either do it voluntarily or
> we'll do it for you at some other point, and it won't be convenient'."

In summary, future regulations can provide firms with a significant
incentive to think in innovative ways about their current and planned
environmental performance. Firms have the greatest incentive to innovate
when the regulatory trend was clear and predictable. Benefits from such
anticipatory innovation include reduced compliance costs, increased
flexibility in choices over ultimate compliance strategy, and reduced
regulatory uncertainty. Many anticipatory firms choose to eliminate
regulated releases altogether.

## III. Direct Production Costs

Environmental performance, as such, is often not what motivates firms to
innovate. Rather, motivation derives from the savings associated with
reductions in material inputs, waste disposal costs, inventory
management costs, and production down-time. The environmental
consequences are considered a welcome bonus.

> "Generally the bottom line is: does it save money? We comply with the
> law, of course. But beyond that, we change to save money."

Among interviewed firms, those environmental managers focusing on the
cost-reduction benefits of improved environmental performance, rather
than on compliance concerns, were often the most effective at motivating
innovative activity at their firms. Framing environmental activities in
terms of enhancing the firm's bottom line helped these managers 'sell'
environmentally preferable approaches to management and staff. One
particularly innovative

firm explained the company culture \-- that reducing production waste
was both good for the environment and good for cost minimization.

> "As a company we really try to approach it from dollars and cents
> rather than looking at regulations as an inconvenience. Waste is
> waste. If you waste something, you're wasting money. That's really the
> driving approach."

### A) Direct Production Inputs

Production inputs are processed into manufactured product or are lost in
the form of environmental releases during the manufacturing process.
Efficient use of an input requires that as little as possible becomes
waste. Reducing wastes helps ensure costly inputs result in products
which can be sold, rather than in environmental releases for which firms
bear costs. The desire to minimize direct costs can motivate innovations
that reduce environmental releases.

Manufacturers use a variety of methods in their attempts to minimize
costs which also reduce environmental releases. They might attempt to
increase the efficiency with which input materials are used, reducing
the inputs used per unit of product by reducing the waste generated.
They might do this by implementing housekeeping measures or by changing
their processes. Sometimes firms reduce input costs and environmental
releases by substituting less costly alternative inputs which also are
less toxic. Firms might be able to not only reduce input costs, but also
reduce costs associated with waste disposal or release.

This environmental manager explained that his company's efforts to
reduce solvent evaporation is motivated by a desire to minimize
production costs:

> "And, of course, it would help us save money if we \-- I think
> there\'s what they call a 'make up' solvent \... to make up for
> whatever has evaporated along the line. And we go through a whole lot
> of that. And that\'s where we would save money \-- if we could prevent
> that from happening."

The following firm explained that its waste minimization program is a
major avenue for cost reduction. While their efforts benefit the
environment, the major push is to reduce production costs:

> "We have a lot of major cost reduction programs, looking at different
> ways of doing things to minimize waste ... For example, a lot of our
> systems have an ongoing continuous rinse water that goes through the
> system and just goes ... to our wastewater pretreatment system and we
> have to treat it, and it costs money to treat, 7 cents a gallon; you
> have to buy all the chemicals, you know, sulfuric acid and all. ...Our
> motivation is: Where can we cut costs?"

One environmental manager explained that his firm's decision to change
to a more efficient and environmentally preferable coating technology
was motivated by the opportunity to reduce costs and to be a good
corporate neighbor:

> "\[T\]he over-spray plumes were extremely heavy. And you could
> actually see them come out of our exhaust stack. ... We would have
> wanted to stop that regardless of cost savings. But the cost savings
> makes it a whole lot more palatable. I mean, it was like a 3 month
> payback project."

Low transfer efficiencies for some painting processes can result in
higher input costs and higher levels of waste, both air pollution and
solid waste. This can motivate firms to search for and develop processes
with increased transfer efficiencies which reduce costs associated with
waste.

> "We installed a parts washer and dip tank with a water-based enamel to
> apply paint to service parts. ... This was a VOC reduction, which gave
> \-- being more efficient utilization of our paint \-- resulted in some
> cost savings."

Sometimes firms can substitute a less toxic input, which is also less
expensive, for a more toxic one. This is especially true if the waste
by-product from the more toxic material requires special (i.e. more
expensive) disposal. Many of the interviewed firms stressed both of
these complementary savings. The following firm explained the motivation
behind its search for a less toxic production input:

> "MEK is costly. ... And you know, we\'re also paying for the emissions
> of it but also to get it recycled or incinerated. So if I can find
> something that was safer and cost effective, definitely I\'d go for
> it."

Another firm pointed out that its decision to find an alternative
chemical to 1,1,1-trichloroethane, while initially motivated by
regulatory push, also reduced its production costs:

> "I would have to say \[switching to a less polluting alternative was\]
> a positive thing because we can justify savings here. You know, the
> price went up for everybody using trichlor \... In industry, if we
> want to reduce our costs or maintain our costs we have to invest some
> money in."

Similarly, this firm explained that its participation in the EPA's 33/50
program led it to make input substitutions that both reduced pollution
and saved money:

> "And we came in, and in one fell swoop, cut about 60% of our VOCs out
> of the plant. ...We just, when \[33/50\] came out as a program, there
> was a couple of clever things we thought we could do, we just did them
> \... It saved the company money, and we looked at the environment,
> there was a win-win situation for everybody."

### B) Inventory Management

Reducing the volume of inventory and substituting less toxic inputs can
reduce costs. In addition, reducing the number of different types of
inputs used can improve a firm's bottom line. Firms that simplify their
inventory management by reducing the number of production inputs often
simultaneously improve their environmental performance. Because
inventory cost reductions may require innovative approaches, innovation
may ultimately be sparked by a desire to reduce inventory costs.

Offering customers many different coatings, for example, requires a
large inventory so that different color needs can be met. This takes
more accounting and management time. Further, having multiple inputs can
affect the prices paid for coatings, since smaller batches of any given
type are ordered.

> "Fewer coatings, it's less inventory, okay? Have to keep inventories.
> The more coatings you have, the more separate inventories you gotta
> have, okay? You have to invest in inventory."

Similar sentiments were voiced by a firm that discovered that it could
reduce the number of different oils that it used in its production
processes:

> "It was a management decision that we just didn't want to be fooling
> with more things than we had to fool with. ... We just started looking
> at ways to save money. One of them is to buy one kind of oil instead
> of six kinds of oil. Rather than maintain six inventories of oil."

Maintaining many different materials increases clean-up costs. With each
change in material inputs, production machinery may need to be cleaned
to prevent contamination. This requires cleansing materials and
increases the waste of the original production inputs.

> "The more you change over \[the more\] you waste coating. \[And\] you
> waste solvent washing up, cleaning up."

The upshot is that reducing inventory management costs can also improve
a firm's environmental performance. But to reduce the number of
different inputs that a firm must use often requires that the firm
develop innovative approaches to production.

### C) Waste Disposal

Unlike production savings associated with reducing inputs and inventory,
savings from waste reduction exist only because regulations make such
waste expensive. State and federal environmental regulations from the
1970s and 1980s require that waste water be treated and air emissions
controlled. Other regulations place stringent requirements on how
hazardous waste is transported, stored, and disposed of. Environmental
regulations make waste generation costly to the firm, and create
incentives for firms to find innovative ways to reduce their industrial
releases.

The desire to avoid or minimize these costs has triggered much
innovation. The following firm explained that the prospects of hazardous
waste disposal costs had prompted it to switch to non-hazardous input
materials. They avoided expensive testing, as well as the fees paid to
disposal facilities.

> "The motivation is the disposal of the \[hazardous\] product after
> you\'re done. TCLP \[a test of hazardous waste\] costs what, \$200 to
> \$280, \... plus I\'ve got to ship it, dispose of it. So now I\'m
> looking at a \$1,000 drum of product that only cost \$250 to buy. So
> it\'s a dollar and cents motivator."

The benefits of eliminating toxic materials from their production
processes was echoed by other firms who pursued input-substitution
strategies:

> "Well, we have eliminated chrome so we are down to one hazardous
> waste. ... We would like to eliminate all hazardous waste if we could.
> ... It\'s good business."

Such efforts are facilitated if firms have accounting systems that show
the potential cost savings associated with waste minimization.
Understanding of the actual costs of pollution generation enabled this
firm to justify the capital expenditures necessary to take innovative
measures to separate and minimize its hazardous from its non-hazardous
waste:

> "We split the streams and treated the lead \[metal\] waste separate
> from the other waste and decreased our volume of sludge generated by
> only treating the part that was toxic. And it was a pretty big capital
> expenditure to do that. We were originally paying -- well, we had
> close to \$720 a drum for disposal. And now we're paying, I think
> \$110 a drum for disposal. We've also taken it from being hazardous to
> being non-hazardous."

Other firms reduce hazardous waste disposal costs by reusing
intermediate wastes on site. The following firm explained that its
decision to begin internal recycling of wastewater was motivated
entirely by the cost-reductions that recycling generates:

> "We have started installing re‑circulation units on our die spray
> systems. So we pick up the wastewater, filter it, and re-spray it on a
> part. We have eleven die casting machines; I believe we have it on
> maybe three of them. It\'s just something we\'re starting to do now.
> That one is a straight‑out cost reduction. We don\'t ship the waste,
> we don\'t pay for it type of deal. So that one was very justifiable."

Finally, some firms reduce their waste disposal costs by developing
innovative control technologies. One firm that developed an innovative
waste-water treatment strategy was initially motivated by the desire to
reduce waste disposal costs.

> \[I\]t actually started out as a cost-saving thing. We had some
> inefficient probes in there that were high maintenance, to the tune of
> \$1,000 a month, on four separate probes. We found some \[new\] probes
> that control pH that were more suited to that hostile environment and
> we taught our people how to care for them.

### D) Production Down-time

For some firms, innovative approaches to reducing waste also help to
avoid production down time. When production lines must be shut down,
workers are idled, nothing is produced and time is lost in cleaning up
and restarting the line. Production down-time is reduced when fewer
different production inputs are used. One firm explained:

> "The more coatings you have, the more you have to change over. ...
> Lost production time. That sort of thing. So if you have closer to a
> universal coating, that means the lines can run longer without
> changing over, which means they don't have to stop. Okay? So
> productivity, generate less waste, and all sorts of things."

Hence, minimizing the number of different materials used in production
can reduce inventory management and production costs, as well as
environmental impacts. Firms can simultaneously cut their down-time and
environmental impacts in other ways besides simply minimizing the number
of different materials used during production. In the following quote,
innovations to reduce emissions had the added benefit of reducing
breakage of a continuous strip of film. The nylon film is the medium
onto which dyes are placed for making flexible packaging.

> \"Actually, the nylon\'s advantage to us, above and beyond being able
> to keep \[down\] our emissions, which is the primary reason the
> advantage to us, is that it\'s a stronger carrier film to start with.
> When that machine is running, it\'s running at 40 feet per minute.
> \[When \] we have a film break, we have one heck of a mess real fast.
> Nylon carrier film lessens the chance of breaking a film. It\'s a
> no-brainer. It\'s going to cost us a little more up front for the raw
> material, the nylon film, but it lessens the impact on the environment
> and lessens the potential down-time and clean up time, and waste.\"

##   {#section-3 .unnumbered}

## IV. Indirect Production Costs

The foregoing suggests that the prospect of reducing production costs
can spur firms to search for innovative ways to prevent and control
pollution. All of the costs considered so far are relatively easily
quantifiable, so long as accounting systems are adequate. But given
existing laws and regulations, pollution generation can also impose
costs that are no less real but which are much harder to quantify.

Liability for hazardous wastes, compliance paperwork costs, and employee
exposure all can be affected by the amount of pollution generated, and
are all costs ultimately borne by the firm. In contrast to many of the
direct cost reduction motivations (which often induce firms to take
measures that produce environmental benefits as a fortuitous
side-effect), the difficult-to-quantify costs considered here often
induce firms to focus attention directly on "environmental" projects. An
environmental manager provided his perspective on the relative
importance of these indirect and difficult-to-quantify costs of
pollution generation:

> "If you do a straight labor cost or if you only base it on two or
> three traditional accounting parameters, environmental solutions
> hardly ever pay off. But if you can take risk assessment into effect,
> liability reduction, safety, if you take in a number of nebulous
> things that drive the accountants crazy ...."

This section explores difficult-to-quantify costs associated with
pollution generation that can motivate firms to reduce their
environmental impact. The first subsection addresses the role that
liability can play in firm production decisions. Liability for hazardous
waste management and clean up, for being in noncompliance with
regulations governing ongoing operations, and for accidental spills and
releases are each considered. The second subsection explores how
reducing emissions can reduce the paperwork costs associated with
regulatory compliance. The third section concludes by considering the
employee benefits associated with less polluting processes.

### A) Financial Exposure From Liability

Liability can provide a significant motivation to find innovative ways
to prevent and control pollution. Importantly, it can encourage firms to
implement controls and safety procedures beyond those specifically
required. Liability concerns can originate both from within the firm and
from customers who wish to secure reliable suppliers, i.e. suppliers
unlikely to go out of business because of large environmental
liabilities. Overall, interviewed firms cited liability as a major
influence on their environmental compliance strategies.

> "Well, environmental liability is always a big concern of ours. We've
> done things which actually increase \[our direct\] cost, but our
> liability is substantially less ...."
>
> "On environmental, you look at the cost to comply with the regulation
> that's out there. But there's in many cases a bigger driving force:
> what's the liability if you don't do this in the first place?"

Three different types of liability can motivate firms to innovate. The
Comprehensive Environmental Response, Compensation, and Liability Act
(CERCLA, or Superfund) establishes strict liability for environmental
damage caused by hazardous waste; cleanup costs can be enormous. Second,
firms can be liable for natural resource damages, cleanup, and
third-party damages that can stem from accidental pollution spills.
Third, firms are subject to penalties for noncompliance with
environmental requirements.

#### Liability for Hazardous Waste

Liability for clean-up of hazardous waste can be enormous. Under CERCLA,
a firm can be held individually liable for cleanup of an entire waste
disposal site, even when the site received only a small amount of the
firm's waste. When CERCLA was enacted many firms were startled to
realize that what had traditionally been acceptable waste disposal
practices now opened them to great financial exposure. A facility was no
longer insulated from future liability even if in full compliance with
today's discharge limits, disposal practices, or other regulatory
requirements.

One firm explained that Superfund liability drove its waste minimization
efforts. Concern about future costs has been integrated into the firm's
"culture" and its decisions about production processes.

> "That has been a plus to our waste minimization effort because any
> time we bring up a \[production\] issue we try to throw in how much
> liability there is going outside. ... We have done a lot of things in
> this company to bring our liability back in our walls instead of
> having it out around the company. We find that our own best interest
> makes a better decision train and then if we do screw up, we don\'t
> have such a hard time swallowing the problem. When someone else messes
> up handling your waste or whatever it is, then you get into a fighting
> match: 'Who's responsible, who's liable?' and you end up pushing your
> resources that way ...fighting it through the courts."

Several interviewed firms concluded that the best way to control
potential Superfund liability was to reduce or eliminate the amount of
waste generated. The following firm explained that the possibility of
future liability had prompted it to recycle its waste materials, even
though it was more expensive to do so than to landfill them and despite
the fact its waste is not currently considered hazardous.

> "Based on that, it would actually be less expensive for us to dispose
> of this in a landfill rather than recycling it. Now we are not going
> to do that, we are not going to landfill it. ... It costs less to go
> to a company that is just going to stick it in the ground, rather than
> a company that is going to put it into a kiln and recover all the
> metals... \[Q: So you decided to continue to recycle.\] Yes. \[Q: Was
> concern about liability for your waste out there in a landfill part of
> that decision?\] Yes."

Superfund liability concerns prompt firms to take measures that benefit
the environment in ways that extend beyond their own efforts to minimize
or eliminate hazardous waste. Because most firms cannot completely
eliminate their generation of such waste, they are forced to rely on
facilities that specialize in its treatment, storage, and disposal
(TSD). Environmental contamination is likely to be reduced if such TSD
facilities themselves take extra precautions. Many interviewed
manufacturers take particular care in choosing a TSD facility to try to
ensure that they are not subject to future clean-up costs; they are
often willing to pay extra for TSD services that they consider reliable.

> "Why I started using \[name\] was because of reliability. ... They
> supply our virgin solvents, they supply our waste pickup. I've been
> down through their facility a dozen times. ... They are highly
> recognized in the area for good quality, the way they dispose a thing.
> They never landfill under any circumstances. So I think I am paying a
> bit more, but I got a very secure feel of what I am doing and that's
> worth the extra added expense."
>
> "...\[It\] affects my business decisions on who I use. And I'm willing
> to spend a little more money for a little more comfort as far as
> what's going to happen thirty years from now."

Customers may help to make firms more aware of incentives to reduce
liability. Several interviewed firms explained that customers evaluated
a firm's exposure to environmental liability as one of several measures
of reliability. Some firms said they were helping to reassure customers
by reducing their potential liability.

> "\[E\]verybody has been downsizing the number of vendors that they
> have, so now they are down to one or two casting suppliers and they
> are doing everything physically possible to ensure that nothing
> happens to them. And they are even beginning, much more, to look at
> the environmental aspects. ... \[They want to make sure that\] the
> company is reliable, that they don\'t have Department of Justice at
> their door, incurring costs, or that they are not going to go out of
> business."

On the other hand, some firms find themselves using less hazardous
materials in their production processes because their *suppliers* have
switched to more environmentally friendly products. For example, one
interviewed firm started moving to water-based coatings because:

> "Primarily the suppliers were moving in that direction because of the
> liability on their part. Not so much on the user end, but the
> manufacturer."

#### Liability for Accidental Releases

Firms can also be liable for damages caused by accidental releases (as
opposed to disposal practices or permitted releases.) For example, the
Oil Pollution Act (OPA) makes entities that spill petroleum into surface
waters liable for cleanup, natural resource damages, and third party
damages caused by the spill. Similarly, the Clean Water Act (CWA) makes
responsible parties liable for cleanup costs for a spill of hazardous
substances into surface waters. Liability costs can be extremely large
under the CWA and the OPA, as illustrated by Exxon's well-publicized
experience following a large oil tanker spill into Prince William Sound
in Alaska in March 1989.[^7]

Several interviewed firms explained that they had taken measures to
increase the security of areas that were more likely to be the site of
an accidental spill, to avoid damages and liability.

> "Last year we put in a new truck off-loading area, a containment area,
> in case of a truck spill. Now, it wasn't a direct compliance issue
> there, but it was more general liability and, you know, related to
> things like stormwater or just general environmental liability."

Other firms take steps to eliminate the possibility of accidental spills
altogether. This firm removed oil storage tanks from its facility to do
just that:

> "... We're on top of a hill. The road's there and the river's across
> the way. You know if you rupture, it'll be 120,000 gallons or
> something of oil sitting up in various tanks up on that hillside. And
> we wanted to be out of that liability."

#### Liability for Noncompliance Penalties

In addition to liability that is directly related to damages from
accidental spills or improper waste disposal, firms are also subject to
penalties for permit violations. Penalties for noncompliance can be
high. The Clean Water Act calls for \$25,000 per day per violation,
increasing to \$100,000 per day for repeat offenders who knowingly
endanger human health or property.[^8] The Clean Air Act and Resource
Conservation and Recovery Act (RCRA) have similar penalties.[^9]

As discussed earlier in the section on regulatory motivations, many
interviewed firms wished to have a broad safety margin to help ensure
compliance and avoid penalties. This firm explained what prompted it to
make capital expenditures to allow it to reduce its emissions beyond
what regulations require:

> \[Q: Has your firm ever made capital expenditures to go beyond
> compliance?\] "Well, we've got a number of things on our wastewater
> treatment that I would say have done that." \[Q: What was your
> motivation?\] "Partly safety margins; broaden\[ing\] them. You are
> safer, less likely to miss a target number."

This theme was regularly echoed by others:

> "We still have to over-comply. I mean, you can't live at 90% of your
> most stringent wasteload allocation. You just, you wouldn't sleep at
> night..."

The possibility of criminal prosecution can similarly prompt firms to
act. Indeed, the threat of criminal penalties can help boost
environmental performance as a management priority.

> "Well, I mean if someone is going to go to jail, they get real
> motivated".
>
> "\[Y\]ou sign these hazardous waste manifests, and one of the things
> it says on there is you have to have an ongoing program to reduce
> hazardous wastes, et cetera. And once in a while my name appears on
> there, so! (laughter)..."

Among interviewed firms, most environmental managers are held
responsible for the environmental performance of their company, and are
likely to have their performance evaluated less favorably when
noncompliance penalties or expensive waste cleanup or liability awards
occur. This suggests that liability can act as a very powerful
motivation for managers to identify and implement new ways of reducing
the potential for penalties, spills, and hazardous waste responsibility.

> "I sign all the forms ... Your name goes on there and you want to make
> sure that the people that work for you and with you are doing the
> right things because ultimately I'm responsible, as \[name\]'s
> supervisor, of the things he does. ... If they feel lazy one day and
> they, 'ah, who cares, we'll dump it out', you know, well if it comes
> back, which it ultimately does ..."

In summary, liability creates an incentive for innovative approaches to
reducing pollution. Theory suggests that liability creates an incentive
for firms to prevent pollution in the first place rather than risk
potential future costs. The theory seems to be validated by the firms
interviewed for this study.

### B) Regulatory Burden

Besides requiring that firms curtail pollution, environmental
regulations also impose costs associated with monitoring, reporting, and
recordkeeping. These can include personnel costs, costs of collecting
information, completing paperwork, understanding and dealing with the
regulatory apparatus, and facing inspections and potential noncompliance
issues.

If a firm can entirely *eliminate* waste streams it reduces its
regulatory burden. But, in addition, many environmental regulations have
applicability levels that exempt firms whose pollution releases fall
below a threshold amount. For example, RCRA requires small quantity
hazardous waste generators to comply with fewer requirements than large
quantity generators. Similarly, many CAA provisions place fewer control
equipment, inspection, recordkeeping, and reporting requirements on
"minor" sources. Thresholds are intended to avoid placing unreasonable
regulatory burden on small sources, or on sources believed to have a
minimal impact on the environment. If a firm can *reduce* releases and
fall below the threshold it can reduce its regulatory burden. The
opportunity to reduce regulatory burden can motivate firms to take steps
to eliminate or reduce releases.

Interviews suggested quite clearly that firms are aware of and often
responsive to the benefits of eliminating or reducing their emissions
below regulatory threshold levels. This firm explained that it had been
motivated to eliminate one of its waste streams to avoid the efforts of
otherwise complying with a set of DNR regulations:

> "We pretty much tried to put those issues to bed, directly. \... At
> one time I tried to get us out from under the auspices of NR 101. And
> we achieved that. The trigger for some of the changes you saw out
> there \[on the plant floor\] was not only SARA triggered, but they
> were triggered to get out from under the auspices of NR 101."

Costs are incurred in proving compliance and demonstrating that reported
environmental releases reflect actual releases. One firm explained that
it was working to eliminate all air emissions to avoid such costs:

> "We\'d like to eliminate all stacks. ... Because it\'s always part of
> your air emissions inventory and things like that. You\'re always
> proving you\'re in compliance. If you eliminate the stack, you no
> longer have to prove you\'re in compliance."

The following environmental managers explained that prospects of
eliminating costs associated with monitoring, recordkeeping and
reporting had motivated efforts to eliminate and prevent \-- rather than
simply minimize \-- hazardous waste generation.

> "I tell everybody that minimization is a stop gap, because it keeps
> you in a system at a lower level but your costs every year \... you
> end up about the same; even if we cut waste production by as much as
> 25-50 percent, our costs of management is the same each year."
>
> "So we\'re getting all of our waste streams in line, and we\'re trying
> to get to zero. If we go to zero, then we don\'t have to worry about
> the regulation."

An often-cited benefit of dropping below regulatory thresholds derives
from reduced paperwork and personnel costs. The following firms\' desire
to reduce paperwork costs motivated action:

> "Because it\'s expensive to deal with them, we don\'t want to have to
> deal with the additional paperwork that\'s involved."
>
> "It\'s the recordkeeping, monitoring, reporting, those kinds of
> things. So there are hidden costs associated with all the
> recordkeeping, the overhead."

A similar motivation was noted by a firm that eliminated its use of
acetone:

> "Well, our goals are to eliminate all that, so we don\'t have to fill
> out the paperwork. And that\'s what my goals are. Because with me and
> \[colleague\] working on it, it takes a lot of our time doing that."

Regulatory paperwork and personnel costs are both real and quantifiable.
This environmental manager elaborated the costs associated with being a
'major' air emissions source, as defined by the CAA, as opposed to a
'minor' source:

> "With the Title 5 air permits, we have to do \[emissions reporting\]
> every six months, we have to do an inventory for them on where we are
> at. Every six months \-- that's two reports a year! \... So that's two
> more weeks of my time. Let's say another 80 hours thrown into the
> environmental ... the difference between a major and a minor."

Firms can avoid the paperwork associated the Emergency Planning and
Community-Right-to-Know Act (EPCRA) by reducing or eliminating waste
streams. If hazardous waste generation is sufficiently low then a firm
can avoid having to prepare such emergency plans. This firm explained
that the prospect of avoiding these costs had contributed importantly to
its general strategy of trying to eliminate hazardous materials from its
facilities:

> "Well, there\'s a lot more reporting requirements if you have an
> extremely hazardous substance around. And so the whole concept is, to
> avoid the reporting requirements and the emergency planning and
> things, you just get rid of the substance. It makes sense."

Some firms see the benefits of eliminating releases or dropping below
regulatory thresholds as deriving primarily from being able to avoid the
basic hassle of having to deal with the regulatory apparatus. This firm
explained the extensive measures to eliminate use of cyanide from its
metal plating operations, as well as its more general efforts to
minimize waste streams:

> "Too hard to treat it, too hard to screw around with. Too many
> regulations \-- too many people on your back all the time ... And we
> were over but we worked like hell to get under \[the regulatory
> threshold\]. We did counter-flows, you know, and did different
> things."
>
> Other firms have acted because they have observed that firms
> considered "major" sources of pollution are inspected more often than
> firms that are "minor" sources. They think that firms that reduce
> pollution to the point that they fall below a regulatory threshold can
> enjoy an additional and significant benefit: less frequent inspections
> by the regulating agency. Fewer inspections translate directly to a
> decrease in liability, since firms inspected less often are less
> likely to be discovered to be in noncompliance. This firm explained
> that the prospect of fewer inspections was motivating it to reduce VOC
> emissions sufficiently for it to be considered a "minor" source of air
> pollution:
>
> "If I can eliminate myself being a major source I don\'t have to worry
> about as many inspections \... It could be a couple less inspections
> or maybe they could find a violation where somebody screwed up. You
> know, we work with humans and unfortunately somebody leaves a top off
> a drum, and they come through as another inspection because you\'re a
> large quantity generator, you know you get a \$3,000 fine. Well, there
> is your savings."
>
> The motivation to innovate offered by the prospect of reduced
> regulatory burden can work in concert with other motivations such as
> anticipating future, more stringent regulatory standards. The
> following quote comes from a firm that wanted to eliminate its use of
> a pollutant before the MACT standard governing that chemical became
> effective.
>
> "So our intent is to be out of \-- that\'s a trichloroethylene cleaner
> vapor degreaser, formally 1,1,1- \-- that our intent is to be out of
> it before the MACT standard kicks in next year."

While suppliers of inputs were generally not studied, interviews
suggested that firms' desire to reduce regulatory burden results in
pressure on suppliers to develop less polluting alternatives.

> "\[O\]ne of our goals is to \... reduce our purchases of hazardous
> materials and hazardous chemicals because of the reporting
> requirements. The less we report on, the less we have to worry about."

Many firms regularly work with their suppliers to develop
environmentally-preferable production inputs. Suppliers are thus pressed
to develop more environmentally-benign chemicals.

> "First off, we looked at the glycol ethers. We looked at the
> regulations involving what recordkeeping was required for the glycol
> ethers, and went to our suppliers and said 'we want to do whatever
> possible to keep from using glycol ethers'."

Thresholds can motivate firms to innovate in an attempt to drop below
the regulatory threshold. They can also motivate innovation at
facilities that already fall below the threshold. The following
corporate environmental manager explained that he had urged one of his
facilities \-- which had pollution levels that were threatening to
require an *upward* regulatory classification \-- to reduce its use of
toluene to avoid being classified as a "major source" under the CAA:

> "\[W\]e looked at \[the firm\'s emission profile\] and said 'you use a
> lot of toluene. You\'re going to be a major source for toluene and
> nothing else in the plant. We need to prove to the people that you can
> be a minor source. ... And there\'s no reason for you to come under
> MACT and all the regulations under major sources. So why don\'t you
> see what you can do about toluene and get it down?'"

### C) Employee Exposure 

> The potential to reduce employee exposure to hazardous substances can
> motivate firms to search for innovative environmental approaches.
> Firms can benefit from a safer environment for their employees in a
> number of ways. The economics literature indicates that wages demanded
> for working in more hazardous jobs are greater than those demanded for
> working in safer jobs.[^10] Worker exposure to contaminants may also
> reduce employee productivity, or increase firm liability for worker
> compensation if employees fall ill. Hence, the motivation to innovate
> may derive from the prospect of reducing labor costs. Alternatively,
> firms that reduce pollution and provide their employees with a safer
> environment are less likely to run afoul of Occupational Safety and
> Health Administration (OSHA) regulations. Finally, many firms appear
> simply to care about the welfare of their employees.

Some firms are conscious of the benefits that they will receive if their
employees enjoy a safer workplace. The ability to capture such benefits
can prompt efforts to reduce pollution in innovative ways. This firm
explained that its priority for reducing perclorethane was driven
largely by the desire to protect employees.

> "DuPont, back in the late \'80s, was selling perc as the solvent to do
> this. And we worked with several other suppliers to eliminate that and
> go to a non-hazardous solvent. \[Q: What was driving the change?\] ...
> Just employee. Internal employee. And certainly we saw it as a golden
> opportunity for eliminating air emissions."

Another firm sought similarly to improve employee welfare, and to boost
company loyalty, by providing a safer work environment. It explained
that its decision to reduce hazardous materials was driven in part by
the desire to be the "employer of choice":

> "When you're dealing with low quantities, a couple of thousand gallons
> of a solution that has a pH of 13.5, you don't want to spill it
> obviously. So from a safety perspective and a waste disposal
> perspective and pure volume, those are the streams that we're
> concentrating on right now. ... One of our objectives, not an
> environmental objective but an overall corporate objective, is to
> become the employer of choice. We want our employees to feel that this
> is the best place to work."
>
> In many instances employee benefits seem to be the main driver behind
> innovative efforts. Several firms explained that employee exposure
> concerns determined its environmental priorities:
>
> "The biggest thing, I think, is just to try to find a non-, a less
> hazardous solvent for the employees, because you don't want them
> overexposed. They already wear hoods. The urethane operation, they're
> using isocyanides, things of that nature. So you know to try to
> eliminate the exposure of the employees."
>
> \[Q: What is your main environmental priority?\] "I guess it would
> have to be the waste cleaners that we send, that we presently dispose
> of, and our waste phosphatizing solutions, which are our largest
> volume. They're the, from an OSHA perspective, the most unsafe to
> handle and deal with, too..."

Another firm explained its decision to eliminate methylene chloride was
driven primarily by concern for its employees:

> "Just because of the methylene chloride, and the environmental issues
> affecting our employees up there. I mean, we're under all the
> threshold limits, but if it's something we can eliminate, why not
> eliminate it?"

Yet another firm explained that its switch from solvent-based to
water-based cleaners was motivated by a concern for worker safety and
satisfaction:

> "Most of the solvents that were probably on the market then also had
> drawbacks, as far as employee exposure. And I think that's what really
> drove the project initially. ... Employees dislike vapor degreasers.
> They just don't \-- it's a very volatile thing. You can smell the
> solvent, they realize there\'s a' exposure, and they just don\'t like
> that."

The desire to improve workplace safety motivates many firms to make
environmentally-preferable changes to their production process, even if
the changes involve switching to more expensive materials. This firm
explained that a recent technology change \-- made to decrease employee
exposure to hazardous materials \-- has increased its production costs:

> "We actually spend more dollars per year with the DBE \[a solvent\]
> with the disposal and everything else for the materials and labor, but
> it's better for our employees. It reduces some of their risks. They're
> not having it all over their hands."

Another firm explained that while its input costs had increased,
nevertheless they had made a production change in part because of
associated employee benefits from the less hazardous technology:

> "It's an expensive paint ... the driver of this was environmental. ...
> We are getting employee benefits out of it. The other paint was very
> volatile, there was always exposure concerns with the employees in the
> area, which have gone away."

Still another firm explained that it continues to make changes to
protect workers, even though it is difficult or even impossible to
justify cost savings from doing so:

> "But we do have projects from time to time where you really can\'t
> calculate a return on investment. ... Safety and environmental are the
> two areas that come to mind. I mean we may do something for ergonomics
> that, sure, we could extrapolate out, I mean, if five people strain
> their backs and lost three days of work, you could potentially have a
> savings, but we don\'t intend to do that \[calculation\], because the
> correct thing to do from an ergonomics standpoint \[would be not to
> let them strain their backs.\]"
>
> Improvements in environmental performance can be accompanied by
> improved workplace safety. Firms can often indirectly enjoy the
> benefits of happier, healthier workers. Some firms seem to make
> changes to reduce workplace hazards regardless of the net contribution
> that such efforts make to the bottom line. In either case, however,
> concern for worker exposure often motivates firms to change production
> technologies in environmentally preferable ways.

## V. Product Quality / "Green" Market Niche

Earlier sections of this chapter explore motivations for innovation that
are driven either by regulations or by the desire to reduce production
costs. But concern about product performance or customer demands can
also induce firms to alter production processes in environmentally
innovative ways. Firms are sometimes motivated to innovate because the
new approach provides superior product quality; the fact that the
process has a preferable environmental impact is a fortuitous
side-effect. In other cases a product's "greenness" \-- the degree to
which its manufacture is environmentally benign \-- is a marketable good
in and of itself. This section explores each of these incentives.

For some firms, superior environmental performance is a welcome
side-effect of changes initially motivated by an effort to improve
product quality. One firm shifted from sand-blasting to CO2 pellets for
cleaning its production molds. The switch significantly reduced the
firm's solvent use \-- an environmental improvement. However, the switch
was motivated primarily by product quality concerns.

> "Probably the biggest reason was ... the fact that you\'d damage the
> pattern of the \[mold\]\... this was a way that you could actually
> clean it non-destructively."

Another particularly innovative firm explained that it had switched to
an environmentally preferable coating because of its superior product
performance:

> "It just happens to be a good coating, as much as it is from
> environmental purposes. It's really tough, good, durable coating is
> what it is."

Customer demand for environmentally friendly products can motivate firms
to think innovatively about their products and processes. In explaining
what motivated it to switch to a less polluting coating, one can
manufacturer explained:

> "\[L\]ike a lot of things it's customer driven. ... So a lot of our
> customers are top end of the line customers in their fields. And
> they're getting mileage from the green factor, if you will. They like
> to be able say that their products are 'environmentally friendly',
> they're manufactured with the best..."

Another firm said that its general environmental performance, as
evidenced by its environmental awards, had proved to be a useful selling
point:

> "But the need to work towards \[improved environmental performance\]
> is not just regulation. It's customer, to some extent. They walked in
> the other day, a new customer from Asia, wanting to know about our
> environmental aspects, and wanting to know what we've done. So we can
> pull out -- we got the Governor's Award once ... Does it help?
> Certainly!"

In summary, the desire to improve product quality or to exploit a
"green" market niche sometimes prompts firms to innovate and improve
their environmental performance.

## VI. External Relations, Firm Ethics

The desire to avoid the negative publicity associated with a high
ranking on the Federal Toxic Release Inventory (TRI) list motivates some
firms to reduce their pollution. Firms do not want to be on any "top
ten" list of polluters, and may try innovative approaches to pollution
prevention and control to drop off such lists. When asked why it had
launched a facility-wide source reduction program, this firm explained:

> "I think the corporation sees the handwriting on the wall, and is very
> sensitive to the public relations aspect of emissions. And the Form
> SARA 313 \[Toxic Release Inventory\] report certainly elevated \-- it
> certainly played in the picture."

Another firm, which had been on the state's "top ten" TRI list,
explained that the resulting negative publicity had been one of the
reasons that it had worked to eliminate a number of its waste streams:

> "We were in the top ten for a couple of years, and we're no longer on
> that. ... \[T\]hat was one of the reasons, not the reason, but was one
> of the reasons that made us aware of, say, you know, maybe there's
> alternatives."
>
> Earlier sections of this chapter emphasized the costs associated with
> liability for hazardous waste, accidental spills, and noncompliance
> penalties. However, some firms also consider the risk of negative
> publicity to be a liability. Thus, the negative publicity that can
> accompany accidental spills or citations for regulatory noncompliance
> can importantly motivate firms to reduce their pollution. This firm
> explained that it was working to reduce and eliminate its use of toxic
> chemicals in part to reduce the likelihood that it will suffer
> negative public attention:
>
> "We understand the jeopardies when people do things wrong. We also
> kind of look at the big picture. Do we need \[our firm's name\] and
> everything spread out all over the front page of the Journal or the
> Times or something? ... \[Y\]ou have paint and waste paint solvents,
> you have mineral spirits, we do have alkaline cleaners, we do use
> coolants. We have all the things that everybody else has, maybe not in
> the magnitude in some areas that other people do, but it\'s all there.
> It\'s just good business sense, and that\'s what we\'ve been working
> on, is if you go to zero discharge\...\"

Firms seem likely to be especially sensitive to potential negative
public relations if they are located close to or within areas of high
population. Accidental releases that can be sensed in some way are more
likely to be discovered, so that neighborhood concerns may be piqued
even if the problems are not reported in local media. This firm
explained its motivation to go "beyond compliance" to reduce an
intrusion on the surrounding community:

> "To eliminate the problems. Again, we've done things to eliminate
> odors downstream. We want to be good neighbors. There's no monetary
> value to that. There is goodwill. And goodwill is worth a lot. And
> we'll do things for goodwill. ... I mean, the city is only, like, four
> blocks this way. And then you're at the lake. So you're impacting the
> city a lot."

One environmental manager explained the role of his company's CEO in
promoting environmental innovation:

> "I'm sure what attracted \[the CEO\] was the fact that he wanted to
> make the company into an excellent environmental performer. Like most
> execs, he had a lot of issues about what was going on, but he wanted
> the company to be nothing but a great environmental performer. So, the
> company looked at the available opportunities and moved to the aqueous
> processing that they do now ..."
>
> Another firm explained that its proactive environmental efforts
> resulted in part from the environmental views of its president.
>
> "The president has always held himself out as being an
> environmentalist; he received the Teddy Roosevelt Environmental Award;
> and so, all the \[subsidiary\] companies are directed to be very
> proactive. Now, that\'s not to say cost isn\'t an issue, because with,
> you know, I\'m going to want to know what the benefits would be and at
> what cost those benefits come to us."

## VII. Conclusion

Interviews suggest that a plethora of factors can induce firms to search
for innovative ways to control and prevent pollution. In general, firms
do not appear to be motivated to innovate for any *single* reason.
Rather, a combination of complementary motivations spurs firms to
innovate. Which combinations ultimately prove to be effective depends on
particular firm circumstances and goals.

However, the majority of innovation motivations spring either directly
or indirectly from the regulatory regime. Regulatory requirements can
create the ultimate pressure for firms to change how they conduct their
operations: non-compliant firms can be shut down. The prospect of future
and more stringent regulatory standards is a particularly important
motivation, especially given that innovations take time to develop.
Regulations can also make it expensive for firms to pollute, and so
harness firms' interest in reducing production costs. Regulations make
firms liable, in various ways, for the pollution that they generate, and
the desire to reduce this liability can prompt firms to innovate.
Finally, firms that sufficiently reduce their environmental releases can
enjoy the benefits of regulatory reclassification, including reduced
paperwork and personnel costs.

Firms do face several non-regulatory reasons to innovate. Firms that
reduce their employees' exposure to hazardous materials may enjoy lower
labor costs and more loyal employees. Some firms exploit the "greenness"
of their products as a marketing point; the ability to do so may prompt
them to search for environmentally innovative production approaches.
Finally, the prospect for reducing the likelihood of negative public
attention seems to induce some firms to try to improve their
environmental performance in innovative ways.

While environmental regulations can importantly motivate firms to change
their behavior, some claim that current regulations and the way that
they are implemented block the force of cost savings and other
innovation motivations. Evaluating this claim is the central purpose of
this report. And it is a question to which we turn in the next chapter.

\[BLANK PAGE\]

#   {#section-4 .unnumbered}

# CHAPTER 3. HURDLES TO INNOVATION

One of the principal purposes of the Wisconsin DNR ETI project was to
identify the extent to which the current regulatory system creates
barriers to environmental innovation. The previous chapter explored what
motivates firms to innovate. Firms may be influenced by a variety of
potential benefits from environmental innovation including: cost
savings, reduced regulatory hassles, improved market position, and
enhanced public image. This chapter discusses the extent to which
environmental regulations impede those motivations, and discourage firms
from innovating.

We were interested in hurdles that might cause firms to choose
conventional approaches in preference to innovative approaches to
pollution control, or that might cause firms to forgo pollution
reductions altogether. Some regulatory requirements hinder firms'
action, but do not hinder innovative actions any more than traditional
approaches, and thus are not likely to concern us here.

This chapter examines hurdles to innovation erected both by the
environmental regulatory system and internal firm organization and
incentives. The chapter places the effects of environmental regulations
in context, by addressing more broadly why innovation sometimes fails to
occur. The chapter provides an understanding of the *relative* impact of
regulations \-- as opposed to internal firm restrictions \-- on
innovation. This understanding should facilitate better decision making
about the size of the regulatory-induced problem, and potential
solutions.

Hurdles can be grouped according to the way in which they affect whether
a firm is likely to innovate. Innovative approaches are invented or
adopted only after a chain of events, and hurdles can arise at each link
in the chain. Figure 1 **(see page 43X)** shows the conceptual model
that we used in thinking about hurdles.

Innovation occurs as the end product of a chain of events. Some
innovation occurs in response to regulatory incentives. Other innovation
occurs in response to market incentives. In both cases, incentives must
first be created if firms are to deviate from their normal routines and
try to develop innovative environmental approaches. Once incentives
exist, firms must then recognize and respond to those incentives; they
must initiate the innovation process. Next, if a firm is to develop a
new approach to dealing with its pollution, it must succeed in
developing an innovative idea. Finally, firms need to implement the
innovative ideas that they have developed.

Innovation can be stifled at each link in this chain. If a link is
broken, subsequent incentives will not be felt. If regulators *fail to*
*generate incentives to innovate* despite opportunities to do so, or
blunt incentives that already exist, then firms have less reason to
innovate and are less likely to do so. If firms *fail to recognize
existing incentives* to innovate then they will not respond to those
incentives. If firms *fail to develop innovative ideas*, despite being
fully cognizant of the incentives to do so, then no innovation will be
forthcoming. Finally, firms with innovative ideas *can face hurdles to
their implementation*, either from regulatory or within-firm origins.
Importantly, a perceived hurdle can stifle innovation *even if the
perception is wrong*. When it comes to innovation, perceptions are
reality. The major sections of this chapter reflect these four ways that
the innovation chain can be broken.

If hurdles are anticipated, they can cause the innovation chain to break
at an earlier link. Environmental managers are much less likely to try
to generate an innovative idea if they believe that their innovative
approach would cause permitting problems \-- i.e. they will fail to
adequately appreciate innovation incentives if they believe there are
important hurdles to innovation implementation. CEOs will be less likely
to create incentives for plant managers to innovate if the CEOs believe
that permit writers are especially hesitant to approve new approaches
\-- i.e. they will do less to lower hurdles that blunt incentives to
innovate if they perceive a hurdle to innovation implementation.

Firms differ in the extent to which they respond to innovation
incentives, are affected by hurdles, and are able to overcome hurdles.
Large firms are more likely than small firms to have research and
development budgets, and so need rely less on suppliers, trade
associations and other information networks for innovative ideas. Small
firms may find it easier to translate management goals for environmental
innovation into floor-level goals, where each employee is motivated to
look for innovative opportunities. Some firms with a history of
compliance problems may be gun-shy about untried approaches, while
others may see innovation as a way of improving compliance and
increasing operating flexibility. Some firms' environmental managers
work closely with production staff to identify opportunities for
innovation, while others do not. Firms located in areas that do not meet
environmental goals often face stricter standards and thus greater
pressures for innovation than firms located in cleaner areas.

Firm interviews confirmed some hurdles that could dissuade firms from
innovating. Of note, surprisingly few of the identified hurdles stemmed
from the regulatory system. More typically, hurdles arose because of
internal corporate characteristics, such as capital constraints or the
firm's corporate culture. Therefore, not all hurdles imply the existence
of a problem which a policymaker can address.

Firm interviews revealed a few instances where the environmental
regulatory system can make it more difficult for firms to innovate than
to use conventional approaches to pollution control, and a few other
situations where the regulatory system fails to provide firms a strong
incentive to innovate. However, no interviewed or surveyed firm could
identify a specific instance where they sought to use an innovative
approach to controlling or preventing pollution but were prevented from
doing so by environmental regulations, how those regulations were
implemented, or how they were enforced. The extent to which an
individual firm is impacted by hurdles to innovation is influenced by a
wide variety of factors and ultimately is site-specific.

**\[Insert Figure ONE Here\...\]**

The following table identifies the locus of the hypothesized hurdles.

+---------------------------------------------------+--------+--------+
| **Potential Barriers**                            | **In   | **R    |
|                                                   | ternal | elated |
|                                                   | to     | to     |
|                                                   | Firm** | Regula |
|                                                   |        | tion** |
+---------------------------------------------------+--------+--------+
| I. *Hurdles That Affect Incentives for            |        |        |
| Innovation*                                       |        |        |
+---------------------------------------------------+--------+--------+
| > A\) Industry Expertise Not Incorporated in      |        | X      |
| > Standard Drafting?                              |        |        |
+---------------------------------------------------+--------+--------+
| > B\) Regulations Specify Technology?             |        | X      |
+---------------------------------------------------+--------+--------+
| > C\) Permits Limit Production?                   |        | X      |
+---------------------------------------------------+--------+--------+
| > D\) Short Compliance Timeframes?                |        | X      |
+---------------------------------------------------+--------+--------+
| > E\) Enforcement?                                |        | X      |
+---------------------------------------------------+--------+--------+
| > F\) Differential Regulatory Treatment of Old    |        | X      |
| > and New Sources?                                |        |        |
+---------------------------------------------------+--------+--------+
| > G\) Permit Limits That Do Not Affect Firm       |        | X      |
| > Behavior?                                       |        |        |
+---------------------------------------------------+--------+--------+
| > H\) Monitoring and Recordkeeping Costs?         |        | X      |
+---------------------------------------------------+--------+--------+
| > I\) Regulatory Thresholds: Reclassification     |        | X      |
| > Increases Regulatory Burden?                    |        |        |
+---------------------------------------------------+--------+--------+
| II\. *Hurdles That Affect Firm Sensitivity to     |        |        |
| Incentives*                                       |        |        |
+---------------------------------------------------+--------+--------+
| > A\) "Culture of Compliance"?                    | X      |        |
+---------------------------------------------------+--------+--------+
| > B\) Costs and Benefits of Industrial Releases   | X      |        |
| > Not Tracked?                                    |        |        |
+---------------------------------------------------+--------+--------+
| III\. *Hurdles That Affect Idea Formation*        |        |        |
+---------------------------------------------------+--------+--------+
| > A\) Employees Do Not Appreciate Benefits of     | X      |        |
| > Innovation?                                     |        |        |
+---------------------------------------------------+--------+--------+
| > B\) Communication Limitations Within the Firm?  | X      |        |
+---------------------------------------------------+--------+--------+
| > C\) Environmental Quality Managers Lack Time,   | X      |        |
| > Training, Responsibility?                       |        |        |
+---------------------------------------------------+--------+--------+
| IV\. *Hurdles That Affect Implementation*         |        |        |
+---------------------------------------------------+--------+--------+
| > i\. *Internal Firm Hurdles to Implementation*   |        |        |
+---------------------------------------------------+--------+--------+
| > A\) Product Quality Concerns?                   | X      |        |
+---------------------------------------------------+--------+--------+
| > B\) Capital Constraints?                        | X      |        |
+---------------------------------------------------+--------+--------+
| > C\) Non-Depreciated Equipment?                  | X      |        |
+---------------------------------------------------+--------+--------+
| > D\) Employee Resistance to Change?              | X      |        |
+---------------------------------------------------+--------+--------+
| > E\) Risk Aversion \-- Fear of Going First?      | X      |        |
+---------------------------------------------------+--------+--------+
| > ii\. *Regulatory Hurdles to Implementation*     |        |        |
+---------------------------------------------------+--------+--------+
| > A\) Agency-Preferred Approaches?                |        | X      |
+---------------------------------------------------+--------+--------+
| > B\) Distinguishing Between Agency Suggestions   |        | X      |
| > and Requirements?                               |        |        |
+---------------------------------------------------+--------+--------+
| > C\) Obtaining and Modifying Permits: The Costs  |        | X      |
| > of Delay?                                       |        |        |
+---------------------------------------------------+--------+--------+

##   {#section-5 .unnumbered}

## I. Hurdles That Affect Incentives for Innovation

An incentive to innovate can initiate a chain of events that ultimately
leads to implementation of an innovative approach to pollution
reduction. Regulators can generate incentives to innovate through
product bans, stringent requirements, or by reducing the reporting costs
of firms with small releases. When the costs of pollution generation are
borne by the firm, or if customers demand "green" products or
performance, the marketplace can also create innovation incentives. Some
regulatory provisions either fail to create an incentive to innovate, or
dampen the effect of other provisions designed to encourage innovation.
Such provisions can act as hurdles to innovation. (See the first
"hurdles" box in figure **1**).

### A) Industry Expertise Not Incorporated in Standard Drafting

Some complain that agencies are inflexible and irrational when drafting
pollution control standards. In this view, firms have minimal input into
the regulatory development process.[^11] Lacking the benefit of industry
expertise, regulators thus may inadvertently and unnecessarily stifle
incentives to innovate. Regulations might be written in ways that unduly
restrict how firms can comply with a given performance standard.

In contrast to this view, interviewed firms tended to believe that the
rulemaking process incorporates industry input. Several interviewed
firms had participated in a regulatory development process and found
regulators responsive to industry input.

> "And right now we\'re working with EPA to help generate the MACT
> standards for ammonia. ... \[W\]hat we\'ve done as a subcommittee is
> we reach consensus within the committee as to what we feel the MACT
> standard should be for the industry."

Interviewed firms highlighted standards for air toxics as exemplary of
requirements that do not place major constraints on process choice, in
part because industry input was incorporated into the rulemaking
process. One environmental manager said:

> "I think the version \[of the standard\] that we see now gets the same
> results and at far less cost. It seems reasonable. I think that
> there\'s some real movement on the agency\'s part, compared with the
> first version."

He further explained that the applicable standard will allow his firm to
identify the most appropriate compliance approach:

> "\[W\]hen we come under the Clean Air MACT standards, methanol will
> certainly be reduced significantly. However we decide to comply, there
> will be several options there. From what I understand, we\'re going to
> get kind of a smorgasbord approach, where you\'ll be given -- we can
> comply in several different ways, whichever is most cost effective."

Another firm described agency rulemaking as:

> "...a give and take process. ... \[P\]robably in September of the year
> we were doing this, they \[EPA\] were to the point of having the more
> in-depth workshops. You know, 'here\'s draft forms that a couple of
> pilot plants have filled out, and here\'s how you\'re going to
> actually fill \'em out, and here\'s what goes in these blanks, and
> here\'s what we think this means.' And they were still asking for
> feedback so that there would be one final revision of the forms, and
> there\'s been revisions several times since we\'ve filled them out
> even."

In general, then, the rulemaking process appears to incorporate a fair
degree of industry input. Some might urge, in fact, that industry has
too much input into the process, and that standards are set lower than
necessary.[^12] While the most appropriate level of industry involvement
in the standard-setting process is not a question that this report can
answer, we underline that interviewed firms generally portrayed the
rulemaking process as one that succeeds in incorporating industry
expertise sufficiently to prevent rulemaking that might stifle
environmentally innovative approaches to preventing or controlling
releases.

### B) Regulations Specify Performance Not Technology 

Much of the concern about the regulatory system\'s effect on
environmental innovation centers on whether regulations, *as written*,
stifle innovation. If they are *not* to stifle innovation, environmental
regulations and the permits that reflect those regulations must be
written to require that firms achieve environmental performance, not
that they install a specific technology. A major contention of many
critics is that regulations require specific technologies for particular
processes. They therefore hold that the current "command and control"
regulatory system inhibits innovation.[^13] Regulations and permit
conditions written to require a specific technology would create
barriers to innovation. Any new technology would, by definition, not
meet the existing standard, and so would have difficulty getting
permitted, if it even were possible. This would prevent innovative
approaches to meeting limits more cost-effectively or of further
reducing environmental releases.[^14] It would obscure innovation
incentives to which the firm might otherwise be attuned.

In fact, specific technologies are virtually never specified by
regulations; standards specify minimum levels of environmental
performance. The Clean Water Act's "effluent guidelines" and the Clean
Air Act's RACT and MACT standards are determined by assessing the
performance of existing technologies. The resulting guidelines are
expressed as performance standards -- mass or concentration limitation,
averaged over a specified time period, with daily caps -- and not in
terms of the reference technology. In consequence, incentives to develop
innovative approaches that perform better than the existing performance
standards are not blunted.

Our legal and regulatory analysis provides little evidence that
standards exist that specify required technology. More importantly, no
interviewed firm described deviation from performance-based regulations.
Firms perceived and experienced environmental standards as specifying
*performance* rather than technology. The following response was typical
of firms describing the conditions of their permits.

> \[Q: The permit, then, has a significant amount of flexibility?\] "It
> just says what we're allowed to put down the sewer. The metals we're
> allowed to put down the sewer. I don't think they care how you do it;
> in fact, I'm sure they don't."

While environmental regulations do not appear to require specific
technologies, interviews did turn up a case where performance standards
appear to be too narrowly written and in a way that could discourage
innovation. Standards for painting on metal focus on the VOC content of
the *paint*, rather than the VOCs actually emitted during the painting
process. This blunts innovation incentives, since the performance
standard focuses attention on reducing a paint's VOC, rather than on
reducing VOC emissions from the painting process.

The following firm demonstrated that it could release fewer VOCs using a
dip tank with a higher-VOC paint than it would using a spray booth using
RACT-compliant, lower-VOC paint. While in theory the regulatory system
has variance procedures to overcome unintended one-size-fits-all
regulatory standards[^15], this firm had difficulty obtaining a variance
to implement its environmentally superior paint system.

> "We had a dip tank operation and they used a solvent-based paint which
> had 4.8 pounds of VOC per gallon. We could prove to them that using
> that operation was more efficient and would emit less VOCs at the end
> of X period of time \-- month, year, day -- than if we were to
> eliminate that tank and spray all of the parts using a 3.5 \[pounds
> per gallon\] paint. ... \[F\]inally we solved the DNR \[concerns\],
> and we applied for a\[n EPA\] variance... It was initially denied \[by
> EPA\], and we had 30 days to ... file suit in the 7th Circuit Court."
> \[Q: What was EPA\'s basis for turning you down?\] "Basically, \...
> 'this is the rule, they\'re going to do it this way.' ... I\'d take a
> garbage can, and I\'d dip that part in there, and I\'d pull it out,
> the paint was in these holes, well it stayed there. Actually made a
> video of that, and showed that to a group of EPA representatives in
> the Milwaukee DNR office. 'Well,' they said, they\'d 'have to think
> about it.' EPA agreed to settle on our terms, basically."

This particular example was the only one in which performance-based
regulations were found to be written too narrowly, in a way that blunted
incentives to innovate. Nevertheless, it suggests that further work
should be devoted to determining whether other regulations are also too
narrowly written.

There is no evidence that regulations specify *technologies* rather than
environmental *performance.* It does appear, however, that performance
standards are occasionally written too narrowly and in a way that may
discourage innovation. While the one firm that had encountered this
innovation hurdle was able to surmount it, others may not have the
resources or inclination to pursue regulatory relief.

### C) Permits Limit Production as Surrogate for Pollution

Environmental standards, even though performance-based, can inhibit
innovation if permits reflecting those standards limit production or
production inputs, rather than a firm\'s environmental releases. And in
fact, permits sometimes are written to limit firm\'s production inputs,
rather than overall emissions from processes. Unfortunately, EPA
requires air permits to contain a production or operational limitation
in addition to the emission limitation. The reasons for this derive from
EPA\'s response to a court decision, [United States v. Louisiana-Pacific
Corporation]{.underline},[^16] which established criteria to determine a
firm\'s "potential-to-emit",[^17] explained further in Appendix A on
regulatory context.

One interviewed firm explained that they were subject to a regulatory
cap on the amount of coating used in their process, rather than on the
amount of VOCs released by the process.

> "\[T\]he DNR capped that process to limit the amount of emissions from
> this plant. And it\'s based on ink and also, for whatever reason,
> clean-up solvents, or clean-up materials. Those are the two limiting
> factors for that operation back there, so there\'s a certain amount of
> ink that we can use in our process in a month. It was 1200 gallons, or
> something like that. ... \[So your permit is based not on total VOCs
> but on number of gallons of ink applied?\]. That\'s correct."

If a permit caps or limits the use of a production input, then a firm
has less incentive to consider creative ways to reduce its *emissions*
per unit of product. A cap on production inputs motivates a firm to
reduce its use of production *inputs* per unit of product -- an
incentive that the firm, in trying to minimize production costs,
presumably has regardless of regulatory controls.

While a reduction in input use may well reduce emissions, capping input
use can fail to encourage other innovative emission reductions. A firm
would have less incentive to reduce emissions from a capped input, by,
for example, going to a lower-emitting alternative input, such as a
lower-emitting ink. If the cap were solely on emissions rather than
inputs, the firm might be motivated to substitute the lower-emitting
alternatives to gain an increase in production capability. The firm
would use more ink, produce more product, but lower its emissions. Under
an input cap, a firm could elect to make such input substitutions, but
to increase production it might have to obtain a new or modified permit.
If so, it would have to go through the hoops of re-opening its permit
and getting the regulatory agency to re-calculate its input cap; this
would be for changes that would *reduce* environmental releases. In
addition, while the cap on production inputs may be recalculated and
raised if a firm chooses lower emitting approaches, it is not obvious
that firms understand this.

The incentives for innovation are reduced by the court-ordered
requirement that production caps be written into permits. Caps on
production inputs dampen the incentives firms might otherwise feel to
innovate. Permits or standards that limit production or production
inputs rather than emissions have the potential to inhibit innovation.

### D) Short Compliance Timeframes

Innovative approaches to controlling industrial releases often take more
time to develop than do conventional ones. If firms believe that the
amount of time that they have to comply with regulations is short, then
they are less likely to begin the search for innovative solutions, even
if perceived benefits are substantial.[^18] That is, incentives to
innovate are blunted if firms face very short compliance deadlines.
Firms may face short timeframes within which to achieve compliance
either because the regulations themselves specify what firms perceive to
be a narrow window, or because firms do not learn about applicable
regulations in a timely manner.

Compliance deadlines may be set by statute or regulation, and can vary
considerably. The acid rain program established by the Clean Air Act
Amendments of 1990 required electric utilities to comply beginning in
1995. In contrast, effluent control requirements for pulp-and-paper
plants went into effect 45 days after EPA promulgated the final
regulations, and almost exactly two years after the initial EPA
proposal.[^19]

Smaller compliance windows need not mean that innovation is impossible.
Some processes are reasonably amenable to input substitution and other
changes that do not require a great deal of development time. The
following two quotes come from firms that are able to make adjustments
to their processes relatively quickly. When asked how long it takes to
come up with an innovative compliance strategy, they responded:

> "I would say six months. Because through the development of a new
> process, you do the best up-front engineering that you can. Once you
> start it up, that's when all the problems start punching their heads
> up. You need to lop those down as they come up. And so I'd say six
> months..."
>
> "Well ... you look at first, how can you make those guidelines by a
> certain date. You have to start there. And in the meantime, you're
> talking with other people and talking about the alternatives. By the
> time it gets through a committee, through MSDS, by the time you talk
> to your suppliers, by the time you get the product in here, by the
> time you make a little stand to try it and everything else, you're
> talking six months."

The quotes suggest that some innovation is possible, for some processes,
even given relatively short deadlines for compliance.

Nevertheless, narrow compliance windows in some cases may lead to
reduced innovation. This environmental manager explained that he thought
compliance deadlines were too narrow for his firm to develop an
innovative approach, and that any innovation would take a number of
years to develop given that the production technology in their industry
is slow to change:

> "When you're given two years to comply, for example, you don't have
> time to re-engineer your process. And we're talking about a process
> that has developed over a period of 4,000 years, and to change it in
> two \[years\] to meet a specific objective was not possible. Over a
> longer term, it is possible to do things in the realm of process
> development and process change. ... I've seen some significant changes
> in 25 years. Heck, I've seen significant changes in five years."

A short timeframe may be a conscious tradeoff made by policy makers. To
achieve environmental and public health goals, policy makers may opt for
imminent implementation of existing solutions rather than allowing more
time for development and implementation of the 'best' solution. In the
case of the industry discussed in the previous quote, policy makers may
have decided \-- given that innovation in this industry can take a very
long time \-- to have a compliance deadline that would perhaps not allow
for much innovation, but that would meet environmental and public health
objectives.

Firms sometimes try to anticipate standards so as to increase their
timeframe for compliance. However, making investment decisions based on
potential requirements can be difficult. One environmental manager
noted:

> "\[T\]he final standard isn't out yet. ... So you're caught planning
> for something you can't quite define. And suddenly it's here. And
> you're usually caught in the gears of rushing to get something
> through. And then after -- you find an immediate solution -- but after
> the fact trying to find the best solution."

Trying to balance the need for compliance with the desire for
environmental innovation, regulations often extend the compliance
deadline for facilities adopting innovative solutions or offer variances
to firms testing innovative approaches. For example, the Clean Water Act
allows firms a two-year compliance extension if they test innovative
technologies with potentially broad application.[^20] In Wisconsin,
firms in the pulp and paper industry have been allowed some additional
time to get into compliance with applicable MACT standards:

> "They're allowing a time delay here, because ... they want to make
> sure that \[firms\] don't have to do things twice. So there's just
> some extra time there to fully assess what's the best way to achieve
> full compliance."

Similarly, storm water regulations allow firms that implement best
management practices (BMP) more flexibility in their compliance
deadlines. This firm explained that the extra time was important in
allowing it to adopt a relatively capital intensive pollution prevention
alternative for eliminating its storm water run-off:

> "If that provision hadn't been in the regs it would have been a
> problem, because BMP had to be implemented within two years of having
> your permit and so on. Obviously the four years wouldn't have fit."

Regardless of the timeframe which policymakers allow for firms to
achieve compliance, if firms fail to learn of applicable regulations in
a timely manner then incentives to innovate will be blunted. Some
interviewed firms complained that they do not have fool-proof ways of
finding out about new or revised regulations. Asked to explain how he
finds out about new regulations, this environmental manager explained
that doing so can be a hit-or-miss proposition:

> "Sometimes somebody will call. And I've done this to others: 'What are
> you doing about such and such?' 'I've never heard of that'. 'Well, I
> suggest you talk to your lawyer, or you talk to this, because you out
> of, you are in violation, you are out of spec', and people do stuff,
> you know. \... They expect you to read the Federal Register daily and
> nobody, none of us do that."

To try to reduce these problems, many firms rely on seminars, trade
associations, and other publications to keep up-to-date.

> "We go to seminars on a regular basis. We have subscription services
> that keep us updated every week. We go to legal seminars. There's
> seminars plus we have trade associations that we belong to."

Learning about new regulations is probably easier for large firms.
Specialized staff, greater resources, and sometimes a company-wide
tracking process help them track emerging requirements. One
environmental manager from a large firm explained that he did not have
to personally track new regulations:

> "I leave that up to our corporate people . . . They are very closely
> following all of these regulations. We have corporate specialists that
> are working very closely with the agency, with other industry
> representatives

The parent companies of other large firms may sponsor regular regional
seminars for its environmental managers at local plants to keep them
informed of regulatory trends.

> "\[Our corporate parent\] also has conferences they do, regional
> conferences they do to keep us abreast of what's going on. They do
> those annually. As a matter of fact there's four of them going on this
> spring. You know, being the size company we are we have those
> resources."

In summary, if firms believe they face a short timeframe for compliance,
they are less likely to begin the search for innovative solutions.
Compliance timeframes may be thought short either because the
regulations specify what firms consider to be a narrow window, or
because firms do not learn about applicable regulations in a timely
manner. The problem of narrow compliance windows is one that inherently
involves policy tradeoffs; the more time firms have to comply with
requirements and to innovate, the longer it will be before environmental
and public health goals are achieved. One way that agencies finesse this
dilemma is to grant extra time to firms that are trying to develop
innovative solutions. The problem of firms failing to learn about
applicable regulations in a timely manner seems more likely to afflict
smaller firms, which have fewer resources with which to track regulatory
changes.

### E) Enforcement

Regulatory agencies have the authority to compel compliance with
regulatory mandates. Noncompliance penalties range in severity from a
"notice of violation" issued by the regulatory agency, to imprisonment
and fines of \$25,000 per day per violation.[^21] Agencies can also put
less direct pressure on firms to maintain compliance, such as by
publishing the names of noncompliant firms in local newspapers or other
public forums. While enforcement actions may be required by statute or
by EPA regulations, state agencies have significant discretion regarding
how sanctions are applied. If firms are discovered to be out of
compliance, agencies decide what type of enforcement penalty to use, and
at what level of severity within the range prescribed by statute.
Agencies can also decide to increase the frequency of inspections for
firms failing to maintain compliance.

The enforcement discretion that agencies have may reflect a belief that
enforcement efforts can be most effective and create the best incentives
if agency action is tailored to specific circumstances.[^22] It is not
surprising that enforcement efforts, if not properly pursued, can act as
a hurdle to innovation. On the one hand, lax enforcement can remove the
regulatory incentive to develop innovative compliance approaches;
conversely, an overzealous enforcement style can reduce the strength of
other incentives to develop innovative environmental approaches.

Lax enforcement can reduce firms' incentive to innovate. Regulatory
compliance is a primary motivation to innovate; without enforcement,
environmental requirements would be essentially voluntary. While charges
about insufficiently vigorous enforcement efforts have been levied
towards other states,[^23] none of the interviewed firms described
regulatory requirements as inadequately enforced. On the contrary, many
described the implications of being out of compliance as a significant
motivation for them to aggressively control pollutant releases:

> "I mean, you can't live at 90% of your most stringent waste-load
> allocation. You just, you wouldn't sleep at night..."

Enforcement is necessary to maintain the direct regulatory motivation to
innovate. However, inappropriate enforcement measures or style can
reduce the power of other innovation incentives and so act as a hurdle
to innovation. One of the most common complaints in the literature is
that firms that try something innovative risk being fined for
noncompliance if their efforts fail, even when those efforts are made in
good-faith.[^24] Many theorize that unless agencies can be counted upon
to provide firms with a "soft landing" if innovative efforts fail, firms
may be reluctant to attempt to implement innovative ideas. ("Soft-
landing" provisions would allow agencies to consider good-faith
compliance efforts and other factors "such as justice may require" when
deciding an appropriate agency enforcement response). [^25] While
plausible, we failed to find any firm \-- either through interviews or
survey work \-- that had wanted to do something innovative but was
discouraged from doing so out of fear that they might suffer enforcement
*penalties* \-- i.e. fines or criminal prosecution.

However, enforcement actions and style can reduce incentives to innovate
beyond the direct effects of enforcement penalties. For example, some
firms feel an incentive to innovate because they seek to project a
positive public image and to foster community relations. Since there is
a risk that innovative efforts may fall short of regulatory
requirements, the firm could be cited for noncompliance. The risk of
negative publicity from potential enforcement action may outweigh the
possible positive gains in public relations from innovating, thus
discouraging innovation.

This occurred to one interviewed firm that wanted to promote positive
public relations. The firm installed an innovative wastewater
pretreatment system, but the effort took more time than expected to
perform to specifications. As a result, the firm exceeded its permitted
discharge levels. The resulting notice of violation from the state
environmental agency, and the EPA required public notice posting in the
local paper, caused internal dismay. The firm explained that they may
"play it safe" next time with more proven approaches. That is, this
firm's incentives to innovate were blunted by the bad public notice
generated by the enforcement action. Another firm that had been out of
compliance, complained similarly about agency inflexibility with regard
to having a violation written up in enforcement actions:

> "The only exception I've ever taken to any \[enforcement\] action is
> he gave us a notice of violation for \[exceeding\] the 3.5 \[pounds of
> VOC per gallon of paint limit\] when we had the \[emission-control\]
> equipment waiting to be installed. And I said, 'this is kind of
> ridiculous, because the equipment is here and we're just going to put
> it in.' And he said 'no, we've got to go ahead and do this.' ... What
> he told me was that ... DNR had to do this so that they could prove to
> the EPA that they were enforcing this."

While this environmental manager did not claim that such agency action
reduced its incentives to innovate, the example illustrates how a firm
interested in fostering a positive public image might be dissuaded were
its regulatory violation written up unnecessarily.

Enforcement style can reduce firm incentives to innovate in other ways,
as well. A strong environmental ethic, or an interest in promoting a
positive relationship with the regulating agency, can motivate firms to
innovate. Both motivations can be blunted by an overzealous enforcement
style, in which well-meaning firms believe that they are being treated
as "bad actors," caught in a game of "gotcha!" The firm referred to in
the previous paragraph explained that the negative attitude of
enforcement staff was a potential disincentive to pursuing future
innovative efforts. The following quote comes from a firm that uses very
low-polluting painting technology, and reflects resentment about
enforcement style:

> "She was a bitch, ok? \... \[S\]he didn\'t have to be so heavy handed.
> What the hell; I don\'t want to pollute any more than anybody else. I
> mean, she didn\'t have to be so heavy handed."

Some firms expressed concern that by making changes they could
inadvertently subject themselves to increased surveillance by the
environmental agency. By stepping out and proposing something out of the
ordinary, they could attract too much agency attention. This attention
could not only interfere with fine-tuning and testing innovative
proposals, it could possibly result in additional regulatory
requirements and make their regulatory burden more onerous.[^26]
Uncertainty about whether changes might trigger new requirements or
regulatory oversight may stop firms from developing new ideas, or it may
hinder their actually implementing good ideas.

> \[Q: At what point in an innovation do you bring in the DNR?\] "Well,
> I'm going to be frank with you. You hate to get the DNR involved right
> away, because most people in industry think you're sending up a flag
> to the DNR, and that they'll be here down your throat the next day to
> see what you're doing. ... you talk to a consultant and say, 'can you
> call this agency, don't tell them who we are.' ... You don't want to
> leave your name and who you are with the DNR."

Enforcement is necessary if regulations are to have any prospect for
influencing firm behavior. Thus, half-hearted pursuit of enforcement
efforts can serve as a hurdle to innovation, since compliance
motivations are eviscerated. On the other hand, an overzealous
enforcement style can reduce other incentives to innovate facilities
have, such as promoting a positive public image or fostering a good
relationship with the regulating agency.

### F) Differential Regulatory Treatment of Old and New Sources: Grandfathering and New Source Performance Standards

Old manufacturing equipment is often subject to different \-- generally
less stringent \-- regulatory standards than is new equipment.
Differential regulatory treatment can arise in two ways. First,
regulations may completely exempt, or "grandfather", existing equipment.
Grandfathered status may last in perpetuity, or expire after a fixed
period. Second, if substantially modified, then for regulatory purposes
older equipment may be considered to be sufficiently modified to be
classified as "new" and subject to new source performance standards
(NSPS), which are more stringent than the standards that apply to
unmodified "old" equipment.[^27] Stricter NSPS reflect Congress' and
EPA's sense that new facilities can more readily install
state-of-the-art treatment technology, where it would be economically
unreasonable to require existing facilities to retrofit their processes
and systems to include such technology.[^28] The Clean Water Act[^29]
and the Clean Air Act[^30] call for EPA to establish pollution control
standards for new sources.

However, differential standards may reduce a firm's incentives to
replace existing production technologies and processes with cleaner,
more innovative approaches. [^31] Firms may not upgrade or modify
existing equipment for fear that the stricter environmental standards
would be sufficiently costly as to wipe out the advantages conferred by
modern and (presumably) more efficient production technologies. Consider
a firm that could reduce its emissions, either by substantially
modifying old or by purchasing new equipment. If the resulting pollution
reduction is not sufficiently great for operations to comply with
performance levels required of new sources, and if the additional cost
of meeting new source standards is greater than the benefit of adopting
the innovation, then the firm will likely leave operations unchanged. In
consequence, industrial releases would not be curtailed, and
environmental improvement would be foregone.

A firm considering upgrading its facility might think twice before
moving forward, lest its construction be considered a "major
modification" subject to NSPS. [Wisconsin Electric Power Co. v.
Reilly]{.underline}[^32] held that the replacement of deteriorated
components at an old power generating plant was a modification that
triggered more stringent NSPS. At the WEPCo plant, the modification did
not increase the emissions rate or increase the plant's historical
operating capacity, but did result in more emissions being produced
after the renovation than were emitted from the deteriorated plant
shortly before the project. After the WEPCo decision, many predicted
that firms would be hesitant to modify their plant by installing
innovative technologies.[^33]

A few interviewed firms did express concern about the potential for
innovation and facility upgrades to trigger NSPS. One firm felt it was
important enough that they hired a consultant to ensure planned changes
would not be considered a major modification and trigger NSPS. NSPS may
deter firms from innovating if the likely return on the innovation is
not sufficiently large.

Nevertheless, even when asked, no interviewed firm said that it had
failed to adopt new or retrofit old technologies out of concern that its
new equipment would be subject to more stringent standards. It may be
that the benefits of new equipment \-- in terms of production efficiency
\-- generally outweigh the additional costs of environmental compliance
with stricter standards. One environmental manager that had new
equipment permitted was asked whether the regulatory hassle involved had
been worth the benefits offered by the new technology. He explained:

> "Oh yeah. Yeah, yeah. You know, because the reason it makes
> environmental sense is because there's less VOCs being used. Well,
> obviously we have to pay for every pound of VOCs that go up our stack.
> So it translates directly into saved revenue."

Differential regulatory treatment of old and new equipment may also slow
the rate at which old technology is replaced with newer, more innovative
approaches. We have good evidence that stringent standards induce some
firms to innovate. If strict standards do indeed motivate innovation,
and if older equipment is subject to lower (or no) regulatory standards,
then firms with older equipment are likely to have less incentive to
innovate. Since little confidence can be placed in the answers to
hypothetical questions, firms were not directly asked \-- and no firm
volunteered \-- that they would have innovated had their older equipment
been subject to more stringent limits.

Nevertheless, differing regulatory standards for old and new equipment
clearly does generate perverse incentives for firms to retain old
equipment and to pollute more than they would prefer. More stringent
emissions limits on a newer machine may effectively cap production from
that machine. As a result, firms have incentive to retain older, less
efficient and more polluting equipment, and to run it when stringent
standards limit the number of operating hours on new equipment. This can
indirectly curtail innovation since firms are encouraged to retain
dirty, older equipment for the flexibility it affords them, rather than
to search for innovative approaches. The remainder of this section
explores how less stringent standards on older equipment can induce
firms to pollute more than they would prefer, and creates an incentive
for firms to not replace their old equipment. (Note that this is an
issue not of innovation *per se*, but one of environmental quality more
generally).

Many interviewed firms have equipment of different ages, producing the
same type of product, but subject to different regulatory requirements.
One environmental manager noted:

> "I have one permit for this machine operating on these different
> limits, I have got an identical machine, pretty much identical over
> here, operating on totally different limits. I have got four machines
> over here of similar type that are all grouped under another one. I
> have got some that don't have a permit because it's grandfathered ..."

Several firms described circumstances where different permit limits on
different machines created perverse incentives to run dirty instead of
more environmentally benign equipment, and to keep dirty machines
on-line for production flexibility.

> "My most efficient machine, it's my most clean, environmental machine.
> You know, after control I am looking at basically 3½ % emissions. I
> have similar machines sitting under a different permit that are
> combined in with three other machines that I can't go over 160 tons. I
> don't even come close overall with all my machines, I only do about
> 120. So I have got plenty of room in that one. But it's a dirty
> machine. I mean, after capture and that, it's about 15% emissions."

The irony of shutting down cleaner-operating machines to run dirtier
ones is not lost on environmental managers. One noted:

> "When I reach my limit, I've got to shut down this efficient one but I
> can go over there and pollute all I want on the other machine. Does
> that make sense? Is that promoting, is the EPA promoting me to reduce
> my emissions? No. It's ridiculous. It's ridiculous for me to have four
> different permits for similar operations.

Of course, no one intended to create such perverse incentives. It seems
likely that most regulators assumed grandfathered equipment would
persist only for a short time, expecting companies to replace worn out
equipment with modern substitutes. However, for at least some industries
this has proved not to be the case. One firm explained that
grandfathered equipment may remain useful for a very long time:

> "The original idea was, gee, ... 'we will grandfather and as times
> goes on everybody does capital improvements, modifications,
> reconstruction, and everything, and in twenty years, everything will
> be un-grandfathered.' Hey, if you're a polypropylene plant and all
> you're doing is putting polypropylene through the same plant, it never
> un-grandfathers, you know."

Given that some equipment is grandfathered, regulators sometimes allow
firms to employ an emission "bubble" over several machines. The goal of
a "bubble" is to reduce the incentive to run dirty machines without
requiring that the more polluting machines be scrapped. Bubbles combine
emission limits of each separate machine under a unified emissions
limit. So long as total emissions stay below the bubble's maximum
permitted level, a firm may operate its machines in any combination that
it chooses. This firm explained how it had worked with the DNR to
establish a bubble over several machines.

> "We had two roll coaters for finishing and one roll coater for the
> oiling operation. Each of those had specific limits for the specific
> machines. The oiling machine had the highest limit because \[it was
> an\] old curtain coater, and we had the most VOCs going through there.
> ... What we were able to do is combine the permit for the three, so
> that instead of having a specific permit limit for each of the three
> machines, we had a total limit for the three."

While bubbling may reduce present environmental releases, the bubble
approach does nothing to remove the disincentive to replacing existing
equipment created by grandfathering.

Some interviewed firms believe that the 1990 Clean Air Act Amendments'
Title V operating permit acts to sunset grandfathering:

> "Well, Title V pulls everything out of grandfathering. So whatever is
> grandfathered is on its way out."

Title V does require that all sources *that are not exempt* must have an
operating permit. However, it does not apply standards of increased
stringency to any firm. Exempt facilities are still exempt. Facilities
that have equipment subject to limits that differ, depending on the
equipment\'s installation date, still have multiple limits. Title V
permits allow firms to self-monitor compliance, so Title V permits may
result in more uniform monitoring and information collection for all
equipment, regardless of the date of purchase. Despite beliefs to the
contrary, the 1990 Clean Air Act Amendments\' Title V permit program
does not appear to correct perverse incentives generated by differential
standards for old and new equipment.

This section introduced two hypothetical ways differential standards for
older and newer equipment might reduce incentives to innovate. First,
stricter standards for new or modified equipment could discourage firms
from upgrading equipment if the costs to meet the stricter standards is
greater than the benefits offered by the new equipment. Direct evidence
in favor of this hypothesis is slim. Second, less strict emission
standards for older equipment could reduce firms\' incentive to
innovate, or provide an incentive to not innovate if it entails
replacing older equipment. Our finding that strict standards induce some
firms to innovate suggests that applying strict standards to older
equipment, for example, grandfathering equipment for only a limited
number of years, would motivate more innovation. Evidence supports that
differential standards create incentives for firms to maintain and run
their older, less efficient, more polluting equipment.

### G) Permit Limits That Do Not Affect Firm Behavior

As explained earlier, strict standards can create a need for firms to
change operations. Some firms respond by searching for innovative
compliance approaches. Hence, just as grandfathering and less stringent
standards for old equipment can reduce incentives to innovate, one
should expect a more general negative influence from regulatory
standards that fail to induce firms to change their environmental
performance. This section explores how a firm's total permitted levels
of pollution may be too generous to create incentives for innovation.

When chemicals are entirely unregulated, there is clearly *no*
regulatory incentive to innovate. A number of firms use potentially
hazardous chemicals that are not regulated, allowing them to increase
these releases freely. For example, one environmental compliance manager
observed that:

> "\[M\]ethylene chloride is exempt from VOC rules." \[Q: And have you
> done anything to try to get rid of methylene chloride?\] "No, we're
> talking about what we can do to use \[more of\] it."

Among substances that *are* regulated, environmental statutes and
regulations set minimum levels of environmental performance by industry
category and sub-category. The use of these minimum levels in setting
overall permitted emissions may fail to create sufficiently strong
incentives to innovate. For example, the Wisconsin DNR generally
requires that paint which is applied to metal should not exceed 3.5
pounds of VOCs per gallon. However, a firm's overall permitted emissions
are often determined by multiplying its expected emission rate times the
number of hours of operation. While the emission rate must reflect the
actual (or anticipated) technologies employed, and while such rates must
comply with the relevant regulatory standards, the total number of hours
of operation need not reflect a firm's actual or expected operations. In
consequence, overall permitted emissions often assume firms operate 24
hours a day, 365 days a year despite the fact that firms maintain a far
less intensive production schedule. Hence, firms often do not find that
their overall permitted emissions limits serve as incentive to innovate.
Their overall permit limits are not limiting.

Firms often request that their permits reflect a much greater number of
operating hours than the plant actually functions. The goal is to
maintain the ability to expand production in the future without having
to have their permit modified. This firm requested that its Clean Air
Act Title V operating permit assume nonstop production, in the event
business opportunities were to make that economically desirable:

> "For example, our mold shop. They didn't know how many molds they
> would be making in a year. We structured that into the permit, so they
> could have molds cranked out. We looked at the capacity of a 24-hour
> day, 7-day a week production in the mold shop. And there's probably
> 100 -- the maximum theoretical emissions were about 100 times higher
> than the actual emissions."

Many interviewed firms are not constrained by their overall permitted
pollution limits. The following quotes come from five different firms:

> "Our permit limits are set high enough that we don't have to watch it
> real closely." \[Q: What're your actuals compared to your
> allowables?\] "Well, it used to be about 50%. And I think we're
> starting to get higher than that in certain areas."
>
> "Our permit allows us 100 parts per million and we're usually around
> 17, somewhere in there."
>
> "We have certain limits in pounds that we can discharge, and that's
> not hurting us at all. I haven't seen anything that's coming up that
> might affect our industry."
>
> "I was permitted and still am allowed 160 tons on that. I am allowed
> 39 tons on this machine, and I am allowed 25 tons on this machine. But
> when you add all that up, that's like 220 some tons. I only emit at
> 120 tons."
>
> "Our actual paint usage is so much below what we are limited to by our
> permit ... we're limiting ourselves via the permit to 10,500 gallons
> of paint a year. We typically use 5,000 to 6,000 gallons."

The foregoing does not imply that environmental regulations have no
effect on firm behavior. In non-attainment areas, a firm's total
emission limits are generally determined differently than the
"emissions-rate times hours-of-operation" formula, and thus often do
motivate innovative action. Regulatory standards that apply to specific
processes do cause firms to adopt cleaner technologies than they would
in the absence of the regulatory apparatus. Product bans are the
ultimate regulatory incentive for firms to innovate. Some environmental
requirements can also put indirect pressure on firms to improve their
environmental performance, such as those found in the 1990 Clean Air Act
Amendments that require firms that locate in nonattainment areas to buy
offsets if they emit 25 tons or more of VOCs per year.[^34] Some respond
to this pressure by seeking out innovative alternatives.

In summary, for many firms overall permitted emissions impose no
pressure to find innovative ways to reduce releases. Many limits are
sufficiently generous to allow significant business expansion using
existing equipment. While the standards for specific processes may
affect firm behavior, for many firms permit limits do not stimulate
innovation.

### H) Monitoring and Recordkeeping Costs

Many interviewed firms complained that complying with environmental
monitoring and reporting requirements is excessively time-consuming and
expensive.[^35] This raises the possibility that innovation may be
stifled, as reporting burdens siphon firm resources that might otherwise
be used to develop environmental innovations. Alternatively, firms may
refrain from implementing innovative projects that might increase a
firm's reporting burden.

Innovation requires staff time. Transferring technologies to a new use
-- a common method of innovation -- is no exception. Not being mandated,
innovation may be pushed out of the way by reporting and other
requirements. Compliance with environmental information reporting
requirements often takes much of an environmental compliance manager's
time. This environmental manager explained that he spent much of the
first 6 months of every year meeting reporting requirements:

> \[Q: What's your reporting season?\] "February 15th, the air reports,
> the NR101 air reports are due. There's a lot of concentration getting
> those out and getting them done. SARA is due July 1st. Usually it's
> the, probably the first 6 months of the year, before the SARA is
> complete in July, a great deal of time is spent preparing reports."

Another environmental manager, responsible for three of his companies
facilities, reported that he too spent roughly half his time complying
with reporting requirements:

> "I tell my boss, okay, the first 6 months of the year is strictly
> compliance. Because I had all the DNR and EPA reports. You know, the
> air and the water and the hazardous waste report, and the TRI form Rs,
> and all that. For three facilities."

One manager explained that the constraint of having to comply with
monitoring and reporting requirements made implementing innovative ideas
a relatively low priority:

> "I guess our first priority is compliance with the regulations, so
> that's first and utmost. We make sure we have our reports done ... At
> the same time, concurrently, we're pursuing other waste-min projects,
> but quite frankly, it's not at the top of our list."

Another environmental manager expressed the same sentiment, explaining
that reporting requirements reduced his ability to pay attention to
environmental innovations and made it hard for him to justify time spent
on activities that *might* save the firm money.

> "And to get that technology transfer from one industry to another can
> be very difficult. And it takes time to research all of that stuff and
> basically, we're so busy ... filing all the reports and that, that
> it's hard to get accomplished and justify to management that you
> should be working on that \[other\] kind of stuff -- which might be
> the real place where you can save money."

Time requirements increase when forms change. When existing systems for
collecting, aggregating, and recording emissions data need to be
upgraded, the time involved in making such changes can be considerable.
Firms find such form changes arbitrary, usually providing the regulating
agency with essentially the same information but in slightly different
form.

> "We have computer spreadsheets and it's automated. They change the
> forms on us periodically. You can't imagine the kind of pain it causes
> us to have the form changed. It took three people two months putting
> together the air emissions report. And that's just for the State of
> Wisconsin. I have another person that does Minnesota and another
> person that does other states."
>
> "I'll tell you, we were forced to submit that on a computer and that
> was a hardship for us." \[Q. Was this the first year you did it
> electronically?\] "No, we did it last year, too. But the format last
> year was the same as for the previous 5 years." \[Q. When you did the
> paper form last time, how long did it take you?\] "I probably put in
> 100% more time on the computer; it was tough. You know, the computer
> is for the convenience of the people getting the data, as opposed to
> us. I don't think it should be that way. Why do we have to fill out
> the forms for the DNR that essentially report the same thing to the
> EPA, and the country, and the library, and the sheriff, and goes to
> who knows who else? I mean, Why? I mean is that what we are paying
> taxes for? ... I mean we report the same numbers to EPA and DNR. So
> why do it for both of them? I mean, the phones run from Washington to
> Madison, too. I mean, you must have access to their data bank and them
> to yours. And it's in a different format, but it's essentially the
> same information."

Environmental information costs extend beyond filling out required
reports. Installing monitoring equipment, and performing required tests
can also be expensive.

> "MACT rules for chrome ... it's not that we can't beat the MACT rules
> because we're meeting them right now. We have a water scrubber up
> there. But, my God, it's going to take us like \$8,000 or \$9,000 just
> to prove that we're within the MACT rules..."

Firms may refrain from implementing environmentally innovative
approaches if the implementation would cause an increase in
recordkeeping, reporting, or monitoring requirements. This type of
problem appears to be mostly limited to experiences with hazardous waste
regulations. Firms with on-site solvent recovery equipment are required
to have a permit as a hazardous waste "treatment, storage, and disposal"
(TSD) facility. Such facilities are subject to stringent recordkeeping
requirements. The following firm describes how paperwork burdens
prevented it from installing solvent recovery technology at its plant:

> "One example of \[disincentives to innovate\] I can think of, that is
> not so much innovation but if you choose to not get involved in the
> process, because just the recordkeeping requirements and
> responsibility of running a solvent recovery still in your plant ...
> The recordkeeping requirements are so much. We had \[a still\] here.
> When that was implemented, we read all through \[the regulations\],
> and I says 'we're taking it out'. And we took it out at the end of the
> month, just because it \[the paperwork requirement\] was so onerous
> that we chose not to do it."

Whether regulations should encourage firms to recycle hazardous waste on
site, or ship it to a commercial TSD facility for recycling, is a policy
question that is not addressed in this study.

> The question regarding regulatory burden, as it pertains to
> innovation, is whether a drop in monitoring, recordkeeping, and
> reporting requirements would result in more innovation. While
> reporting of data helps track environmental progress, and can support
> sound environmental business decisionmaking, it also takes up the
> environmental quality managers' time. This regulatory burden could
> keep some environmental managers from using their time to innovate,
> but this time-consuming burden can also stimulates innovation (see
> chapter on Motivation, section IV(b), Indirect Production Costs:
> Regulatory Burden.) Decreasing this burden would thus have uncertain
> results. Some firms might innovate more, given the extra time to
> innovate, even though they might lack some environmental information
> on which to base their decisions. Other firms might innovate less,
> seeking cost savings in environmental staff reductions rather than
> through the development of innovative environmental solutions. When
> asked the hypothetical question, whether they would apply staff
> resources for more innovation, or whether they thought they would
> merely cut their staff if they faced less reporting, one firm with a
> small environmental staff thought they would innovate rather than lay
> off staff:
>
> "I'm sure at some companies that would be the result, that less
> regulatory issues means less staff needed, and therefore fewer heads,
> but for the most part we have a two-person staff. You know, if you
> were going to tell me that regulatory issues would now take 50% less
> time, starting tomorrow, I don't think our staff size would change at
> all." \[Q: Would your attentions be redirected to figuring out how to
> go beyond compliance?\] "Yeah, I think it would be for that expanded
> list of projects."

This section has discussed how recordkeeping, reporting, and monitoring
requirements can require considerable firm resources. While this can
motivate innovation, it also means that such time may be unavailable for
the development of environmental innovations. The net effect of
recordkeeping on innovation cannot be ascertained.

### I) Regulatory Thresholds: Reclassification That Increases Regulatory Burden, A Lost Opportunity

Some environmental statutes and regulations may encourage firms to
reduce their pollution by setting a threshold below which the regulatory
burden is less. The previous chapter describes how the potential for
reclassification may provide firms motivation to innovate. If
reclassification does *not* significantly reduce a firm's regulatory
burden then it will not motivate innovation.

For example, under the 1990 Clean Air Act Amendment Title V program, the
Wisconsin federally enforceable state operating permit (FESOP) allows
facilities to reclassify from a "major" source to a "synthetic minor"
source in exchange for the facility accepting voluntary restrictions.
Synthetic minor sources voluntarily reduce their potential to emit to
below the threshold for "major source" classification. They do so by
limiting production, installing pollution control equipment, or
otherwise innovating to reduce releases. Reduced regulatory burden \--
including reduced reporting frequency, a simplified Title V permit, and
avoidance of other federal environmental requirements for major sources,
such as MACT hazardous pollutant requirements \-- was the purported
incentive to reclassify to synthetic minor status.

Nevertheless, many firms who could have opted for synthetic minor status
chose not to do so. Many interviewed firms reported that synthetic minor
status would *increase* their regulatory burden. While synthetic minor
status reduces reporting *frequency*, synthetic minor sources are
required to show that they are in compliance with their self-imposed
restrictions. Therefore, firms could see a great increase in required
monitoring, recordkeeping, and reporting if they choose synthetic minor
status. This would be especially true for facilities with emissions near
the synthetic minor limit. Facilities close to the synthetic minor limit
might also be subject to greater agency oversight, increasing their risk
of enforcement. An insufficient differential in regulatory burden
between major and synthetic minor source status thus reduces the
incentive for innovation that synthetic minor status could have created.
One firm explained:

> "\[W\]e could have worked at a synthetic minor, but the way the
> regulations came out you were going to do all the work anyhow. If
> you're going to do all the work anyhow, why not be a major source and
> be done with it rather than fool around with all of this rigmarole and
> all of the stuff that it would take you to become a synthetic minor?
> ... So you become a major, you've got to do your records either way,
> records aren't really much different. It gives you some breathing
> room, some honest breathing room. ... We made it so that the plant can
> really move more efficiently and operate better. But if the rules
> would have been written differently, we might have cranked her down
> hard..."

Another firm echoed these sentiments:

> "When we really got down and looked at us, it didn't affect us. We
> still had to do the same amount of reporting whether we were a
> synthetic minor. So, we figure well, what's the benefit to being a
> synthetic minor if you have to do the same reporting?"

Interviewed firms indicated that reduced reporting frequency was a
relatively modest motivation to innovate, especially in light of the
realities of trying to expand production and maintain operational
flexibility. Reclassification to synthetic minor status fails to
increase many firms\' incentive to innovate because it fails to reduce
regulatory burden while it imposes other costs, such as reduced
flexibility to respond to increased demand for product.

## II. Hurdles That Affect Firm Sensitivity to Incentives

The previous section explored how regulations can fail to create good
incentives for firms to innovate, and can dampen the force of
non-regulatory innovation incentives. But even if regulators create good
incentives to innovate, and avoid inhibiting non-regulatory incentives,
firms still need to be able to recognize the incentives. If firms do not
adequately recognize that incentives exist, then they are unlikely to
try to develop innovative environmental approaches. A metaphor for firm
sensitivity might be that of a radio and music on the airwaves. Some
firms are "built to receive", while others have a harder time picking up
the full range of signals \-- motivations -- that exist. Lack of
sensitivity might be caused by corporate disinterest in environmental
goals, or by limited understanding of how environmental performance can
affect a firm's "bottom line". (See the second "hurdles" box in figure
**1**).

To better organize the material in this and in the next section, we
somewhat arbitrarily divide firms into "management" and "employees". In
this schema, we pretend that innovative efforts are launched only as a
result of management initiative (recall the "innovation chain" \--
incentive-creation to incentive-perception to idea-formation to
idea-implementation). Hence, hurdles to incentive perception are hurdles
that primarily affect *management*. While it is true, of course, that
some innovations are generated by forward-thinking employees acting on
their own, our simplified model allows various hurdles to innovation to
be conceptually organized. Note that no hurdle type is omitted as a
result of this maintained fiction.

### A) "Culture of Compliance"

For many firms, environmental performance goals are confined to being in
compliance with existing regulatory requirements. Regulations are seen
as hoops that need to be jumped through so that the firm can resume its
normal business activities. Firms with this view may be good
environmental actors within the letter of the law. However, firms with a
culture of compliance are typically less likely to innovate than firms
that have a more progressive view of their environmental performance. In
selectively focusing on what they *must* do to achieve compliance, such
firms are more likely to ignore the incentives to innovate that may well
exist.

Firms with a culture of compliance can be characterized as making little
attempt to optimize operations with regard to *all* of their business
activities, including their need to comply with environmental
regulations and to minimize costs associated with pollution generation.
Instead, environmental regulations are seen as a constraint to business
operations, to be dealt with as quickly and with as little disruption to
other firm operations as possible. Rather than trying to choose
compliance strategies to optimize overall operations and to minimize
total costs, firms with a culture of compliance make decisions in a
step-wise fashion. First, the firm makes compliance decisions; second,
once compliance is assured, firms get on with the business of making
profits.

Many interviewed environmental managers emphasized that the core of
their job responsibilities was to keep the firm in compliance with
environmental requirements. Going beyond compliance, or achieving
compliance in the most cost-effective way over the long term, does not
enter significantly into the processes. The following two quotes are
from firms that tend not to innovate on the environmental front; the
perspective of their environmental managers may help to explain why:

> "Staying in compliance, you know. ... That's what I'm here for. ...
> The biggest thing is keeping us out of trouble. If an inspection comes
> through and we have good flying colors, that's where you get your
> 'attaboys'."
>
> "I think we're doing very well if we keep up with regulation, if we
> keep up with this, if we keep up with stormwater, and we keep up with
> Title V, and our permits, and OSHA and recycling, and I think we're
> doing great when we can just keep up."

If environmental managers such as these focus only on compliance
concerns, the benefits that innovations can offer may be ignored. In
consequence, the innovation process may be cut short.

Part of the reason why some firms focus on compliance, rather than on
optimizing over-all operations, may have to do with the fact that
environmental regulations are a relatively recent addition to the
business landscape. This country's major pieces of environmental
legislation are all less than 30 years old. It seems understandable that
when first promulgated, firms would view such regulations simply as
obstacles, nuisances to be surmounted before they could get on with the
business of making products and profits. Consistent with this, one
environmental manager urged that senior management were more likely to
subscribe to a culture of compliance, and to fail to recognize the
opportunities offered by progressive perspectives of environmental
performance:

> "What my experience is is that senior managers are from a different
> era. And they really don't understand the environmental rules,
> regulations, why they're there. They know how they did things and how
> they were allowed to do things, and they don't really understand why
> they would have to change. And so there's not a lot of impetus from
> the top..."

That is, because they are from an earlier generation \-- and hence
around when regulations were first promulgated \-- senior management of
this firm was more prone to react to environmental regulations as
hurdles to be surmounted, rather than opportunities for innovation.

Another possible explanation for why more senior management might be
less attuned to incentives to innovate is that they are acting from
habit. That is, some firms have a tendency not to appreciate incentives
to innovate simply because they are satisfied that current operations
are adequate. One corporate environmental manager explained that older
facilities tended to generate fewer new ideas than newer facilities, in
large part because of the mindset of employees:

> "The newer plants are the ones that are really coming up with the
> creative ideas. \[Plant name #1\] comes up with a lot of them, they're
> a lot younger. \[Plant name #1\] has only been on line for three or
> four years, maybe. They've got new people up there. \[Plant name #2\]
> and \[Plant name #3\] have the older, it's the mindsets of when we
> started, when none of these issues were even looked at. ... When we
> get fresh people, ... it's great. It makes my job much easier."

Firms with culture of compliance may place greater emphasis on
"income-generating" activities, such as manufacturing and marketing,
than on "cost-reducing" activities. An environmental manager, in
describing his value to a firm that is markedly non-innovative,
explained that savings from pollution reduction counted less to the firm
than increases in revenue.

> "\[A\]s an environmental regulatory professional, where it gets a
> little frustrating, is that you can\'t say 'I just saved \$2,000',
> because with the \$2,000 you saved is something that they, you know,
> it\'s fictional money, it\'s not something you can say, 'well, we were
> spending it here and we\'re saving it there'. ... And you can maybe
> reduce those costs, but you never generate dollars with it."

Another environmental manager explained that corporate management did
not provide adequate resources to explore innovative ways of
transferring pollution prevention and control technologies originally
developed for different industries. The reason was that the benefits of
resulting cost reductions are seen as less valuable than revenue
increases:

> "To get that technology transfer from one industry to another can be
> very difficult. And it takes time to research all of that stuff ...
> it's hard to get accomplished and justify to management that you
> should be working on that kind of stuff -- which might be the real
> place where you can save money -- but, they don't want to overstaff
> with people they don't feel contribute to the bottom line exactly."

If firms view "reduced costs" less favorably than "increased revenue,"
then they are less likely to appreciate benefits offered by innovations
that reduce costs associated with generating pollution.

Because firms with a culture of compliance focus on environmental
regulations as an obstacle to firm operations, they have a tendency to
focus on "what they have to do." This tends to focus attention on
existing, rather than future, regulations. However, as noted earlier,
anticipating future, more stringent regulations can enhance incentives
to innovate. In consequence, firms with a culture of compliance who
focus on what they "need" to do now to comply are less likely to
perceive the full range of innovation incentives that exist.

Because firms with a "culture of compliance" focus on what they *must*
do to comply with environmental regulations, they are less likely to
want to perform environmental audits. After all, audits can turn up
problems that then require attention. One environmental manager, who
works for a firm that did not often innovate, explained his firm's
reluctance to perform audits:

> "It's a major undertaking and, of course, if you audit that means you
> also got to fix what you audit, too. That may be a problem."

The implication is that environmental performance should receive as
little attention as possible. Doing anything more than one absolutely
*has* to is viewed simply as a burden. Rather than viewing audits as an
opportunity to gather information about environmental performance \-- a
precondition for determining whether that performance might be
cost-effectively improved \-- firms with a culture of compliance are
more likely to view audits only as a possible nuisance-generator. Such
firms will be less likely to perform audits, and so be less aware of
possible benefits to innovation.

Even for firms that regularly undertake environmental audits, having a
culture of compliance can limit an audit's ability to provide
information that would increase sensitivity to existing incentives to
innovate. The following quote comes from a firm whose corporate
management regularly audits its environmental performance. However, the
audits are designed to find compliance problems, rather than to generate
information that might better allow firms to assess the costs and
benefits of different approaches to dealing with its pollution.

> "We get periodic visits from our own corporate people, that check and
> make sure that \-- you know, all our manifests have been sent in, and
> we\'ve everything certified. So they go through and they have their
> own protocol, keeping check and watching that we\'re complying with
> things."

This firm's culture of compliance leads it to structure audits to
address compliance concerns, rather than to identify opportunities to
cost-effectively improved environmental performance.

### B) Costs and Benefits of Industrial Releases Not Tracked

Even if firms do not have a culture of compliance, they may still fail
to perceive incentives to innovate if they are unaware of their full
production costs. Such incomplete perception can occur if accounting
systems do not track environmental expenses and relate those expenses to
each production line. Expenses such as obtaining environmental permits,
using consulting firm services to apply for permits and comply with
regulations, time spent filing paperwork, utility costs and insurance
premiums are examples of costs often categorized as \"overhead\" but
which are a function of technologies and processes employed. They can
vary with manufacturing practices.

Putting all such "indirect" costs into a single "overhead" category
precludes being able to comprehensively allocate the full costs
associated with each production line. Thus, firms are unable to
distinguish clearly the costs and benefits associated with different
strategies for preventing and controlling pollution. The upshot is that
such firms are not positioned to appreciate fully the incentives that
may exist to developing innovative approaches.

A surprisingly large number of interviewed firms aggregate environmental
costs into general corporate overhead. The response of this
environmental manager as to how environmental costs are tracked is
typical of many firms:

> "It\'s all overhead. Each facility has an environmental account. My
> whole department of Administrative Services that I am in charge of is
> in overhead."

Another firm explained that it does not try to associate waste costs
with processes:

> "For us on a product-specific basis it\'s very difficult to know
> exactly how much of the waste . . . because we\'re a large-quantity
> generator -- very large quantity -- to pin it down to the individual
> process..."

The difficulties that this causes when trying to evaluate the true cost
of a production technology was explained by the following firm:

> That is part of the accounting problem. My department and the salvage
> department together, we wind up paying for \[pollution\] disposal out
> of our budgets. The engineers don\'t see the costs of waste paint. It
> is the same as our energy supply, gas and electric. The departments
> have no reason to turn the thermostat down or turn the lights off,
> because those costs come out of my budget.

Nevertheless, firms that do try to trace the causal connection between
environmental costs and the processes responsible for their incidence
are able to better appreciate the incentives to innovate. The following
quote comes from a firm that has a relatively elaborate accounting
scheme \-- one that produces a "score" \-- for measuring the
environmental performance of different processes and facilities:

> "One thing the score helps you do is it can help you try to
> prioritize. ... You can kind of use it a little bit to key in on
> 'well, if we work on this, it'll drive our score 10%, but if we work
> on this one, it'll drive our score 50%.' It gives you some little idea
> of where you get the most ... And with a spreadsheet you can plug
> those numbers in and run the 'what if' scenarios."

Another firm's management information system directly feeds into its
pollution prevention program. By tracking waste costs, the firm
appreciates incentives to modify operations in innovative ways. Its
environmental manager explained that the information system:

> "\[T\]racks our waste costs as part of the pollution prevention
> program. And we put that out quarterly."

Yet another firm developed a comprehensive material-balance analysis to
better understand the environmental implications of its operations.
While their information system does not translate pollution releases
into direct dollar figures, it does provide a clearer picture of the
consequences of different production processes.

> "\[W\]e've developed a waste stream analysis for \[our firms\] between
> hazardous and non-hazardous \[waste\]. And we discuss where their
> waste ink goes, where their solvent waste goes, what goes into their
> dumpster, and we're fairly specific. ... \[W\]e have that down in most
> plants to individual departments. You can see that there are a lot of
> wastes. There are coatings, laundry, QC lab, nameplates, molding, tool
> room, punch press, anodize, paint lab, sheet spray, screening, et
> cetera."

This last firm explained that it was disaggregating its costs so that
waste disposal costs from painting could be associated with the actual
painting process that generates it.

> "\[O\]ur accounting system is actually being re-thought, itself right
> now. ... Like paint costs: our production cost, where disposal is my
> cost -- an environmental cost -- we are currently, this is the first
> year that we're actually taking environmental -- we'll call it 'my
> department's environmental cost' -- and distributing them to the
> producing departments that generate them."

Of course, while information systems that allow firms to trace
environmental costs to the processes responsible for their incidence can
promote appreciation of cost-reduction incentives to innovate, such
benefits do not necessarily outweigh the costs of setting up a system
that tracks fully disaggregated costs. Many firms make conscious efforts
to improve their accounting systems, but at the same time recognize the
practical limits of doing so. The following quote comes from a firm that
is trying to better link environmental costs with individual production
lines, but acknowledge that their efforts will necessarily be
incomplete.

> "If we shipped die-cast wastewater, that cost goes to die-cast. It
> doesn't go into a large, environmental account, so to speak. We are
> putting the environmental cost into the producing areas, starting this
> year. Yet other costs, as far as comparing the cost of a solvent-based
> paint to a water-based paint, those types of things, they are reviewed
> at the time of the capital expenditure, but to track those ongoing is
> very difficult in the system that we have."

The need to perform some degree of aggregation, on practicality grounds,
was echoed by many firms. The following firm explained:

> "Every month there's a line item that says in our budget "sewer
> treatment". And that's all the money that we spend on sewer treatment,
> whether it's chemicals or hardware."

This section has addressed how, even if incentives to innovate are
present, aspects of a firm's culture or practices can hinder its ability
to appreciate their force or extent. Firms with a "culture of
compliance" tend to focus on what needs to be done to comply with
regulatory requirements, rather than how environmental performance might
be optimized. Firms with inadequate management information systems may
be unaware of cost savings that might result from environmental
innovations. In both cases, hurdles to innovation are erected because
the firm may fail to perceive the full benefits that innovative efforts
may offer.

## III. Hurdles That Affect Idea Formation

Even after management has recognized an incentive to innovate and
expresses corporate interest in innovative approaches, employees must
still generate new ideas. It is rarely costless or easy to develop a new
idea, or to investigate innovative approaches tried by other firms.
Innovation is more likely if management can communicate environmental
priorities and develop organizational structures that support
information flows. Hurdles to idea formation are largely internal to a
firm, and occur for a variety of reasons. (See the third "hurdles" box
in figure 1).

A failure by management to effectively communicate its environmental
priorities to staff may hinder innovative idea formation. Employees who
do not appreciate management\'s desire to reduce environmental releases
may not be on the lookout for such opportunities. Management that does
not actively solicit employee suggestions may not get them. Even though
employees may know of management\'s desire to reduce releases, if the
firms' evaluation processes or other employee incentive programs
discourage risk-taking or activity outside of normal job duties, then
employees may not engage in innovative activity.

If management fails to encourage information flow between departments or
across specialties, they may inadvertently hinder innovative idea
formation. Inter-departmental communication is often key to developing
innovative approaches. Employees in different departments often
understand different aspects of their company\'s product, and face
different incentives, making communication and cooperation both more
important and more difficult. Organizational structure may not encourage
interactions between department staff. If management does not develop
formal mechanisms to encourage that communication, it may not occur, and
potential solutions will fail to materialize.

Finally, if management fails to translate environmental priorities into
an effective environmental quality manager position, then innovation may
be hindered. A manager who lacks time or appropriate training will be
hard pressed to innovate. One who lacks either the responsibility or the
authority to develop innovative solutions will be unlikely to do so.

### A) Employees Do Not Appreciate Benefits of Innovation

The development of innovative ideas often requires input from a wide
range of firm employees, including many who might not often consider
environmental issues during their normal daily routine. If employees do
not appreciate that the reduction of environmental releases confers
benefits then they will be unlikely to develop, or to come forward with,
innovative ideas to reduce those releases.

Sometimes managers face an uphill battle in communicating environmental
issue, fighting against traditional ways of thinking within a firms:

> "\[Floor-level employees\] are the hardest level to get at. Because
> you gotta get at your foreman. And your foreman came from the line.
> And you have to turn your foreman into more than production. They have
> to recognize that their job is broader than just getting the job done,
> whatever it takes. They have to recognize OSHA, they have to recognize
> the environment, they have to recognize leadership\..."
>
> Daily job responsibilities and other priorities can reduce the
> likelihood that employees will focus on environmental issues or
> incorporate them into their decisions. This will present a challenge
> to management\'s communication efforts:
>
> "\[W\]e try to bring \[environmental issues\] to people\'s attention.
> I used to kind of operate on a \-- I\'d hear about a new regulation
> and I\'d send out a memo and I\'d think things were fine. Well, people
> have \-- everyone\'s busy and has different priorities and eventually
> they forget."

Many interviewed firms sought to increase the likelihood of recognizing
opportunities for innovation by expanding the universe of employees
aware of environmental requirements and of the potential benefits from
innovation. Some firms created incentives for all employees, not just
environmental managers, to think creatively about environmental issues.
Incentives can increase the likelihood that employees are aware of
environmental issues and thus encourage new ideas. One company created
an award program for any employee that proposed a useful innovation:

> "We do have a sort of corporate-wide environmental awards program.
> Where if you are -- whatever it is that you implemented at your plant
> and it worked and showed some sort of reduction in waste or so on and
> so forth, you can submit it on a yearly basis and then . . . if you
> are chosen as 'the great idea, head and shoulders above', ... then you
> would get X amount of dollars that would be provided to the place of
> your choice. ... That's an incentive."

If they understand the priority, floor-level employees can be an
important source of new ideas for reducing releases. However, if
management is not listening, does not provide ways for employees to
submit or develop their ideas, then idea formation will be hindered.
Innovative firms tended to have multiple methods for employees to
communicate back up the company hierarchy, some formal, some informal:

> "\[T\]hey'll come up with all kinds of ideas. Some of them are through
> formal suggestion programs, some of them are just in passing to the
> supervisor, some of them are directly to me because I'm walking around
> there."
>
> "This is a non-union facility. I think we\'ve traditionally very much
> listened to the people who work here. I think that there are avenues
> for people to approach us with ideas and concepts. I think we have a
> very well educated, very articulate work force. So we do get ideas
> from them."

Once they effectively communicated environmental priorities, managers at
several interviewed facilities found that giving employees significant
latitude to develop their own environmental solutions has resulted in
innovation as employees have developed a sense of ownership of the
solutions:

> "\[N\]ow we've got the environment to flesh some more opportunities
> out. Because now we've got a lot more cooperation and we're \...
> giving people more latitude to run their process. And they're the best
> ones that know what's going on out there, not \-- keep management out
> of it, and give you the tools to work with, and let you just work
> around these boundaries, and do your own thing."

Employee job descriptions or evaluation processes can inadvertently
discourage innovative idea formation. Developing innovative ideas takes
time. If there is little or no encouragement or recognition for
innovative environmental activities relative to other firm activities,
then employees will be guided away from innovation. Award or incentive
programs, discussed above, can reduce this hurdle. In addition, some
firms have responded to this hurdle by expanding each employee's job
responsibilities to include environmental awareness. One environmental
quality manager stated:

> "I think it's everybody's responsibility \[to think about ways of
> reducing or eliminating releases\]; that's part of our \[in-house\]
> program. And everybody is asked to, if they come up with an idea, they
> see something that we can reduce an emission, if you reduce something
> right from the start, then you don't have to try and worry about
> reducing the waste later, and that's just part of our training here."
>
> Another environmental quality manager discussed his company\'s formal
> incorporation of environmental responsibilities into employee job
> descriptions:
>
> "And we\'re getting into certification, and building systems and
> procedures into these peoples\' job descriptions, and making them more
> accountable."

Idea formation is hindered when management does not effectively
communicate environmental priorities to staff. Management that clearly
enunciates environmental priorities, develops ways for employees to
submit and develop ideas, and correlates non-verbal corporate cues such
as evaluation processes and job descriptions to support innovation,
reduces this hurdle to the development of innovative ideas. Innovative
firms have developed various ways of addressing this internal hurdle.

### B) Communication Limitations Within the Firm

Environmental innovation is most likely to occur where decisionmakers
understand environmental requirements, can identify specific lower
emitting production processes or emission controls, and have authority
to make unconventional decisions. In many firms, different employees are
involved with these three elements. Environmental innovation often
requires the active involvement of many different departments within a
firm, each bringing specific knowledge or expertise to idea development.
If management is unable to engender a spirit of cooperation and to
ensure avenues for communication among employees and across departments,
then potential solutions may fail to surface.

Firms that worked to reduce the hurdles to communication said that
bringing an interdisciplinary and varied perspective to bear on the
issue of innovative opportunities tended to result in more new and
productive ideas than relying on a more homogeneous or specialized group
of employees.

> "We put together a multi-functional group of people, we had everybody
> and his brother working on that project, it seemed like. We had
> purchasing people, product engineering people, manufacturing
> engineering people, ourselves, eventually marketing people ... in
> 1990, when the Clean Air Amendments were still being finalized we were
> getting together and saying 'the handwriting is on the wall, we got to
> be out, we've got to do something'. And so we chose to go to source
> reduction as the method."

Interviewed firms varied somewhat in the measures they adopted to
encourage cooperation and communication among employees and departments.
Some firms created environmental teams that included employees from
across the firm. Others held meetings, more or less formally, to
encourage information sharing and cross pollination of ideas. Larger
firms with multiple facilities sometimes took this further and
encouraged information and idea sharing across facilities through
formalized contacts.

Several interviewed firms created corporate teams to address
environmental concerns. Some formed teams to respond to specific
problems, whereas others formed standing environmental teams that
continuously developed new approaches to reducing facility releases and
facility costs. By developing effective teams, management helps to
develop effective communication and effective cooperation which assist
in idea formation.

> "Inside the spray area, we used to have a lot more overspray than we
> have now. We put together a task team to look at the amount of
> overspray which would result in the amount of hazardous waste
> generated in that area, and reduced that to a minimum and also reduced
> the types of cleaning solvents we have back in that area. And I think
> that waste itself went, probably, down by 30%."
>
> "\[W\]e formed a team. It was actually basically three components of
> that team. There was engineering, responsible for testing whatever we
> came up with. There was research, which was responsible for 'let\'s
> find something to test'. And then there was us, this facility, that
> actually did the work."

Other interviewed firms held in-house meetings or training seminars to
explore and share environmental information.

> "There is an environmental council , within \[firm name\], that we
> don't attend, at least I haven't. But our divisional person does. And
> then his corresponding person in other areas. I'm not sure how many
> people are on it, but they all share the notes ... from the
> environmental council meetings. And they meet like four times a year.
> And they share ideas."

Firms might develop meetings and trainings for employees with various
responsibilities within the plant. Some focused on supervisors:

> "We have actual environmental group meetings, training for supervisors
> and particular people in the plant."

Others target floor employees and those responsible for particular
processes:

> "\[T\]he production foremen at this point. We plan to move on into
> that. But you bring in your chem lab people, anybody that's dealing
> with recordkeeping. So you might have your stock room people in
> there."

The attendees varied, but at many firms the environmental compliance
manager, plant manager, and production staff met regularly to share
information. Also common were less formal and more frequent meetings:

> "Well, we\'re a smaller, we\'re not that big of a company. And
> geographically we\'re close. \... Most of our operations are here.
> It\'s easy to pick up the phone and say whatever, and have regular
> meetings with the plant people and interaction. If I have an idea, or
> they have an idea, you know, they seek our advice, and ask us, 'well,
> environmentally, how does this sound?' "
>
> "We have 'as needed' meetings. We have monthly meetings of safety and
> environmental, we have those for all employees, we have\--as I talked
> about\--as part of our capital improvement or equipment review process
> for environmental safety and industrial hygiene. And again, that\'s as
> an 'as needed' basis. Goes for manufacturing, goes for safety, goes
> for environmental."

Some companies have corporate- or plant-wide meetings to discuss
environmental policy developments. One company required plant managers
to interpret regulations, with the help of a corporate environmental
manager, so that they would be more likely to consider environmental
concerns in their decisionmaking. The environmental quality manager
explained that he:

> "Work\[s\] very closely with the plant engineers and help them to
> interpret. They call with questions. We have an environmental
> roundtable -- which is chaired by the corporate legal people -- and we
> meet every couple of months. ... We discuss issues of the day and pass
> things around."
>
> Larger firms with multiple facilities may try to encourage sharing of
> ideas or innovative solutions that might create benefits at more than
> one location. Some firms have regular meetings including all the
> facilities. This firm explained how it shares information between
> environmental managers at its different facilities:
>
> "There's semi-annual environmental conference where ... you get
> together with your, it's kind of tower of Babel because they're all
> from different states, and all the different state regulations provide
> for some interesting conversation. ... You always learn something that
> you can bring back and apply here and apply to your plant, at every
> conference."
>
> Other firms have corporate environmental management provide the
> information cross-pollination function through separate facility
> visits:
>
> "And they go around the country and have these \[environmental
> meetings\]. And those kinds of innovations are brought to those
> meetings and so the other plants get to see and hear what's being done
> and they can copy them. That sort of thing."

One large firm had staff at headquarters responsible for sharing
information on an ongoing basis.

> "And they're taking that information right now, and they're coming
> back to each individual division and working on those points. And we
> have five people now on the corporate staff that are going to help
> us."
>
> Innovative firms tended to be able to break down barriers to
> inter-departmental cooperation and communication, and thereby
> encourage idea formation. Interviewed firms often created teams or
> used formal or informal meetings to facilitate environmental problem
> solving and information sharing. The role of the environmental quality
> manager in forming teams and facilitating information sharing and idea
> formation often was crucial. The next section discusses ways in which
> the environmental quality manager might be hampered in being
> effective.

### C) Environmental Quality Managers Lack Time, Training, or Responsibility

Some environmental staff do not have the time or training necessary to
effectively develop innovative solutions. Innovation takes time and
talent. Multiple job duties, while potentially providing the
environmental quality manager a broader context within which to
innovate, also can hinder innovation. Some environmental quality
managers are so busy they have no time available for creative efforts.
One environmental quality manager, who had been involved with few
environmental innovations, described his duties:

> "I worked my way up in business, through a lot of different functions,
> but mostly in engineering. \... What falls under my direction is all
> of engineering, which includes design engineering, anything that has
> to do with engineering functions, whether that\'s procurement of new
> equipment, designing equipment, upgrading present equipment, whatever
> it may be. Also, the physical structure of the facilities. The
> warehousing for parts falls under my structure. And needless to say,
> all of the environmental matters. \... I make sales call work. We\'re
> closely related with, our group is very closely related with
> accounting, with manufacturing, with sales, with all the other things.
> I personally, and some of my people, go visit customers quite often.
> We get involved in a lot of areas. We don\'t have a lot of layers at
> \[company name\], so we do whatever has to be done. I mean, there\'s
> not a lack of not doing anything. So all that falls up under our
> guidance."

Some environmental managers may not be adequately trained for their
jobs. Many environmental managers had other responsibilities in the firm
prior to becoming responsible for environmental compliance. This may
provide an understanding of several aspects of the facility, which can
help foster innovation. However, if a manager does not have adequate
training and is learning as the work goes along, is having difficulty
tracking requirements and compliance issues, is unaware of available
alternatives for processes or controls, or doesn\'t understand their
facilities production processes, the manager is less likely to recognize
and take advantage of opportunities for innovation.

> "A guy came in from the state and said 'what have you been doing about
> this?' And I had known nothing about it. And then I went and did the
> 101s. And then I went to MMSD meetings to find out what they wanted,
> what was happening industry-wide, and what we were going to have to
> do. And then it grew on me."

Job responsibilities as defined, or as understood by the environmental
quality manager, can inadvertently discourage innovative thinking. At
most firms, staying in compliance with environmental requirements is
viewed as of primary importance. This priority is often reflected in
evaluation criteria used to evaluate an environmental manager's job
performance. It creates a strong incentive for the environmental manager
to focus on compliance, not innovation.

One firm\'s environmental quality manager had no input into how her
facility met environmental regulations. She lacked an understanding of
facility operations, and clearly was not expected to facilitate
innovation. When asked whether she provided input and direction as to
technology choices and processes, the environmental manager explained:

> "I guess I really don\'t. That\'s something that maybe I, as the
> environmental person, should get more involved in. But the plant
> pretty much takes care of that themselves."

Another environmental manager saw his job as providing information in
response to requests, not as facilitating idea formation:

> "\[T\]hat\'s their choice, not mine. I get paid to bring the
> information to them and then try and put what they decide to effect in
> that. \... Corporate people, and my bosses \[make the decision\]. \...
> I\'m more the go-fer guy."

Some firms surmount the problem of environmental managers not
facilitating idea formation by including innovation and pollution
prevention in job evaluations. Two environmental managers described
their jobs as requiring them to think creatively about pollution
prevention and control:

> "When I get my appraisal, there is something that'll say 'you know, we
> have no compliance issues, good' ... 'Looking at how we approach the
> activity, so to speak, you know, are we cutting edge?' 'Are we making
> positive moves type of deal, versus following just what we have to
> do?' type of staff. You know, that's reviewed..."
>
> "I've got some goals, as far as compliance, and pollution prevention
> is certainly in there."

## IV. Hurdles That Affect Implementation 

After incentives to innovate have been created, perceived, and responded
to with the development of an innovative idea, innovation can still be
thwarted at the implementation stage. New ideas may face a wide array of
implementation hurdles. These hurdles may arise both within the firm and
from the environmental regulatory system. Examples of within-firm
implementation hurdles include concern for product quality, inadequate
capital, and employee resistance to change. Examples of regulatory
implementation hurdles could include agency preferences for particular
technologies, ambiguous permit requirements, or delays in receiving
approvals.

The regulatory system of obtaining, complying with, and enforcing
permits has the potential to put roadblocks in the way of firm efforts
to implement environmental innovations. Such regulatory hurdles would be
vexing indeed, if they occur. They would block innovation at the end of
a chain of events in which incentives to innovate had been created and
received, innovative ideas developed, and internal-firm barriers
overcome. Much of the innovation literature argues that the current
regulatory system does indeed inhibit innovation at the implementation
stage.[^36]

This section explores and evaluates ways in which the environmental
regulatory system may hinder innovation implementation. Our interview
and survey work indicates that, in general, the regulatory process does
not significantly hinder environmental innovation. Most hurdles to
implementation have their source within facilities. Our empirical data
thus appear to be sharply at odds with what much of the theoretical
literature suggests.

This section looks first at hurdles within the firm, and then at
regulatory hurdles.

## i. Internal Firm Hurdles to Implementation {#i.-internal-firm-hurdles-to-implementation .unnumbered}

### A) Product Quality Concerns

Manufacturing firms focus on making products. For most, environmental
performance is a secondary concern. Reasonably enough, firms are very
concerned about the potential impacts of an environmental innovation on
product quality. This can create a general reluctance to adopt an
unproven innovation. Further, some customers require contract provisions
that guarantee product quality. These contracts can make process changes
difficult. To assure product quality, some firms have established an
extensive program to test and analyze potential impacts of innovations.
Customers sometimes demand such testing, which can last several years.
The risk of a decline in product quality, and the cost and hassles of
tests, can swamp the benefits of innovations.

If the product fails to perform as desired, customers are unlikely to
return to the company, regardless of its fine environmental record.

> "It's not just as easy as ... saying, 'hey, tomorrow we're going to
> use a different paint.' And when you're going to, say, a non-VOC
> paint, a water-based paint, it's even worse, because when our
> customers buy one of these transformers, and they expect a certain
> amount of durability. They expect it to last for 25 years out in the
> field. And if the paint all peels off in three years, they're not
> going to be very happy."

Product quality concerns breed a certain degree of conservatism with
regard to environmental innovations. Interviewed firms tended to
approach new ideas with considerable caution.

> "We used sulfuric acid from the very beginning here, from 1971, so we
> were using that up until 1992 or so. And I knew that it worked, and I
> was reluctant to switch to something else until I could test it.
> Because I was putting at risk every piece of water-cooled equipment in
> the facility here. And I wanted to be sure that what I was doing was
> going to not damage that equipment ..."

Some customers closely monitor production processes as a way of ensuring
themselves product quality is consistent. Such monitoring can have a
chilling effect on process innovations.

> "If we're going to change things in our facility we're partly
> customer-driven. We have guaranteed customer quality contracts to
> guarantee delivery, composition, a lot of things. They are here
> auditing. Not like in the good old days, you inspect your products and
> the customer hopefully didn't get any inferior product. Well, now it's
> the statistical process control, and they're in here actually auditing
> us so that we have a statistical process in place throughout our
> production process."

To reduce uncertainty, firms may carefully study how potential
innovations might affect product characteristics and quality.
Environmental managers at two firms noted that analysis and testing can
delay implementation by months or years:

> \[Q: How did you come to pick DBE as the alternative?\] "We tried
> everything. We went the full gamut. ... \[We\] tried it for
> contamination. \[We\] looked at 'does it make material swell?', you
> know, all those different things. ... so it is always a slow process.
> \[We\] were working on this for years. \[We\] tried many different
> other things and just nothing seemed to clean properly. We want to
> give our customers ... they know our consistency and our quality and
> we really try to make sure that we stay on that ..."
>
> > "We have a big research organization ... a lot of the PhDs, et
> > cetera. And they did an extensive study for us, as did outside labs,
> > using different products, whether it's aqueous cleaners, or
> > biodegradable cleaners, citric cleaners. I mean, you name it, we
> > have tried it on our product." \[How long did that experimentation
> > go?\] "The last fifteen years."

If a customer has detailed specifications regarding product quality,
testing can be particularly elaborate and time-consuming.

> "For any process change we have to do full lab analysis ... Then we'd
> have to do full functional testing, and we have a testing lab. ...
> Then we'll typically have to do full dimensionals ... Then we submit a
> warrant to the customer for their approval with all this information
> we've gathered then they'll analyze it, they may want to do some
> functional testing, ... it can be very, very hard. ... It can take up
> to three years ... it probably takes at minimum one year."

Other firms echoed that the need to test performance of products made
with a new approach can put a damper on the desire to innovate.

> "If you\'re talking a substitution or a elimination of a chemical
> often you need as much as two years. Because we have guarantees on our
> products for one to two years. You have to get the materials in you
> have to build the product you have to get it on this long test real
> time test frame."

Many customers are themselves manufacturers who may have particularly
stringent product quality needs. For example, a firm that makes gaskets
for brakes on cars cannot change its product without rigorous testing --
for obvious reasons.

> "A lot of our products end up in brake systems for automobiles. So you
> understand why they want to test and evaluate at every step."

The basic point is that in considering whether to make a process change,
product quality concerns swamp potential environmental benefits. If a
product is likely to be adversely affected, then the environmental
innovation is unlikely to be implemented, regardless of benefits

> "It sounds like a no-brainer to pull a solvent out of there ... but
> you got to be careful because you don't, you can't mess with the
> integrity of your can. So sometimes, by us making a minor change, we
> got to go through a two-year test pact. Make sure it will still hold
> corn or peas or carrots or whatever."

Concerns for customer reactions to a changed product can be enough to
quash innovative efforts

> "Everything gets down to what the buyer wants. One of our lines of
> leather is ... an old standby, dress-show leather. It was what \[firm
> name\] got to be known by, I mean it was one of its trademark
> leathers. High VOC leather. We tried producing a line mimicking it
> with water based, and it just didn't have the qualities that the
> customer wanted. ..."

### B) Capital Constraints

Firms always face capital constraints, whether the money is for
environmental innovations or other purposes. Some firms are simply
capital constrained, regardless of the uses to which it might be put.
Whether or not access to capital constrains the firm's environmental
expenditures depends on several things: culture, accounting practices,
impediments to investment. However, some firms do not let access to
capital constrain environmental quality decisions more severely than
access to capital for other purposes. A firm's culture can inhibit money
being appropriated for environmental projects. This is especially true
if management views cost savings -- which environmental projects tend to
generate \-- as less worthy than increased revenues.

The following firm is not in a position to use capital for any
innovative ideas. Even if the potential return on an innovative
environmental project was very favorable, it is not in a position to
adopt it.

> "\[W\]e're limited on capital." \... I guess what we really look at
> is: boy, we have a thousand ideas and hopefully they all cost 20
> bucks. And we implement them. Okay. It's very tough to have an idea
> and spend a million bucks on it. Even the payback, if we had decent
> payback, it would be tough to do."

A firm's decision-making structure can importantly affect whether
capital within a firm is likely to flow to environmental projects.
Multiple sign-offs can stifle innovative changes if the advantages are
not readily understood by any given link in the management hierarchy.
When asked about who needed to approve the expense of implementing an
innovative idea, one environmental manager in a large firm noted that:

> "Depending on if it's just a procedural change, it might just be to
> their own department. If it's a capital spending, then obviously
> capital spending has to be approved through their ...like the
> press-room manager, actually, through the VP of press operations.
>
> A similarly constrained firm explained that most capital expenditures
> need to be approved by top management.
>
> \[Q: At what level would the capital expenditure trigger going all the
> way to the CEO?\] "Doesn't take much these days, just cause, yeah,
> they're at this point holding things pretty tight."

Firms without a capital budget devoted to environmental projects may
make their environmental managers go through an approval process for all
expenditures -- a requirement that other managers in the firm do not
have to meet:

> "One thing that's, I guess, been difficult from an environmental
> standpoint, is we don't have an environmental budget. I mean, somebody
> looks at the environmental numbers, but they don't give us a budget
> and say 'here, work with this'..."

Firms that do encourage capital spending for innovative environmental
quality projects sometimes allocate capital for discretionary use by the
environmental quality manager.

> "These are \$100,000 buckets of money that are put there for
> miscellaneous items that you didn't think about, items that come up."

The following firm not only has an environmental capital budget, but
also provides its environmental manager with a "hunting budget" to find
and exploit environmental opportunities.

> "\[They\] give me capital money, in other words I have \$25,000 just
> to find ways to improve capture, and cut fugitives ... I have a
> hunting budget."

Although capital is generally scarce, occasionally unappropriated
capital can be exploited by environmental managers. This sort of "fiscal
Christmas" may provide an opportunity for innovative ideas. That these
funds are so readily claimed indicates that capital availability does
indeed curtail implementation of innovative environmental projects.

> "There are cases at the end of the year where there is money
> available, and whoever can come up and say 'I can spend that right
> now', you can get money. ... We've done that in the past right here.
> In fact, the empty barrel storage area, we've done that with. Came in
> December, we had money available, we put it to use real quick."

### C) Non-Depreciated Equipment 

Firms make large capital expenditures on an infrequent basis. Firms are
understandably reluctant to replace equipment that has useful life
remaining. Unless cost savings are substantial, innovative environmental
technologies are unlikely to replace equipment that is still useful to
the firm.

Firms often take advantage of changeovers either in processes, plants or
product lines to introduce environmental innovations. That they do so
indicates that this "fixed investment" problem exists. The rest of this
section illustrates how innovative firms incorporate environmental
concerns into their capital decision processes, and exploit
opportunities for innovation presented by process and product changes.

Firms building entirely new plants take advantage of this changeover to
get to the "environmental frontier":

> "We made major changes when we built this whole plant. Everything was
> geared towards being the best, you know, ergonomically and
> environmentally. And we did a lot of things right, as far as the tank
> farms and waste streams and so forth. But it wasn't something that we
> changed the process within the existing plant. ..."
>
> Equipment changes can provide significant opportunities to adopt
> environmentally innovative approaches. If individual processes are
> being changed, then these can be updated to the state of the art:
>
> "All the new presses that we're putting in right now are being fitted
> with the pre-pack system."

Opportunities are also created when a firm attracts a new customer or
changes its product line. These product changes lead to process changes
which create opportunities for environmental innovation.

> "Because we have the opportunity, as being custom compounders, custom
> painters, is that every time we get a new customer they want something
> different. That's an opportunity for us to work with our suppliers, to
> change that paint package to something that's less of an emitter."

The opportunities to implement innovations are greater when producers
are simultaneously faced with a new product, new customer, and new
plant.

> "We opened that plant up for a new customer. We made sure when we
> developed the polymer systems and cementing systems that we did it
> with water-based cements, and then we've added new customers since.
> ... This plant here, which strictly has been solvent-based cements, we
> would have to go through polymer by polymer, cement by cement, trying
> to make changes."
>
> "Job shops", or firms that produce a specific product for a specific
> customer, typically have the most frequent product changes. In theory,
> therefore, job shops should have considerable opportunities to
> innovate. Some interviewed job shops did indeed encourage plant
> managers to try new ideas and continuously fine-tune production
> processes.
>
> "... A shift in solvents or something like that, the plant manager
> pretty much has an opportunity to do that as long as it doesn't -- as
> long as they get their product out. If in fact they experiment and it
> doesn't work out -- we're doing that all time, constantly doing
> something to try and improve the process."

However, not all job shops view high product turnover as presenting an
opportunity to implement innovative ideas. Some environmental managers
at job shops find that product changes make innovation harder, because
they have little time to perfect production processes.

> "That's one of the additional burdens, because we are a job shop.
> We're dealing with over 300 customers or customer location sites, and
> it's a wide variety of things that can change rapidly. We're not
> making one engine block for months at a time for a particular
> product."

The foregoing suggests that although the problem of fixed investments
does retard adoption of innovative environmental approaches, innovative
firms do exploit the opportunities to improve environmental performance,
and reduce associated costs, presented by capital and product
changeovers.

### D) Employee Resistance to Change

Employees often resist change. This can hinder efforts to implement
innovative environmental approaches. Resistance may stem from a variety
of causes, including deference to tradition, employee satisfaction with
existing procedures, the egos of some production foremen, and peer
pressure. Resistance can occur at all levels in the firm. Many
interviewed firms have worked to overcome employee resistance by
communicating the health and environmental benefits of innovative
changes.

Employee resistance to change can be a barrier to implementation of
innovative ideas. One interviewed firm had adopted an innovative
environmentally friendly process at one of its plants, but three or four
years later other plants remained reluctant to adopt it, citing
site-specific differences:

> "Even though we are very unique and very progressive, sometimes ideas
> that have spawned with one plant or one state don't necessarily make
> it cross the state lines. Just, for whatever reasons, 'we don't think
> that's going to work because, you know, you guys are doing it there,
> but you're at a different elevation, you have different humidity
> levels.' ... There are those types of issues ... They had a prototype
> that sat on the shelf at \[plant location\] for two years. They didn't
> want to use it, no one took the initiative."

Some firms try a new technology, hoping that employees will accept it,
only to replace the equipment in response to continued employee
resistance. The time and expense of such a failed effort can discourage
management from trying innovative approaches in the future.

> "...\[W\]hen I first got here ... I know they had electrostatic units
> in here. ... Something new that they just didn\'t like, or couldn\'t
> work ... Our people weren\'t ready to accept the technology ... The
> units came back out and we went back to the way we always did it."

The pressure of tradition can be very strong. "Traditions" can arise
even at new facilities or on new production lines. This environmental
manager explained that a "tradition" can be established in a very short
time indeed.

> "The hardest for anybody to accept is change. It takes only 15 minutes
> to establish a tradition. You put something new out on the floor, and
> if they like it 15 minutes later -- you know, 'I want you to try this'
> -- they say 'no, we\'ve always done it this way, I don\'t want'."

Sometimes resistance stems from the fact that existing production
processes work, and change has the potential to create problems, to
"fix" what employees do not believe is broken. The following
environmental manager explained that such resistance is common.

> " 'We\'ve been doing it this way for 20 years, why are you going to
> change it now? It works.' Or, 'we\'ve been using this solvent for 20
> years, it\'s the greatest thing since sliced bread, and now you want
> to go to an aqueous degreaser? You guys kidding?' Sure, it happens all
> the time."

Employee resistance to change can arise when employees adopt a narrow
view of the scope of their jobs. Employees who believe that adopting
environmentally beneficial innovations is a secondary concern at best
can seriously hinder environmental innovation.

> "A lot of times you need the buy-in ... in order for someone to use
> it. That\'s maybe why the rag-wringing has not gone gangbusters
> everywhere else, is because, you know, again, those people in those
> departments first of all are concentrating on their core job, their
> core business is to print. ... And everything else is sort of floating
> around them on the sides. ..."

As in many things, personalities also play a part in acceptance of
innovative ideas. Egos or a feeling of "not invented here" can create
employee resistance. One corporate environmental manager explained how
managerial resistance to others' ideas can make it difficult to transfer
innovative approaches from one facility to another:

> "It\'s one of the more difficult things to try to have done. That\'s
> where you get the egos involved. 'Well, I\'m working on this base, and
> yeah, well, the other guy is working on that, and yeah, well, he\'s
> got good ideas. I\'ll talk to him, I respect him. But really I\'ve got
> the right idea...'."

Employee resistance may be amplified by peer pressure, particularly
where an innovation was aggressively promoted.

> "There\'s always potential bottlenecks, and some of it can be peer
> pressure sometimes. Somebody appears to be a little too enthusiastic
> to other employees."

Much as resistance to innovation can have many causes, resistance can
arise at many employee levels. Several environmental managers found that
many types of employees can resist change: the plant manager,
maintenance person, head of another department, the shop floor. One
corporate environmental manager found resistance to change at many
levels within an individual plant:

> "It depends on the plant itself, OK? And the personalities in the
> different plants. And in some cases you just have to circumnavigate
> them, or you have to attack them directly. It just depends on the
> plant and the individual that you are working with."

Engineers resist new ideas if they are unwilling to revisit established
production processes. Their conservatism can be reflected down the
production line, where employees may be understandably reluctant to
change processes without plant engineers' approval. Asked why they did
not change earlier to a cheaper, more environmentally benign production
process, this environmental manager explained that engineer reticence
had played an important role:

> " 'We\'ve always done it that way'. This is a very, very old company.
> Part of it was swaying the engineers... Our engineers upstairs, they
> designed the engine. Zinc phosphating does work well for preserving
> parts, okay? So they write that on the blueprint. All right, well, now
> the process guy says 'I *have* *to* zinc phosphate this...'"

Interviewed firms rely heavily on information sharing as a way to
overcome employee resistance to change. One interviewed firm found
production supervisors sometimes unwilling to trust management's
innovative ideas, because it was the supervisors who were responsible
for production results. The manager has learned that supervisors are
less resistant when given more information about the proposed new
approach.

> "... the more informational training, \[the better.\] The buy-in had
> to be from the production supervisor for that process, because you can
> run into a situation where a guy says 'I want that acid changed every
> day come hell or high water. I want to protect my butt.' So that is
> something you have to get past..."

The same firm found floor operators to be less resistant to change than
production supervisors. The operators were willing to follow
management's ideas so long as the changes were explained, consistent,
and easy to follow.

> "The operators were not resistant at all. One thing you find ... the
> operators will do whatever you tell them to do. The operators want to
> make a good quality product. I mean, you know, there are a lot of
> barriers -- language, culture to a degree. ... Those issues are pretty
> easy to get past. You know what I mean, if you just treat people like
> human beings there is no problem. And making sure that if you have a
> process that ... is consistent and makes sense and is easy to follow.
> As long as you do that, you\'re just fine."

Firms can encourage acceptance of new ways of production when they
explain to employees the health and environmental benefits that can be
gained from innovation. These facilities stress the benefits from a
reduction in worker exposure.

> "'Well, people don\'t like the smell of it.' Well, is it better for
> them? Yes. So they went out to people in the line and said: 'It
> doesn\'t smell good but it\'s better for you and better for the
> environment and we\'re going with it.' "
>
> One environmental compliance manager gained floor-level acceptance of
> a new idea by stressing worker exposure benefits.
>
> "Let me give you an example of one that did work. And that\'s those
> mop closets, those enclosures. That was an idea of somebody\'s, and it
> sounded dumb -- 'what are you talking about, old closets?' And it
> almost died off ... because it was inconvenient for the employees. And
> they kind of resented it. And so it just about died on the vine. And
> it took doing that weights and measurement study and putting it up
> there for everybody to see 'this really does; you\'re standing here
> breathing this stuff, so it ought to concern you'."

Others stressed how an innovation can reduce occupational injuries.

> "We used to pull those rolls by hand and then strip the plastic off
> ... and started using film strippers 7 years ago. It was a chore to
> get some of these people to use the film stripper. They said 'well,
> because it takes more time, and there\'s no roll up there and I can
> pull the roll out, and I don\'t have to take the time ...' So next
> time we had somebody blow an elbow out because they were pulling a
> roll, we said 'Look, we can give you a machine to do that where you
> don\'t hurt yourself, so you don\'t lose two weeks worth of work
> because of a muscle.' After a while, people start buying into it."
>
> Overcoming resistance can be an iterative process, starting with upper
> management. One environmental manager started near the top and used
> two approaches to help sell an innovative idea: incorporating employee
> suggestions, and spreading information on the potential environmental
> and health benefits.
>
> "We went down and pointed out to them ... 'hey look, you\'re in
> trouble and here is the potential.' And I talked to the VP of
> Manufacturing and got his ... input. He just basically said 'go for
> it.' And went down to talk to the plant manager and the chemist was
> there, and the chemist said 'I think we can do something'. And that\'s
> when they started but they were really pussyfooting. And when we went
> down we said 'look guys, look \[name\]' -- he\'s the plant manager --
> 'we have a real potential problem, we\'re not moving on it. I
> recommend you do something. If it\'s just the smell and it\'s better
> for them, tell them. And he agreed and said 'we\'ll do it.' And they
> basically implemented it and it was done."

### E) Risk Aversion \-- Fear of Going First

The forgoing has discussed how product quality concerns, capital
constraints, non-depreciated equipment and employee resistance to change
can function as internal firm hurdles to implementation of innovative
approaches. Sometimes, however, firms simply are reluctant to be the
first to try a new approach. There is risk in doing so; the experiment
may not work. The following environmental manager expresses a view held
by many:

> "Our plans are not to do anything that anybody else is not already
> doing."

The potential advantages and disadvantages of new approaches are untried
and speculative. The urge to go second \-- or tenth \-- can be
overwhelming. The suggestion of further study can often quash
implementation.

> "\[The firm\'s president\] said 'Can you guarantee me that it will
> work?' and I said 'No, but what I can guarantee you is that between
> myself, between the process engineers, and the production people, that
> if it can work, it will work. And the vendor as well. They have it
> running in places right now and we don\'t have to pay for the
> equipment until it works. They will bring in the equipment, put it in,
> prove it out as long as we want.' \[But he wouldn\'t make a decision,
> he said it needed more study.\] ... We really don't want to be the
> first to do any new process."
>
> Another firm expressed similar concerns, even where an innovative idea
> was consistent with overall corporate goals. This environmental
> manager explained that, had they known that they were experimenting
> with unproven technologies, they might not have changed their
> processes:
>
> "We were aggressively trying to get chrome out of the facility ... and
> I called engineering and said 'Hey, you got anything in the works on
> maybe eliminating chrome conversion?' They said 'We got a couple of
> processes.' ... We put in a system ... and I found out \[later\] that
> we were the first facility to put it in a production scale. Which kind
> of bothered me, a little bit."
>
> Going first several years ago, one environmental quality manager said:
>
> \[Q: Would it be important to you to know that their suggestions have
> been implemented elsewhere?\] "Definitely. Especially when you get
> into some of the newer technologies you see advertised out there. You
> say: 'Well, where have you installed this?' And they say: 'Well,
> nowhere.' Well, I don\'t want to be the first one. I want to see that
> it works somewhere first. In industry, quality is important; the
> customers expect the best quality. You don\'t want to switch to
> something and find out 3 months later that the paint has fallen off."

In a more recent interview, this manager explained:

> "\[I\]t\'s new technology. No other\--our chemical supplier in the
> plating department says none of their other customers are doing this."
> \[Q: Are you the first line field test?\] "The technology\'s been out
> there, and we\'re definitely not the first in the field, but we\'re
> way ahead of most companies. So, unfortunately the technology\'s not
> there to answer all the problems. For all the problems that we\'ve
> come up, \[all they can say\] is, 'Gee, we\'ve never seen this
> before.' "

## ii. Regulatory Hurdles to Implementation {#ii.-regulatory-hurdles-to-implementation .unnumbered}

### A) Agency-Preferred Approaches

Firms need permits to discharge to surface water, to emit pollutants
into the air, and to store hazardous waste on-site for very long. When a
firm changes its operations, often it must change its permit as well.
Firms get new or modified permits by filing an application with DNR. The
permit writer reviews the application, and ultimately issues a permit.
Permits conditions govern allowable levels of pollutant releases, as
well as monitoring, recordkeeping, and reporting requirements.

Some theorize that permit-writers are ignorant of manufacturing and
environmental technologies and that their ignorance acts as a brake on
innovation.[^37] The idea is that permit writers are hesitant to issue
permits for technologies or processes with which they are unfamiliar.
Faced with regulator resistance to environmentally innovative ideas,
manufacturing firms are thought to revert to tried-and-true approaches.

Both interview and survey work failed to uncover instances in which
permit writer conservatism had prevented or even hindered an innovative
approach from going forward. The following responses were typical among
interviewed firms:

> \[Q: When you were told ... here's what your limits are going to be,
> did you feel like you were driven into a certain technology?\] "I
> don't think there was any direct connection between what we were doing
> and pushing us to a specific equipment direction"
>
> \[Q: Tell me, when you were getting suggestions from permit writers,
> was it hard to tell the difference between what was a suggestion and
> what was a requirement?\] "No, they made it very clear. 'To get into
> compliance, this is what you need to do' \-- boom, boom, boom. They
> pretty much laid it out in chronological order how they wanted to see
> it done. And then I'd say, 'well, how do I do that?' And then they'd
> explain to me 'we can't tell you how to do it.' "

Interviewed firms did not view their permits or permit writers as
imposing technological preferences. Firms generally appear to feel that
they are in the driver's seat, proposing compliance approaches to the
DNR.

> \[Q: Were there any instances where you felt, talking with your
> permit-writer, that there was a preferred ... way to meet the limit,
> or a preferred way to monitor?\] "I don't believe we had that at all.
> \... \[I\]n the development of the application, I guess I feel it's
> almost our proposal. Let us develop how we can deal with this thing,
> and let us propose to the agency how we best feel we can do it."

The fact that interviewed firms do not believe that DNR staff used the
permit process to limit technological choices, let alone environmental
innovation, does not mean that DNR staff are without technological
preferences altogether. This environmental manager observed that DNR
staff do have technological preferences, and that these vary among
permit writers.

> \[Q: When you go to the DNR do you feel that they have a preferred
> technology or set of technologies in mind? 'This is what we want you
> to do?'\] "Depends on the engineer. And we find that different
> engineers like different things ... they're all three different
> people, different backgrounds and different opinions about different
> things. And they show up in the permits."

Importantly, however, the manager went on to explain that permit writer
preferences were not of the sort or strength that would constrain or
ultimately affect the firm's technology choices.

> \[Q: Does that end up affecting your technology choices?\] "Well, no,
> not usually." \[Q: Have you experienced ... where what you wanted to
> do was at all constrained by the permitter?\] "No. I don't think so.
> Not since I've been here ... no, nothing like that."

Rather than portraying DNR permit writers as both ignorant and
inflexible, many firms described permit writers as willing to listen,
and having the capacity to understand the merits of novel approaches.
One environmental manager described what he would need to do to get the
DNR to approve an environmentally innovative modification to his plant:

> "\[W\]e\'d have to come in and explain it to them, and show them what
> we were doing. Show them that there was some reasonable assurance that
> we wouldn't say one thing and do something else. ...\[The DNR needs to
> be\] relatively confident that whatever plan you set in motion is a
> reasonable plan that makes good common sense, and is achievable."
>
> Indeed, rather than viewing permit writers as ignorant, some firms
> draw on permit-writer expertise:
>
> \[Q: As you move towards putting in a new UV system, what do you have
> to do in terms of talking with DNR or EPA?\] "DNR has been real, real
> cooperative with us. We have a real good relationship with them. ...
> Whenever we've asked for help, explanations, ideas, suggestions,
> they're more than willing to come out and work with us.

That most firms describe their dealings with the DNR as "conversations"
further undermines the notion that permit writers are rigid,
unilaterally telling firms what they must do to comply with
environmental regulations. Interviewed firms explained that they
generally had ample opportunity to discuss possible compliance
approaches with the permit writer. The following firm described a
permitting dialogue with DNR, in which the DNR had proposed a possible
approach that the firm believed unsuitable. The firm responded by
proposing an alternative approach, which the DNR reviewed and accepted.

> \[Q: Did you get a sense that there was a preferred way of complying
> with the regulation, a preferred way of meeting the standard?\] "No.
> Because they had proposed a method that didn't seem suitable for what
> we were trying to do. And I had actually proposed a different method
> of doing it, which they accepted." \[Q: Then they were open to
> alternatives ... there was some flexibility?\] "Yes. His first
> response is, 'we haven't in the past liked to do it that way. But let
> me ask some questions and I'll get back to you.' And they said, 'yeah,
> we see your point, we see where this would be difficult for you, and
> we agree with your proposal."

Another firm found that DNR wanted more monitoring and testing than the
firm felt was necessary. After a back-and-forth discussion, the firm and
DNR reached an acceptable agreement.

> \[Q: In your last permit application, did you feel like you were being
> pushed into a particular direction by the DNR, in terms of how to meet
> the standard?\] "The last permit they wanted me to do more stack
> testing than what I was willing to do, and I just said 'no, you have
> to come' ... and, you know, I am able to ... stand up and say, 'well,
> wait a minute. Do you know do you really need the stack test, or is
> materials balance control fine?' So they are pretty good about it ..."
>
> This type of dialogue between DNR staff and a regulated firm has the
> potential to result in permit limits that achieve environmental goals
> in an innovative way.

Dialogue is facilitated when a firm's environmental compliance staff
knows the DNR permit writers and has worked with them before. One
environmental manager described a good working relationship with DNR as
possible because the permit writers he works with had been in their jobs
for some time.

> "I think that the rapport we have makes it easier. I can call \[any of
> three different DNR permit writers\]. I can call these people, I know
> them by name ... and I'm very comfortable with them. And I think one
> reason is because they've been around a while. You know, one of the
> bad raps that the DNR has is that you never get the same person twice.
> And I'm very comfortable with these people, and if I explain to them
> and I send them a letter, I send them a drawing, what our process is
> going to be, they pretty much respond."
>
> The implication for hurdle formation is that high turnover of permit
> writer personnel could curtail firm-agency communication. This, in
> turn, could hinder innovative efforts. The firms we interviewed did
> not indicate that high turnover was a problem; indeed, many said that
> the lack of turnover made communication with the agency easy.
>
> Some firms were frustrated with the DNR for *not* specifying
> compliance strategies. Of course, these firms do not complain about
> permit-writer technology preferences. However, lack of agency clarity
> about regulatory strictures could cause firms difficulty in trying to
> innovate: it is hard to optimize within a constraint when you do not
> know what the constraint is.

If a firm has an innovative idea, it sometimes call the DNR to try to
determine whether it is likely to be accepted. The DNR cannot
definitively confirm whether a proposed method of complying will meet
environmental standards. Rather, the DNR tells firms that they have
responsibility both to choose a compliance method and to show that
proposed methods will meet performance standards. Permit writers are not
likely to hedge on what the standard is, but may hedge as to whether the
firm\'s proposed approaches will meet regulatory standards.

When asked whether he got definite answers from DNR permit writers about
whether a proposed compliance strategy would be acceptable, one
environmental manager explained:

> "You get a lot of 'maybes and maybe nots'. \... You had a lot of paths
> you go down, you don't have a clear answer, and you're trying to get
> the answer, and nobody knows, or it takes a lot of time. And in the
> meantime, you've got this deadline staring you in the face."

Another firm also complained that permit writers failed to provide
unambiguous descriptions of regulatory requirements.

> "One of the problems is, when you're not certain on a regulation, you
> call the EPA or the DNR, and chances are 90% that you're not going to
> get a definition. ... \[T\]hey have a hard time with defining. ...
> \[Y\]ou can't get a yes or no, you can never get a point blank yes or
> no. It's either a 'maybe, and it's up to you.' Okay, or 'call this
> person'; and you get the same 'maybe.' You never, ever get a yes or
> no."

In opposition to received wisdom, firms more often voiced concern about
the *lack* of agency-prescribed compliance procedures, rather than
permit-writer rigidity.

> "They say maybe. ... I mean it is a real problem, it's a real, real
> problem. ...I don't care what it is, if you were trying to say,
> 'What's your interpretation of this law? Can I do this? Can I do
> that?' You'll never get a yes or no, or very seldom."
>
> \[Q: So have you a sense that DNR has a preferred approach as to how
> you get into compliance?\] "No, I don't know. ... I think the whole
> process is very, very complicated. No matter what agency you are
> dealing with, there is no simple 'check off here' or 'write in here.'
> They are all complicated."
>
> "I strongly believe a company of our size shouldn't have to hire a
> consultant to do it \[figure out how to comply with the
> regulations.\]" \[Q. Have you had to hire a consultant?\] "I won't do
> it. I will sit on DNR\'s doorstep and make them help me. ...When the
> paint line came on line we got a lot of help doing it. But it took a
> lot of our asking, you know, 'we want to do what's right, and we want
> to know how to do this.' "

The comment from the following firm suggests that innovative ideas might
be scrapped for lack of ready and definite answers. When asked what he
does in the face of agency hedging, this environmental manager
explained:

> "You either drop it or you get ... a consultant, and most consultants
> are the same way ... they say 'maybe.' ... \[T\]he way I'll cover
> myself is use common sense."

There may be no simple solution to this problem. One firm that has done
a number of environmentally innovative things explained:

> "And the reason is, \[the DNR\] can't be familiar with everything that
> everybody does. It's like somebody calling me up on a phone and asking
> me to troubleshoot a technical problem that they're having 3,000 miles
> away. Well, I can give them some ideas and stuff, but..."

### B) Distinguishing Between Agency Suggestions and Requirements

The previous section indicates that firms are unlikely to be actively
steered away from innovative solutions. Although there are other, more
subtle ways in which firm-DNR interactions could curtail innovation, as
when firms ask the DNR for suggestions about possible compliance
approaches or for guidance about regulatory requirements, we found no
reason to believe this frequently occurs. The hypothesis is that firms
mistakenly believe that a DNR-proffered suggestion is actually a
required compliance. Such confusion could cause firms to turn away from
innovative approaches to comply with what they take to be
"requirements."[^38]

Most interviewed firms seemed to think that they could readily
distinguish between requirements and suggestions. This environmental
manager's comments draw a clear distinction between the two:

> \[Q: Is it sometimes difficult for you to distinguish between what's a
> DNR regulation and ... a permit writer's suggestion?\] "I guess we try
> to go and find out *what we need to do*. Not that we're opposed,
> against *suggestions*. I have found, and I have called these 800
> numbers for EPA ... I'll call 'em, because they will get me going
> fast. They'll cut a lot of the chaff out of there. ..." \[italics
> added\]

Infrequently we found firms that said they did not distinguish between
suggestions and requirements. When asked whether it was ever hard to
tell the difference between what is a DNR suggestion and a requirement,
one environmental manager explained:

> "Sometimes." \[Q: Do you have any examples that you could share?\]
> "Not really, because we pretty much take all their suggestions as
> requirements. ... Interpretation is a problem, sometimes."

While this is a relatively clear statement of the problem, it is unclear
whether innovation is in fact curtailed. The irony is that the quote
comes from an environmental manager of a particularly innovative firm.

###   {#section-6 .unnumbered}

### C) Obtaining and Modifying Permits: The Costs of Delay

The theoretical literature sometimes describes permits as a
manufacturing straight-jacket, outlining specific operating
requirements.[^39] Permits with too tightly defined operating conditions
could stifle environmental innovation, since firms would need to obtain
permit modifications to make changes even when those changes would
generate environmental and economic benefits. Firms have reason to avoid
the time and delay of obtaining new or modifying existing permits. The
process involves completing an application, negotiating permit
conditions with DNR personnel, receiving public comment, and finalizing
conditions of the revised permit. If the time trying to obtain a permit
or permit modification is considerable, then the benefits offered by
innovative changes can be outweighed by the costs of delay. In short,
permit delays have the potential to discourage implementation of
innovative environmental approaches. However, we did not find this to be
the case.

Permits need not be overly specific. Many firms use their permit
application, and the subsequent dialogue with DNR during permit
development, to help shape a flexible permit. Several firms explained
that they always push for the most general permit that the DNR will
allow. This gives them flexibility to make future production or
pollution control changes without requesting a permit modification.

> "I always try to write my permits as general as I can. I am never
> specific. And the DNR doesn't like that, but I say I have to have
> flexibility because I can't be handcuffed down to a chemical. You can
> limit me to VOC content, but I don't want to see 'chemlock'. I don't
> want to see any brand names in there in my permits." \[Q: Is DNR
> trying to put in the brand name or particular?\] "They wanted to at
> the beginning."
>
> This firm explained that having knowledgeable permit writers was
> important, since this facilitated obtaining permits that are
> sufficiently general to allow operational flexibility:
>
> "Basically what I did is I generated an average of a group of inks in
> a system and reported it as -- and I didn't even report the system,
> what the system ran, I just reported it as Type A, Type B, Type C,
> Type D. Because if I don't do that ... if you report something
> specific, you are held to that, and just that. And I think that's
> wrong. And part of that has to do with the ignorance of not knowing
> the industries. My air environmental engineer from the DNR ... does a
> good job ... is fairly thorough. ... But he is just now starting to
> understand my process to where he can understand when I say 'I can't
> give you that specifically', or 'if I give you that specifically, are
> you gonna hold my feet to the fire on just that? Because if you do,
> you have just taken away all my flexibility of doing business'."

The time involved in processing permit modifications can be a source of
frustration for some firms. This manager felt that the DNR takes much
too long to evaluate an application:

> "I guess just getting them to get off their butts and get something
> going. It doesn't take much to review it. We did all the work. ... it
> takes six months to get it on ... yeah, six to eight months, and this
> was just a little construction permit. Not a big deal, you know? ...
> It's just presenting your case to the department, working with them,
> showing them how you're not going to exceed the ultimate limitation
> that you're trying to comply with, just a better way of doing it,
> sure. It's not too much different than obtaining your original permit.
> You just have to go through a long tedious process."
>
> Another firm thought that this delay might curtail opportunities for
> process changes, although this was not in fact a problem for them:
>
> "\[A\]ll of those people who used to sit in offices and write permits
> that would take you an ungodly amount of time to get. ... If it takes
> six months to get the permit, plenty of opportunity is gone to change
> my process."
>
> Some firms work to shorten the time needed for DNR\'s application
> review by meeting and discussing the proposal in advance.
>
> "We normally preface it before we even start the permit, by meeting
> with them ahead of time and trying to set some ground rules up front.
> And that appears to help ..."
>
> Still, the time that it takes to get a new construction permit can be
> frustrating. This environmental manager explained that the regulatory
> process was threatening to put him in an untenable position, where
> manufacturing equipment for a new line was about to be delivered and
> yet his construction permit had still not been approved.
>
> "\[The permit application\] got down there, got under this one guy's
> desk and that's where it sat. ... I finally got down to the point
> where I was in a problem in the respect that, I was having machinery
> almost ready to be delivered and I didn't have a permit yet. So I
> wound up having to call the permit supervisor ... saying 'I got this
> machine due to be delivered next week and I don't have a construction
> permit yet.' "

Such bottlenecks and delays can be costly. Delays prevent new machinery
from being used. When not operating, new machines cannot generate new
revenue. Carrying financing costs without offsetting revenues reduces a
firm's return on investment. One environmental manager described the
problem as follows:

> "Sure, because \-- they said, corporate said to me -- 'yea, we are
> going to give you X amount of dollars and we are approving this
> because we are basing \[this on the assumption\] that on at such and
> such date, this machine is going to start up and start producing money
> back to pay that off and that our ROI \-- return on investment \-- is
> going to take 2 years or 2 1/2 years to pay off and then the machine
> is going to start making money for us'. Every month that doesn\'t
> start is almost doubling that payback. The money up front, the quicker
> you can start paying it off, the more you make, you know. And so every
> time I am delayed that way \[I lose\]."

On the other hand, firms denied that agency delays had been a problem in
their efforts to make environmentally innovative changes. When asked
whether regulatory delays had curtailed implementation of innovative
pollution prevention ideas, this environmental manager replied:

> "No, I guess we haven't really eliminated anything because of the
> length of time we think it would take to put it into action."

This firm explained that obtaining regulatory approval for improving
their waste water system had not proved difficult:

> "We're certainly subject to local standards, you know, so we
> definitely need DNR approvals and local approvals. But both groups,
> both agencies, have been very cooperative." \[Q: Have they been
> timely?\] "Yeah. It's been more of just delays on our own parts you
> know, on like start over because of staffing changes and other
> priorities."

This sentiment was echoed by a firm that had made a change to its air
permit to reduce VOC emissions through a process change:

> "We contacted our DNR air person, he's really easy to work with, and
> he could understand where we were coming from, and it was actually a
> pretty simple process to get it revised."

Firms try to build flexibility into their environmental permits to avoid
re-opening the permits for minor changes. If they don\'t have that
flexibility, they can be frustrated by the additional costs of
regulatory delays. These costs potentially could make an environmental
innovation unprofitable. However, neither interview nor survey work
uncovered instances in which specific innovative environmental ideas
were not implemented because of anticipated costs of regulatory delay.

## V. Conclusion

One of the principal purposes of the Wisconsin DNR ETI project was to
identify the extent to which the current regulatory system does, in
*fact,* create barriers to environmental innovation. The previous
chapter explored what motivates firms to innovate. This chapter
discussed the extent to which environmental regulations, and internal
firm characteristics, impede those motivations, and discourage firms
from innovating.

Hurdles to innovation were grouped according to the way they might
affect a firm's innovation efforts. Innovation occurs only after a chain
of events: there must be *incentives* to innovate, the firm must have
the sensitivity to *recognize and respond* to those incentives, the firm
must then develop innovative *ideas*, and finally, must *implement* the
innovative approach. Innovation can be hindered at any point in the
process. Hurdles erected earlier in the process may preclude subsequent
actions, making later stage hurdles relatively less important.

We were interested in hurdles that might cause firms to choose
conventional approaches in preference to innovative approaches to
pollution control, or that might cause firms to forgo pollution
reductions altogether. Some regulatory requirements hinder firm action,
but they do not hinder the use of innovative any more than conventional
approaches to pollution control, and thus were not likely to concern us
here.

Firm interviews revealed a few instances where the environmental
regulatory system can make it more difficult for firms to innovate than
to use conventional approaches to pollution control, and a few other
situations where the regulatory system fails to provide firms a strong
incentive to innovate. However, in contrast to the literature, we found
no instance in which the environmental regulatory process was perceived
to be an outright barrier to innovation. No interviewed firm could
identify a specific instance where they sought to use an innovative
approach to reducing pollution but were prevented from doing so by
environmental regulations, how those regulations were implemented, or
how they were enforced.

We did confirm some hurdles that could dissuade firms from innovating.
Of note, surprisingly few of the identified hurdles stemmed from the
regulatory system. More typically, hurdles arose because of internal
corporate characteristics. Internally located hurdles to innovation
include: a "culture of compliance"; an inability to appreciate the costs
of environmental releases or the benefits of innovation; communication
restrictions within the firm; environmental managers' lack of time,
training or responsibility; product quality concerns; capital
constraints; an inability to recover sunk costs; employee resistance to
change; and risk aversion to going first. Prospering firms might not
wish to tamper with their formula for success, whereas faltering firms
might face capital constraints. We found no supporting evidence for many
theorized regulatory hurdles. However, we did confirm some regulatory
hurdles to innovation.

What follows is a brief synopsis of our findings pertaining to potential
*regulatory* hurdles, grouped according to the way they might affect a
firm's innovation efforts.

If the regulatory system fails to create or enhance appropriate
*incentives* to motivate innovation, this could act as an especially
potent 'hurdle' to innovation. Findings regarding the potential hurdles
that would affect incentives for innovation include:

> · For the most part, firms feel that their expertise *is* incorporated
> in standard drafting; contrary to suggestions in the literature, there
> does not appear to be a significant barrier here.
>
> · Regulations do *not* require that firms use specific technologies.
> This finding contrasts with the literature which suggests that firms'
> choices are directly constrained. Rather, both in the regulations and
> in firms\' experiences, firms are required to achieve a specified
> level of environmental *performance*. *However*,
>
> **\*** performance standards sometimes apply to the *content* of the
> input material rather than to environmental releases from production
> activities. This application of performance standards could hinder
> innovation.
>
> · Permits sometimes limit production or production inputs in addition
> to pollution, blunting firms' incentive to innovate.
>
> · Short compliance time frames in some cases may lead to reduced
> innovation. There appears to be a policy tradeoff between achieving
> environmental results immediately and allowing time for development of
> innovative approaches.
>
> · Fear of noncompliance penalties is not a factor in deterring
> innovation. However, firms dislike being treated like "bad actors" if
> innovation attempts run into difficulty. Firms were largely unaware of
> available variances that would prevent compliance problems by allowing
> more time for implementing innovative approaches.
>
> · Differential treatment of existing and new sources \-- existing or
> grandfathered sources subject to less stringent requirements than are
> new sources \-- reduces the incentive existing firms feel to lower
> their releases. This also creates an incentive for firms to maintain
> and use their existing, more polluting, production processes.
>
> · Permit limits sometimes do not provide an incentive to innovate.
> This occurs when the limits are so easy to meet that firms feel no
> incentive to reduce environmental releases.
>
> · Time *is* required to monitor, record, and report environmental
> data, which can take time away from innovative endeavors.
> Nevertheless, innovative firms saw the need for environmental and cost
> data to support their environmental decisionmaking. Moreover, many
> firms indicated that having to take time to report acted as an
> important incentive to change processes and thereby avoid the
> regulatory system. Thus, the net effect of reporting requirements on
> innovation cannot be ascertained.
>
> · Synthetic minor status, allowed under the Clean Air Act Amendment
> Title V program, fails to create a threshold for many firms for
> reduced regulatory burden. This represents a lost opportunity to
> motivate innovative activity.

The potential hurdles that could affect firm *sensitivity to incentives*
for innovation or could hinder innovative *idea formation* arose from
internal corporate characteristics. Many of the potential hurdles that
could affect *implementation* of innovative ideas also were internally
driven.

Other potential hurdles that would affect *implementation* of innovative
ideas were related to the environmental regulatory structure. Findings
regarding the theorized *regulatory* hurdles to implementation include:

> · No interviewed firm felt that their permit writer had a preferred
> approach to compliance. In opposition to received wisdom, firms more
> often voiced concern about the *lack* of agency-prescribed compliance
> procedures, rather than permit-writer rigidity.
>
> · Firms do not appear to be unable to differentiate agency
> requirements from agency suggestions.
>
> · Permitting delays occur, but do *not* appear to favor conventional
> over innovative approaches to pollution prevention and control.
>
> Interviews suggest that few regulatory hurdles to innovation exist. In
> general, firms felt that they were *not* hindered in their innovation
> efforts by the regulatory apparatus. Many firms either directly or
> indirectly cited the regulatory apparatus as motivating their
> innovative activities. When asked why they did not innovate more, most
> firms cited internal hurdles to innovation.

The next chapter suggests policy approaches for responding to the
regulatory hurdles to innovation identified by this study. In addition,
it discusses the aspects of the current regulatory structure that appear
especially effective at motivating innovative behavior among
manufacturing firms.

\[BLANK PAGE\]

#   {#section-7 .unnumbered}

# CHAPTER 4. ENHANCING INNOVATION IN WISCONSIN: POLICY RECOMMENDATIONS

The Wisconsin ETI project seeks to identify the effect of the
environmental regulatory system on environmental innovation. Previous
chapters explored motivations that encourage firms to adopt innovative
approaches, as well as hurdles that discourage such innovation. This
chapter suggests several policy approaches that might be considered as
ways to enhance regulatory incentives for innovation.

The theoretical literature on environmental innovation tends to view
firms as fountains of innovation, with managers bursting with great
ideas that are thwarted by an inflexible and burdensome regulatory
regime. Our interviews suggest quite a different picture. Some firms
innovate, and will find a way to do so despite obstacles erected both
outside and within the firm. Other firms seem more than content to
follow industry leaders, applying the most conventional and
well-accepted strategies for meeting regulatory requirements, and not
stepping forward on their own to innovate. There appear to be relatively
few firms that are on the cusp of being innovative, who need only a
small nudge to become full-fledged innovative trendsetters. This
suggests that policy initiatives intended to promote environmental
innovation should be directed carefully towards the real problems that
face would-be innovators, and towards strengthening the policy
approaches that already appear effective.

This chapter has three sections. In the first section, we discuss
instances in which the existing regulatory regime seems to hinder
innovation, and discuss policy options for addressing them. The second
section focuses on various barriers to innovation that the theoretical
literature considers important, but which in practice appear not to
importantly hinder innovation efforts. Finally, the last section reviews
motivations to innovate that are generated or augmented by current
environmental policies. This section attempts to underline areas in
which existing policies and practices might be strengthened.

The recommendations in this chapter do not attempt to address all
potential barriers to innovation in all contexts, but instead focus on
those which arise out of the environmental regulatory regime. A very
significant set of innovation hurdles is created by factors internal to
firms, but those factors are either out of reach of environmental agency
policies (fear of change, for instance) or involve issues where a
governmental message is readily misunderstood (such as the problems with
a "culture of compliance"). The hurdles to innovation that need
immediate attention are those that occur earlier in the innovation
chain. The policy urgency of addressing later-stage hurdles decreases
with the existence of every earlier-stage hurdle; in other words, fixing
the caboose is less important if the engine is not functional. Finally,
these policy recommendations focus on hurdles that affect the subjects
of this study -- manufacturing firms. Different or additional hurdles
may affect firms that transport, store, or dispose of hazardous wastes
(TSDs), firms that supply control equipment, and firms engaging in
non-manufacturing operations.

Increasing environmental innovation is not costless, nor will it be
easily achieved. Policymakers should be keenly attuned to the trade-offs
that are likely to be implicit in attempts to spur innovation. Nearly
all policies designed to promote environmental innovation are likely to
have costs with respect to other societal goals and objectives. For
example, monitoring and reporting may take time away from innovation
activities, but to lighten such requirements might decrease our
understanding of the environmental performance of alternative
approaches. Further, policies will tend to operate differently on
different types of firms.

Policymakers should recognize that firms often are diverted from
innovation simply because they are busy pursuing other objectives. Many
firms stressed that they are in business to make products and profits.
Even where innovation may create cost savings and increased profits,
other firm activities may generate greater profits still. One firm
explained the pressures:

> "There's another factor which is very hard to calculate in, that in
> these years we've shown such tremendous growth ... We started out in
> building one, now we're up to building ten. ... there was this
> incredible growth period, where we were really just trying to keep our
> business above the level, and then all of a sudden you've got this
> little device that comes along on the side that can save us some money
> \[and reduce environmental releases\], but yet we're just trying to
> install machines so we can keep up with production and service
> customers and everything else ..."

## I. Regulatory Hurdles that Appear in Practice to Discourage Innovation

Firms in Wisconsin do face hurdles that impede innovation. Such hurdles
were discussed at length in a previous chapter. This section reviews the
nature of each identified hurdle, and suggests policy options to
consider as a means of addressing the hurdle.

The hurdles discussed below can be grouped into two categories. The
first group of regulatory hurdles are caused by permits that limit
something other than the firm's environmental releases. In the two types
of cases found, permits either limited production or limited the
VOC-content of substances used in production, rather than simply
limiting environmental releases from production. These hurdles create
hardship for those firms who may wish to innovate in ways that reduce
releases but increase the surrogate measure limited in their permits.
The second group of regulatory 'hurdles' are caused by regulations'
failure to create or enhance incentives for innovation. Regulatory
incentives might be applied inconsistently across firms or felt
differently by firms \-- firms that do not have the incentive have a
more difficult time engaging in innovative activity. Included in this
group of hurdles are the differential treatment of old and new equipment
and permit limits that do not affect firms' behavior. Also included in
this group is the lost opportunity to enhance incentives for innovation
found in the way the synthetic minor provision of the Clean Air Act
Amendment Title V permitting program was implemented.

### A) Performance Standards Applied Too Narrowly

Environmental regulations do not appear to require specific
technologies, either in the written law or in the eyes of manufacturing
firms in Wisconsin. As discussed above, regulations are typically
performance standards. However, performance standards are occasionally
written so that what is limited is the VOC content of the input - paint,
ink, etc. - not the emissions from the process - painting, printing,
etc. Many of the VOC regulations limit these inputs, not the emissions
from production. Firms that use a lower VOC paint are still limited to a
certain rate of production which assumes a higher VOC paint is used. In
a variation on this problem, one interviewed firm could not adopt an
innovative technique to reduce its VOC emissions because the standards
for metal painting focus on VOC content of the *paint* rather than the
VOCs actually emitted during the painting process. This firm
demonstrated that it could release less VOCs per painted object using a
dip-tank with higher-VOC paint than it would using a spray booth with
lower-VOC paint that complied with the standard. The firm unsuccessfully
applied for a variance, sued EPA, settled out of court, and was
eventually allowed to use a higher-VOC content paint with a dip tank and
thus lower its emissions.

The one interviewed firm that encountered this hurdle was determined
enough to surmount the hurdle. Other firms might not have the resources
or the inclination to pursue regulatory relief. While we found only one
example in which a performance-based standard was written in a way that
could hinder innovation, it suggests that further work should be devoted
to determining whether other regulations are also too narrowly written.

This hurdle might be addressed with an expedited variance procedure.
This variance would have to be advertised (many firms are oblivious to
variance procedures that presently exist) and would have to be easy to
apply for and quickly processed. Alternatively, the standards themselves
could be revisited, either by the Congress, if the standard is expressed
in law, or the Environmental Protection Agency, if the standard is
expressed in the regulations, and updated to refer to released
pollutants.

### B) Permits Limit Production as a Surrogate for Pollution

Environmental standards, even though performance-based, can inhibit
innovation if permits reflecting those standards limit a firm's
production or production inputs, rather than environmental releases. If
a firm's permit puts a cap on or limits the use of a production input
rather than environmental releases from production, this dampens the
firm\'s incentive to consider creative ways to reduce its emissions per
unit of product.

Unfortunately, EPA requires air permits to contain a production or
operational limitation in addition to the emission limitation. This
stance, further discussed in Appendix D on Regulatory Context, is a
response to a lawsuit and resultant court order (reasons derive from a
court decision, [United States v. Louisiana-Pacific
Corporation]{.underline},[^40] which established criteria to determine a
firm's "potential-to-emit".) While the cap on production may be
recalculated and raised if firms choose lower emitting approaches, it
was not obvious that firms understood this. Also, getting production
caps recalculated involves obtaining a new or modified permit. Thus the
firm must go through the hoops of re-opening its permit for changes that
would *reduce* environmental releases. The incentives for innovation are
reduced by the court-ordered requirement that production caps be written
into permits.

The EPA must comply with the existing court order. State agencies need
to follow EPA requirements when administering a federal environmental
program. As such, the ability to avoid production or operational limits
in permits is curtailed. Short of challenging the court decision, state
and federal agencies can not directly address this problem. What they
can do is to make certain that firms understand that their production
caps are based on their releases and may be recalculated if the firm can
demonstrate that it has reduced its releases. Providing expedited review
of permits with such changes may lessen the hurdle to innovation.

### C) Differential Treatment of Old and New Sources \-- Grandfathering and NSPS

Regulations differentially treat old and new sources. Older equipment is
often subject to less stringent regulatory standards than is new
equipment. The newer, stricter standards may inspire firms to innovate
when they expand. However, differing standards may curtail or slow the
*replacement* of existing production equipment with cleaner, innovative
approaches in two ways. First, stricter standards for new or modified
equipment may discourage firms from upgrading equipment if the cost to
meet the stricter standards applicable is greater than the benefits
offered by the new equipment. Direct evidence in favor of this
hypothesis is slim. Second, less strict emission standards for older
equipment could reduce firms\' incentive to innovate, or provide firms
an incentive NOT to innovate if it entails replacing older equipment.

The Clean Water Act[^41] and the Clean Air Act[^42] call for EPA to
establish pollution control standards for sources. Generally, the
standards for new sources are stricter than for existing sources.
Stricter "new source performance standards" (NSPS) reflect a sense that
new facilities can more readily install state-of-the-art treatment
technology, where it would be economically unreasonable to require
existing facilities to retrofit their processes and systems to include
such technology.[^43] If substantially modified, then for regulatory
purposes older equipment will be considered to be "new" and subject to
the more stringent standards.[^44] Controversy may arise as to whether
construction at an existing facility should be considered a new source
subject to the stricter NSPS limits, or simply a minor modification.
Whether or not the construction at an existing facility constitutes a
"major modification" subject to NSPS is determined on a case-by-case
basis.[^45] A few interviewed firms expressed concern about the
potential for innovative facility upgrades to trigger NSPS. One firm
hired a consultant to ensure planned changes would not be considered a
major modification and trigger NSPS. While we found no direct evidence
of such, NSPS could deter firms from innovating if the likely return on
the innovation was not sufficiently large.

Environmental statutes and regulations often "grandfather" pre-existing
equipment, making the equipment exempt from new pollution control
requirements. Grandfathered status may last in perpetuity, or expire
after a fixed period. Grandfathering is an attempt by Congress and
environmental agencies to avoid creating greater burdens on existing
facilities than on new facilities. It is usually cheaper to incorporate
state-of-the-art pollution control or prevention approaches into new
equipment or facilities than it is to retrofit previously installed
equipment.

The use of grandfathering as an attempt to avoid creating a competitive
advantage for new equipment or facilities has some inadvertent
environmental results. A single facility with equipment of varying ages
is probably operating equipment subject to different pollution control
requirements. Several interviewed firms described circumstances where
different permit limits on different machines created perverse
incentives to retain older, less efficient and more polluting equipment,
and to run it when stringent standards limit the number of operating
hours on new equipment. The irony of shutting down cleaner-operating
machines to run dirtier ones is not lost on environmental managers.

No one intended to create such perverse incentives \-- it seems likely
that regulators assumed grandfathered equipment would persist only for a
short time, expecting companies to replace worn out equipment with
modern substitutes. However, firms are encouraged to maintain older
dirty equipment on-line for production flexibility, and thus they are
not likely to replace them with innovative approaches. And in some
industries grandfathered equipment may remain useful for a very long
time.

Once manufacturing equipment is fully depreciated, the rationale for
differential standards seems to break down. Owners of fully depreciated
equipment would no longer be subject to a competitive disadvantage were
they required to meet pollution control limits reflecting
state-of-the-art capabilities, because they have no unrecovered costs
sunk into old equipment. Indeed, the cost advantages enjoyed by
grandfathered or pre-existing equipment can create unfair barriers to
entry for new companies, who cannot avoid the cost of meeting the new
environmental standards.

One key finding of the Wisconsin ETI project is that stringent
environmental requirements encourage firms to innovate. It follows,
therefore, that a way to spur innovation is to promulgate strict
environmental standards that apply to a wide array of firms. Existing
standards would affect more equipment and more firms were the scope of
grandfathering reduced. Congress and the EPA could address the issue of
grandfathering in the legislation and regulations. To the extent
possible, grandfathering in legislation and regulations should include
sunset provisions that would eliminate the preferred status enjoyed by
older, more polluting equipment. NSPS could also be written to apply to
all equipment and firms after a number of years, long enough to ensure
full depreciation of previously existing capital. Or applicability of
new standards could be based on firms\' accounting system depreciation
schedules. The point would be to encourage the creative replacement or
upgrading of existing, polluting equipment with cleaner approaches to
production. A state-by-state approach to eliminating grandfathered
status is likely to fail due to the political unfeasibility of passing
stricter or more broadly-applicable standards, applicable solely to
within-state facilities.

### D) Permit Limits That Do Not Affect Firm Behavior

Product bans, stringent limits, and standards for specific processes
have the potential to greatly affect firm behavior. However, permit
limits for many interviewed firms provided little incentive to find
innovative ways to reduce releases. Many interviewed firms were not
constrained by their permitted limits, and in fact could significantly
increase their releases under existing authority. Many firms\' limits
were sufficiently generous that they needed to pay little attention to
their releases, other than monitoring releases for environmental
reporting.

If limits do not in some way constrain behavior then they will lack
impact as an incentive for innovative action and firms will feel little
pressure to develop innovative compliance solutions. There is a clear
tradeoff between policy objectives that should be explicitly considered
and balanced as regulations are developed and permit limits are
calculated.

### E) Regulatory Thresholds: Synthetic Minor Status a Lost Opportunity

Some environmental statutes and regulations may encourage firms to
reduce their pollution by setting a threshold below which the regulatory
burden is less. Interviewed firms view the potential to reduce
regulatory burden and compliance costs as a powerful incentive to adopt
innovative environmental approaches. The time and attention firms give
to reducing emissions and achieving regulatory reclassification is
discussed in detail in the chapter on motivations. If reclassification
does *not* significantly reduce a firm's regulatory burden then it will
not trigger a search for innovation.

The example related in some interviews is that the 1990 Clean Air Act
Amendment Title V program provides for states to allow facilities to
reclassify from a "major" source to a "synthetic minor" source in
exchange for the facility accepting voluntary emission restrictions. The
incentive to reclassify to synthetic minor status was to be a reduction
in regulatory burden, including reduced reporting frequency, a
simplified Title V permit, and avoidance of other federal environmental
requirements for major sources, such as MACT.

Many eligible Wisconsin firms have not opted for synthetic minor status.
Interviewed firms found that while such status reduced reporting
*frequency*, synthetic minor sources would need to report additional
information to show compliance with their self-imposed restrictions. As
a result, firms anticipated an *increase* in required monitoring,
recordkeeping, and reporting -- hardly an incentive to innovate in order
to change status. If firms\' regulatory burden is not reduced by
reclassification to synthetic minor status, then the option will fail to
encourage firms to engage in innovative activity to achieve the change
in status. This represents a lost opportunity to motivate innovative
activity.

At this point, it is difficult for state agencies to ease the regulatory
burden so that firms will opt for synthetic minor status. The synthetic
minor experience nonetheless provides a cautionary tale that could prove
instructive to Congress and the EPA in future legislation and
rulemaking.

##   {#section-8 .unnumbered}

## ***II. Theoretical Regulatory Hurdles That Have Limited or No Practical Effect***

This section discusses hurdles that the theoretical literature views as
important, that in practice do not appear to significantly impair firms'
interest or abilities to innovate. These hurdles have limited or no
practical effect on innovation.

### A) Requirements Do Not Specify Technology 

A common chorus from the theoretical literature is that current
environmental regulations "command and control" firm operations,
mandating technology rather than performance.[^46] Regulations
specifying that firms must use a particular technology would indeed act
as a brake on innovation. Adoption of a new technology under these
circumstances would require a change in the regulation.[^47]

However, a detailed review of statutory and regulatory requirements
reveals no example where a particular technology is specified under the
Clean Air Act, Clean Water Act, and RCRA. Requirements typically mandate
a level of performance. These performance standards often are based on a
reference technology, such as "best available technology" (BAT) or
"maximum achievable control technology" (MACT). But what a regulated
firm is legally required to achieve is the emissions control
*performance* of the reference technology, not successful installation
of that technology. Performance standards allow individual sources the
freedom to achieve the same degree of pollution control by equivalent
means.

The pervasive use of performance standards throughout the three
environmental statutes suggests that the problems associated with
technology specification rarely occur. In fact, both our interviews and
survey failed to uncover instances in which facilities felt that there
was a "DNR-preferred" way to meet environmental standards. What we found
was quite the opposite -- some facilities expressed a desire for a
regulator to tell them what approach they should adopt to meet the
performance standard.

This is not to suggest that technology-based standards such as BAT and
MACT cannot be misunderstood. The possibility exists that a firm will
decide that the reference technology is the approach preferred by the
regulatory agency. Since the required performance level is based on what
the reference technology can achieve, the reference technology is the
safest route to compliance. Mistakenly viewing a technology-based
performance standard as a *de facto* technology-specification would
severely dampen the flexibility inherent in performance standards. Such
a misunderstanding does not seem a pervasive problem with manufacturing
firms in Wisconsin.

###   {#section-9 .unnumbered}

### B) Enforcement: Firms ***Not*** Risk Averse to Penalties, but Dislike Being Considered "Bad Actors"

EPA is aware of the potential for enforcement to have a significant
dampening effect on innovation. EPA Administrator Carol Browner has
noted

> "Traditionally enforcement personnel have been reluctant to grant
> exceptions for businesses that make bona fide attempts to comply using
> an innovative approach but need extra time or fall short of the
> regulatory mark."[^48]

A theory recurring in the literature is that firms that try to innovate
run the risk of being fined for noncompliance if their efforts fail, and
thus they are discouraged from innovating.[^49] Interviews and survey
work failed to uncover firms that had wanted to do something innovative
but were discouraged from doing so out of fear that they might suffer
enforcement penalties in the event that their experiments did not work.
The evidence is slim that this is a widespread or particularly important
problem.

One possible reason noncompliance penalties have limited effect on
innovation is that penalties are not all that common. Regulatory
agencies have considerable discretion as to the appropriate enforcement
response or penalty size. Very few firms are subject to enforcement
penalties. For example, in 1994, of the Wisconsin firms discovered to be
violating air emissions regulations, fewer than ten percent were fined.
Firms that were fined tended to be those most recalcitrant about
correcting problems. If innovative firms also are knowledgeable about
actual enforcement practices -- an arguably reasonable correlation,
since both innovation and good understanding of regulatory practices
require a considerable degree of sophistication -- then it is not
surprising that fear of enforcement penalties apparently has little
dampening effect on innovation.

Regulatory agencies have an array of enforcement tools to compel
compliance with regulatory mandates, in addition to penalties. These
tools include verbal warnings, notices of violation, and additional
reporting requirements or inspections. Agencies also sometimes publish
the names of non-complying firms in local newspapers and other forums.

As noted above, regulatory agencies often have considerable discretion
as to the appropriate enforcement response. Use of enforcement
discretion can be controversial, as it can result in differential
punishment for similar noncompliance offenses. However, discretion
allows agencies the ability to craft an agency response appropriate for
the circumstances. Ideally, firms that make good-faith efforts to comply
using promising innovative approaches are not punished severely.
Publicly available rules-of-thumb guiding use of this discretion could
help reassure innovative firms and lessen the appearance of
arbitrariness.

There are instances when state agencies are not allowed enforcement
discretion. One interviewed firm attempted to install cutting-edge
wastewater pretreatment technology; problems with installation put the
firm out of compliance. Although the firm self-reported the problem, DNR
was required by the EPA to publish the firm's name and noncompliance
status in the newspaper. The firm was understandably upset at the
negative publicity from the enforcement action, given that they were
innovating in an effort to go beyond compliance. This type of treatment
could discourage innovation.

Especially where they lack enforcement discretion, state agencies might
wish to encourage firms that propose compliance through untested
innovative approaches to apply for a variance or innovation waiver, such
as that in the Clean Water Act[^50], prior to going forward with
installation. This would allow state agencies an avenue for providing
firms "elbow room" for working out unexpected kinks, in advance of
actual noncompliance problems. The Clean Water Act and Clean Air Act
have provisions for variances to accommodate site-specific
circumstances. One variance explicitly is to encourage development of
innovative technologies by extending compliance deadlines by two years
when an innovative approach is used.[^51] Others are intended to avoid
excessive hardship under various circumstances.[^52] Variances can
provide the extra time or flexibility a firm may need to perfect a
promising innovation.

However, variances assist innovation only when firms know they are
available and so can take them into account when making decisions. Among
interviewed firms, only a few were aware of the availability of
variances. Firms did not appear to think of variances as a means of
preventing potential compliance and enforcement problems. No interviewed
firms were aware that the "innovation waiver" variance was available. If
firms were more familiar with the innovation waiver, its offer of a
two-year extended compliance deadline might be influential in an
otherwise close decision about whether or not to innovate.

Environmental agencies should consider ways of better publicizing the
existence of variances for innovative endeavors, and of encouraging
their use among firms they believe will use them to good effect.
Information brochures and presentations at seminars are one way of
spreading the word about the availability of variances; one-on-one
discussions between the facility and permit writers are another.

Finally, agencies should consider addressing issues of enforcement
style. One of the biggest complaints from the firm discussed above was
that it was treated as a "bad actor" by the seasoned compliance
inspector when the firm was trying to go beyond compliance by doing
something innovative. The *attitude* of agency staff created the lasting
bad impression. This issue might be addressed as part of the training
program or review for enforcement staff.

### C) Information Access for Small Firms

A common assumption in the literature is that small firms lack access to
information critical to successful innovation and that this lack of
information keeps them from adopting innovative pollution reduction
technology[^53] Such information might include details on current
regulations and expected changes to requirements, or on the availability
of cutting-edge pollution prevention and control techniques.

Large firms may have large staffs dedicated to tracking regulations and
regulatory developments, and researching alternative approaches to
prevention or control of releases. In contrast, an environmental manager
at a small firm typically has multiple responsibilities \-- in addition
to identifying new and existing regulatory requirements and ensuring
compliance they may be responsible for employee safety or for
production. While staying in compliance with existing regulations has a
high priority, researching emerging regulations or innovative approaches
to compliance often is a luxury these managers can not afford.

The majority of interviewed firms seemed to understand current
requirements. However, tracking emerging regulations seemed to pose
somewhat of a problem for small firms. Managers hear about existing
requirements from colleagues, trade associations, newsletters, DNR
materials, and other sources. Vendors sometimes explain current
requirements to facilities, as a way of encouraging purchase of their
pollution control-related products. These information sources appear
adequate for existing requirements, but may be less satisfactory for
pending regulations.

In addition to information about environmental requirements, firms need
information about available alternatives if they are to innovate. It did
not appear that small firms had significantly less access to information
about innovative approaches than large firms. However, smaller firms
were less likely to have time to avail themselves of the information.
Our research confirms previous surveys of firms about their information
sources.[^54] Many firms, large and small, rely on their suppliers for
information about ways to reduce their pollution. In addition, they
consult with their trade associations and trade journals.
Agency-sponsored seminars were highlighted as an opportunity for
environmental managers to network; such networks appear to be an
important source of information sharing and exchange.

When firms fail to hear about emerging regulations or available
alternatives, they have a harder time innovating. It is unclear that
much can be done by environmental agencies to remedy the problem. More
information and seminars can be launched, increasing the availability of
information and networking. But unless small firms feel that the
potential benefits of tracking emerging requirements and researching
alternative approaches is worth the investment in time, such efforts
will not achieve the desired results.

### D) Little Confusion About Requirements versus Permit Writer Suggestions

Firms sometimes ask the permit writer or inspector for suggestions about
possible compliance approaches, as well as guidance regarding regulatory
requirements. This raises the possibility that a firm might
misunderstand and believe a permit writer suggestion is actually
required. Such confusion could stop a firm from thinking about
innovative approaches; instead they might comply with what they take to
be "requirements."

This confusion is a potential hurdle to innovation that arose during
interviews, but was not explicitly stated by interviewed firms as a
problem. While most interviewed firms seemed confident that they are
able to distinguish between requirements and suggestions, some firms
blurred the two.

> "...We pretty much take all their suggestions as requirements.
> ...Interpretation is a problem, sometimes."

Permit writers and other staff should continue to be careful about the
nature of the advice they provide. Larger or more sophisticated firms
are usually in a good position to understand the difference between a
requirement and a suggestion, but others may not. The potential negative
impact on innovation is such that taking extra care to make explicit the
difference between suggestions and requirements is probably worth the
effort.

### E) Permitting Delays Occur, But Do Not Appear to Inhibit Innovation 

The process of acquiring a new permit or modifying an existing one
involves completing an application, negotiating permit conditions with
permit writers, receiving public comment, and finalizing conditions of
the permit. The benefits offered by innovative changes may at times be
outweighed by the costs of permitting delay. EPA has raised concerns
about permitting delays for innovative technologies:

> "Many of the most innovative ideas that might be applied in a
> particular facility have to work their way through a permitting
> process. And many times, the permit writers themselves, or indeed the
> people who might buy those technologies, aren't sure they work."[^55]

While some interviewed firms experienced frustrating delays, firms
denied that agency delays had been a problem in their efforts to make
environmentally innovative changes. Most firms felt that their permits
were handled expeditiously.

Nevertheless, to prevent potential costs associated with permitting
delays that could discourage innovative activity, the environmental
agency may wish to consider "one stop shopping", where a single office
or person has final authority for all permits and coordinates
information from various media programs for an applicant. Alternatively,
the agency may wish to develop an expedited permit review process for
firms using innovative approaches.

### F) Monitoring and Reporting Environmental Data: Net Effect Uncertain 

Some environmental compliance managers interviewed for this project
spent half or more of their time collecting, processing, and
transcribing information to meet reporting requirements. Several stated
that the first half of each year was "the reporting season," with
accurate preparation of the air emissions inventory and Toxic Release
Inventory (TRI) reports consuming virtually all their time. Survey
respondents also highlighted reporting burden as limiting opportunities
to think creatively.

The question regarding this regulatory burden, as it pertains to
innovation, is whether a drop in monitoring, recordkeeping, and
reporting requirements would result in more innovation. While reporting
of data helps track environmental progress, and can support sound
environmental business decisionmaking, it also takes up the
environmental quality managers' time. This regulatory burden prevents
some environmental managers from using their time to innovate, but this
time-consuming burden also stimulates innovation (see chapter on
Motivation, section IV(b), Indirect Production Costs: Regulatory
Burden.)

Decreasing this burden would thus have uncertain results. Some firms
might innovate more, given the extra time to innovate, even though they
might lack some environmental information on which to base their
decisions. Other firms might innovate less, since the incentive to do
so, and the information to support such activities, would be reduced.
These firms may seek cost savings by reducing their environmental staff
rather than through environmental innovations, which could further
reduce the likelihood of innovation . The net effect of recordkeeping on
innovation cannot be ascertained.

Nevertheless, in the interest of tracking environmental progress
efficiently, state and federal environmental agencies could expand their
efforts to increase harmonization and reduce duplication among the
different reporting programs both within environmental regulations and
between OSHA, DOT, etc. All too often firms complained that they must
provide the same pollutant release information multiple times, with
format varying from program to program. Other firms with multi-state
operations complained that different information was required, and in
different formats, depending upon the state that required the
information, even if the operations in the various states were virtually
identical. Collection of release information takes time; adapting that
information to meet a variety of reporting formats takes additional time
that may have little resulting environmental benefit.

However, before making any changes to reporting requirements, regulators
should note that several interviewed firms complained that they were
required to make changes in how they calculated or presented release
information, and were not given any explanation for the change. Firms
felt that frequent changes were made without taking into account the
ways in which they currently collected, managed, and analyzed data.
Agencies should recognize that changes to required information will mean
that firms must revisit their systems for data collection, analysis and
presentation. Requiring firms to change their existing reporting systems
should be done only for good reason, with a healthy respect for the time
constraints environmental quality managers already face.

Finally, one reporting burden might be eliminated if environmental
agencies would fully test their computerized reporting methods before
disseminating them or making their use mandatory. Many interviewed firms
complained vociferously about emissions inventory reporting software
that was full of "bugs" and other programming glitches that precluded
its ready use. Many environmental managers wasted precious time
\'learning\' faulty software, and cursing the environmental agencies who
had provided the software. This time could have been available for
innovative endeavors if the software had been fully operational prior to
its dissemination.

## III. What Works Well: Creating the Right Kind of Incentives

A variety of factors motivate firms to try to control pollution, prevent
its generation, and dispose of it in innovative ways. As discussed in a
previous chapter, some of these motivators stem from aspects of the
regulatory regime, while others are less directly created by
regulations. This section highlights programmatic elements that appear
to encourage innovation, and suggests how to further enhance their
positive effect.

### A) Environmental Requirements that Limit Environmental Releases

This chapter spoke earlier of circumstances where a facility's permit
fails to limit releases. Because emission limits are so far above actual
emissions they provide no constraint on firms' behavior. These
circumstances fail to create an incentive to firms to seek innovative
solutions to reduce their pollution.

Three areas exist, however, where limits do indeed appear to be
stringent enough to induce firms to modify their operations. First,
product bans are perhaps the clearest form of a "stringent" limit. The
CFC phase-out, for example, unleashed a wave of innovation with regard
to new chemicals and processes. Second, emissions limits for particular
processes appear to reduce industrial releases. For example, Wisconsin
regulations prohibit firms who apply paint on metal to use paints that
contain more than 3.5 pounds of VOCs per gallon of paint, a limit
stringent enough to spur paint suppliers to innovate. Finally, firms
located in nonattainment areas often *do* bump up against their
allowable emission levels. If production is to expand, emissions per
unit of product need to be reduced. This is a powerful incentive for
firms to find ways to reduce industrial releases.

The foregoing suggests that if innovation is the policy objective, then
regulating agencies and legislative bodies can promote innovation by
setting emission limits that, in one way or another, limit a firm's
ability to release pollutants. Environmental compliance is one of the
costs of doing business, and firms have an incentive to keep those costs
as low as possible. Stringent environmental standards can provide a
significant incentive to find less expensive and more reliable ways of
controlling or preventing pollution.

Industry resistance to proposals that would tighten regulatory standards
is likely to be in direct proportion to the extent that the proposals
would actually affect firm behavior. No firm wants to face a stiffer
pollution control challenge, one likely to require creative solutions.
Changing firm operations is time-consuming and may require up-front
capital outlays. There is a tradeoff, however; regulatory standards that
do limit releases are a tried and true way of sparking innovation.

### B) Anticipation of Stricter Future Standards

Environmental statutes require EPA to periodically review whether
emission control standards remain appropriate, in light of scientific
and technological advances. For example, the Clean Water Act requires
the Agency to review technology-based performance standards such as BCT
and BAT every five years.[^56] This leads to a regulatory environment
where standards change over time, creating stricter requirements and
pressure for firms to be forward-looking in their compliance strategies.

Anticipation of stricter pollution control standards was discussed by
interviewed firms as a significant incentive for innovation. Many firms
were thinking ahead. Firms that believed future limits would indeed be
stringent felt considerable motivation to consider how process decisions
today would likely affect their compliance options in the future.
Several were thinking creatively about how to reduce or eliminate
releases of a particular pollutant so that the firm would not be subject
to future regulations. Because anticipated requirements are in the
future and not imminent, firms have more time to be creative in their
approaches to pollution prevention or control. While interviewed firms
no doubt would appreciate stasis in regulatory standards, the presence
of a credible threat of tighter future standards appears to be an
important motivation for firms to think in innovative ways about their
waste streams.

The effectiveness of future, more stringent standards as an innovation
motivator depends on at least two factors. First, Congress, EPA, and
state agencies should avoid signaling that firms may expect a hiatus
from the ratcheting of standards that has thus far characterized
regulation. Conversations amongst themselves and with the regulated
community offer opportunities to assure firms that current environmental
law envisions "best" technology getting better and "maximum achievable"
technology to be achieving more reductions in the future.

A second factor that determines how effective future standards are in
spurring innovation is the extent to which firms are able to accurately
predict the direction of those standards. Process changes and control
strategies may involve considerable capital investment. An innovative
firm seeking to anticipate future requirements does not want to be too
far off the mark. One interviewed firm complained about making changes
to their process in anticipation of a new standard only to have the
environmental agency scrap the change at the last minute. As agencies
develop standards and rules they should avoid last-minute course changes
to the extent possible.

### C) Liability for Environmental Releases

Pollution control costs, both the cost of owning and operating control
equipment, but also the potential cost from liability stemming from the
treatment and disposal of process wastes, are a significant motivation
for innovation. Many interviewed firms stressed that fear of large but
difficult-to-quantify liability costs have led them to think creatively
about how to reduce or eliminate process wastes. To further enhance the
effect of liability on innovation, environmental agencies might clarify
to firms that full compliance with permit conditions is no shield
against liability for harm caused by process wastes. This is a point
often misunderstood, and worth clarifying.

### D) Regulatory Thresholds: Reclassification that Reduces Regulatory Burden

While the time required to monitor, record and report environmental
information can take time away from innovative activities (as described
above,) it can also motivate innovation if there exists a threshold
below which firms can lessen or avoid the regulatory reporting burden.
Environmental laws can create such thresholds. Interviewed firms have
expended a great deal of creative energy to drop below thresholds or out
of the regulatory system altogether. The firms described their
motivation as reduced costs for pollution control, less paperwork and
required staff time, decreased frequency and intensity of inspections,
and general satisfaction from having fewer regulatory issues with which
to deal.

Changed regulatory status creates motivations for environmental
innovation only when the new status results in actual benefits. An
earlier section discussed how the "synthetic minor" reclassification
failed many firms in this regard, because firms perceived the burden and
inflexibility below the threshold as actually greater than above it.
Where possible, laws and regulations should be written to clearly reduce
firms\' regulatory burdens when they drop below a well-identified
threshold. For firms that are close to the thresholds, agencies could
enhance the incentive to innovate by highlighting for the firms the ways
in which their environmental regulatory burden would be lifted if they
reduced their releases.

### E) Public Information on Environmental Releases

Public reporting of environmental release information is required under
a variety of environmental laws, most famously the Emergency Planning
and Community-Right-to-Know Act (EPCRA). EPCRA establishes a requirement
that all but the very smallest manufacturing facilities annually report
their releases of several hundred pollutants to air, water, and land.
The resulting "Toxic Release Inventory" (TRI) reports are publicly
available, and often summarized in the popular media as "the top ten
polluters in our state."

A firm might be motivated to innovate because it wishes to be perceived
as a good "environmental citizen", which requires its TRI and other
reports to show low or lowering emission rates. Such an image might
reflect a corporate environmental ethic, help expand a market niche,
satisfy existing customers, or just help the business exist comfortably
in its community. Many interviewed firms seemed to place a high
importance on external relations and public image.

Environmental rankings on lists such as the "Toxic Release Inventory"
are a significant motivator. Firms do not want to be on any "top ten"
list of polluters. A number of interviewed firms talked about their
awareness of the TRI "top ten" and desire to stay off the list.

> "I think the corporation sees the handwriting on the wall, and is very
> sensitive to the public relations aspect of emissions. And the Form
> Sara 313 \[Toxic Release Inventory\] report certainly elevated -- it
> certainly played in the picture."

Several options exist to further enhance the effectiveness of publicly
available information as a motivator for environmental innovation. One
criticism of such public information is that it is difficult for the
public to understand -- data is expressed in pounds or tons, and rarely
in terms of comparable risk factors. This can lessen the effect it has
on public image, thereby reducing the incentive firms feel to think
creatively about how to reduce reportable emissions. Environmental
agencies could work with public health agencies to help package toxic
release information with health risk information, thereby enhancing the
power of the data to influence innovative thinking. Release data
expressed in terms of risk also could help focus firms\' innovative
activities on reducing releases of pollutants posing the greatest
environmental and public health hazard, rather than on those with the
biggest numbers.

## IV. Conclusions

Using firms\' perceptions as a guide, we defined environmental
innovation to be *any change by a facility that reduces or prevents an
environmental release at the same or lower cost to the facility; or any
change that reduces a firm\'s costs but results in the same or lower
level of environmental release*. Our definition accommodated firms'
actions that produce benefits that are difficult to quantify \-- such as
reducing liability for hazardous waste.

The majority of manufacturing firms affected by environmental
regulations face minimal regulatory hurdles to environmental innovation.
Suggestions for the remedy of identified hurdles can be found in the
pages above. In general, the environmental regulatory regime does not
*discourage* innovation, but rather, very importantly *encourages*
environmental innovation. Policymakers concerned about innovation should
use care when considering proposals that would dilute these regulatory
incentives.

[^1]: Browner, Carol M. 1994. "EPA's Technology Innovation Strategy,"
    EPA Journal. Vol. 20 (#3), pp. 9-10.

[^2]: Gardiner, David. 1994. "Questions the Reader Might Ask: An
    Interview with David Gardiner," EPA Journal. Vol. 20 (#3), pp.
    14-17.

[^3]: A regulatory standard is "stringent" if it induces a firm to
    change the way that it conducts its operations. Not all regulations
    appear to have this effect.

[^4]: Clean Water Act §301(d). *See also* Clean Water Act §304(m).

[^5]: Clean Air Act §112(f).

[^6]: For more discussion of "challenge regulation", *see* U.S.
    Congress, Office of Technology Assessment, *Environmental Policy
    Tools: A User's Guide*, OTA-ENV-634 (Washington, D.C.: U.S.
    Government Printing Office, September 1995), pp. 113-119.

[^7]: As of September 1994, Exxon had already spent \$3.4 billion to
    clean up the spill and settle federal and state suits for cleanup
    reimbursement and natural resource damages. In addition, a jury
    awarded \$5 billion to Native Alaskans and fisherman for third party
    damages -- roughly equivalent to a year's worth of Exxon profits.
    See, e.g., "Long Shadow of the Exxon Valdez", New York Times, p.
    A22, September 21, 1994.

[^8]: Clean Water Act Section 309, 33 U.S.C. Section 1319.

[^9]: Clean Air Act Section 113, 42 USC Section 7413; RCRA Section 3008,
    42 USC Section 6928.

[^10]: See, for example, Biddle, Jeff E. and Gary A. Zarkin. 1988.
    Worker Preferences and Market Compensation for Job Risk, *Review of
    Economics and Statistics*; 70(4): 660-67; *or* Martinello, Felice
    and Ronald Meng. 1992. Workplace Risks and the Value of Hazard
    Avoidance. *Canadian Journal of Economics*; 25(2): 333-45; *or*
    Sandy, Robert; Robert F. Elliott. 1996. Unions and Risk: Their
    Impact on the Level of Compensation for Fatal Risk. *Economica*;
    63(250): 291-309.

[^11]: See, e.g., Inside EPA, "EPA Rejects Call to Loosen Standards to
    Accommodate New Technologies", *Inside EPA* (August 12, 1994), pp.
    15-16; Hoerger, F., "Desirable Attributes of Environmental
    Regulations", Resources for the Future Discussion Paper CRM-93-01,
    January 1993, p. 28. See also National Academy of Public
    Administration, [Setting Priorities, Getting Results: A New
    Direction for EPA (Washington, DC: NAPA April 1995), pp. 89-104 for
    a discussion of this problem and its potential
    solutions.]{.underline}

[^12]: See, e.g., Landy, Marc., et al., [The Environmental Protection
    Agency: Asking the Wrong Questions (New York: Oxford University
    Press, 1990), pp. 204-237.]{.underline}

[^13]: See, e.g., National Advisory Council for Environmental Policy and
    Technology, "Transforming Environmental Permitting and Compliance
    Policies to Promote Pollution Prevention: Removing Barriers and
    Providing Incentives to Foster Technology Innovation, Economic
    Productivity, and Environmental Protection" (EPA No. 100-R-98-004,
    April 1993).

[^14]: See, e.g., Jaffe, A., and Stavins, R., "Dynamic Incentives of
    Environmental Regulation: The Effects of Alternative Policy
    Instruments on Technology Diffusion", Journal of Environmental
    Economics and Management (1995).

[^15]: For example, see: Clean Water Act §§ 301 (k) innovation waiver, §
    301(m) modification of effluent limits for point sources, 301(n)
    modification for 'fundamentally different factors'. Such waivers and
    the broader regulatory context are discussed in Chapter XX.

[^16]: 682 F.Supp. 1122 (D. Colo. Oct. 30, 1987), 682 F.Supp. 1141 (D.
    Colo. March 22, 1988).

[^17]: See the Regulatory Context Chapter, section [Provisions Affecting
    Technology Incentives]{.underline}, subsection *Determination of the
    "Potential to Emit"* for details.

[^18]: *See, e.g.,* Stewart, R., "Regulation, Innovation, and
    Administrative Law: A Conceptual Framework", 69 Calif. L.Rev. 1256
    (1981).

[^19]: Proposed rule: 46 Fed.Reg. 1430 (January 6, 1981); Final rule: 47
    Fed.Reg. 52006 (November 18, 1982). The final rule made its
    requirements effective as of January 3, 1983.

[^20]: Clean Water Act §301(k). To be eligible for the two year
    extension, the technology must (1) have the potential for
    industry-wide application, and (2) a substantial likelihood of
    achieving greater effluent reduction than the effluent limitations
    require, or will result in significantly lower costs.

[^21]: See, e.g., Clean Water Act §309, 33 USC §1319; Clean Air Act
    §113, 42 USC §7413; RCRA §3008, 42 USC §6928.

[^22]: See, e.g., Tietenberg, T., [Innovation in Environmental Policy:
    Economic and Legal Aspects of Recent Developments in Environmental
    Enforcement and Liability (Hants, England: Edward Elgar Publishing,
    Ltd., 1992).]{.underline}

[^23]: For example, the US EPA is considering revoking Virginia's
    delegated authority to manage its NPDES and air programs. See "EPA
    Investigating Virginia Agency, Warning of Takeover, U.S. Accuses
    Office of Not Enforcing Air, Water Laws" (The Washington Post, July
    15, 1997, p. A01). See also "Top Virginia Natural Resources Official
    Complains of Federal Emphasis on Enforcing Environmental Laws", (The
    Virginian-Pilot, June 14, 1997, p. B6).

[^24]: See, e.g., Wasserman, Cheryl, "Federal Enforcement: Theory and
    Practice", in Tietenberg, T., [Innovation in Environmental Policy:
    Economic and Legal Aspects of Recent Developments in Environmental
    Enforcement and Liability (Hants, England: Edward Elgar Publishing,
    Ltd., 1992), pp. 21-51; and Segerson, K., and Tietenberg, T.,
    "Defining Efficient Sanctions" in Id., pp. 53-73.]{.underline}

[^25]: Current law could accommodate "regulatory soft landing"
    provisions. For example, CWA §309(d) calls for consideration of "any
    good-faith efforts to comply with the applicable requirements... and
    such other matters as justice may require" when setting civil
    penalties. The Clean Air Act §113(e) includes similar
    considerations.

[^26]: See, e.g., [Wisconsin Electric Power Co. v. Reilly,]{.underline}
    893 F.2d 901 (7th Cir. 1990), where the court held the replacement
    of deteriorated components at an old plant was a modification that
    triggered the need to comply with stringent NSPS. At the WEPCo
    plant, the modification did not increase the emissions rate or
    increase the plant's historical operating capacity, but did result
    in more emissions being produced after the renovation than were
    emitted from the deteriorated plant shortly before the project.

[^27]: See, e.g., Revesz, R., "Technology-Based Emission and Effluent
    Standards and the Achievement of Ambient Environmental Objectives",
    91 Yale L.J. 792 (March 1983). Note that the Clean Air Act
    §111(a)(2), 42 USC §7411(a) defines a modified source as "new" for
    purposes of NSPS; Clean Water Act §306, 33 USC §1315 adopts a
    similar approach. For more detail regarding the regulatory context,
    see Appendix D.

[^28]: Appendix D contains a more thorough discussion of the broader
    policy reasons for NSPS and for grandfathering.."

[^29]: Clean Water Act §306.

[^30]: Clean Air Act §111.

[^31]: Differential standards do not necessarily stifle adoption of new,
    cleaner technologies. Indeed, stricter standards for new equipment
    may inspire firms to innovate when they expand. This section is thus
    addressed primarily with the *rate* at which firms adopt innovative
    approaches.

[^32]: 893 F.2d 901 (7th Cir. 1990).

[^33]: *See, e.g.,* Reitze, A., [Air Pollution Law]{.underline}
    (Charlottesville, VA: Michie Press, 1995), pp. 137-148.

[^34]: New firms may actually emit more, if they secure offsets at a 1 -
    1.2 ratio from other firms.

[^35]: See, e.g., Barry, C. "A Practical Guide to Surviving Multimedia
    Inspections", *Environmental Law Reporter* Vol. 24, p. 1 (June
    1994). Some have noted that EPA's process for approving new
    monitoring techniques is itself time-consuming and expensive. See,
    e.g., Moore, J., Jr., "Barriers to Technology Adoption",
    *Environmental Science & Technology*, Vol. 28, No. 4, p. 193 (1994).

[^36]: See, e.g., Ashford, N., and Heaton, G., "Regulation and
    Technological Innovation in the Chemical Industry", *Law and
    Contemporary Problems* Vol. 46 (Summer 1983), pp. 109-57; National
    Advisory Council for Environmental Policy and Technology, "Improving
    Technology Diffusion for Environmental Protection: Report and
    Recommendations of the Technology Innovation and Economics
    Committee" (EPA 130-R-92-001, October 1992).

[^37]: National Advisory Council for Environmental Policy and
    Technology, "Transforming Environmentally Permitting and Compliance
    Policies to Promote Pollution Prevention: Removing Barriers and
    Providing Incentives to Foster Technology Innovation, Economic
    Productivity, and Environmental Protection" (EPA No. 100-R-98-004,
    April 1993).

[^38]: For a discussion about the potential for firms to mistakenly
    consider as mandatory the reference technology used to develop a
    performance standard, see Magat, W., "The Effects of Environmental
    Regulation on Innovation", *Law and Contemporary Problems,* Vol. 43,
    No. 1, Winter-Spring 1979, pp. 3-24.

[^39]: See, e.g., Ackerman, B., and Stewart, R., "Reforming
    Environmental Law", 37 *Stanford L.Rev.* 1333, 1341 (May 1995);
    Anderson, S., and Herb, J., "Building Pollution Prevention into
    Facilitywide Permitting", *Pollution Prevention Review*, Autumn
    1992, pp. 415-429 for a discussion regarding flexibility allowed by
    a facilitywide permit.

[^40]: 682 F.Supp. 1122 (D. Colo. Oct. 30, 1987), 682 F.Supp. 1141 (D.
    Colo. March 22, 1988).

[^41]: Clean Water Act §306.

[^42]: Clean Air Act §111.

[^43]: NSPS are discussed in greater detail in the chapter "The
    Environmental Regulatory Context."

[^44]: See, e.g., Revesz, R., "Technology-Based Emission and Effluent
    Standards and the Achievement of Ambient Environmental Objectives",
    91 Yale L.J. 792 (March 1983). Note that the Clean Air Act
    §111(a)(2), 42 USC §7411(a) defines a modified source as "new" for
    purposes of NSPS; Clean Water Act §306, 33 USC §1315 adopts a
    similar approach.

[^45]: 40 CFR §122.29(b).

[^46]: See, e.g., Jaffe, A., and Stavins. R., "Dynamic Incentives of
    Environmental Regulation: The Effects of Alternative Policy
    Instruments on Technology Diffusion", Journal of Environmental
    Economics and Management; National Advisory Council for
    Environmental Policy and Technology, "Transforming Environmentally
    permitting and Compliance Policies to Promote Pollution Prevention:
    Removing Barriers and Providing Incentives to Foster Technology
    Innovation, Economic Productivity, and Environmental Protection"
    (EPA No. 100-R-98-004, April 1993).

[^47]: See, e.g., U.S. Congress Office of Technology Assessment,
    "Environmental Policy Tools: A User's Guide", (Washington, D.C.:
    U.S. Government Printing Office, September 1995), pp. 95-98.

[^48]: Browner, C., "EPA's Technology Innovation Strategy: We Need
    Technologies that Work Better and Cost Less. EPA Journal, Vol. 20,
    No. 3, pp. 9-10.

[^49]: The basis for this conclusion is the rather stiff noncompliance
    penalties established by environmental laws, typically \$25,000 per
    day per violation. See, e.g., Clean Water Act §309, Clean Air Act
    §113, RCRA §3008.

[^50]: Clean Water Act §401(k) allows a two-year extension for
    compliance efforts using innovative technologies that have the
    potential for industry-wide application, and a substantial
    likelihood of achieving greater effluent reduction than the effluent
    limitations require or will result in significantly lower control
    costs. This variance may be unavailable for toxic pollutants, due to
    the prohibition against modification of toxic limits set forth in
    Clean Water Act §301(l).

[^51]: Clean Water Act §301(k).

[^52]: See the chapter on the environmental regulatory context for a
    more detailed discussion of variances, and the criteria laid out in
    statutes and regulations to evaluate whether they should be granted.

[^53]: See, e.g., National Advisory Council for Environmental Policy and
    Technology, "Transforming Environmentally permitting and Compliance
    Policies to Promote Pollution Prevention: Removing Barriers and
    Providing Incentives to Foster Technology Innovation, Economic
    Productivity, and Environmental Protection" (EPA No. 100-R-98-004,
    April 1993).

[^54]: Reducing Hazardous Waste in Wisconsin, Report III, Information:
    Sources, Desired Types and Formats, Publ-MB-005(92), Wisconsin
    Department of Natural Resource, Madison, Wisconsin, August 1992

[^55]: Gardiner, David, "Questions the Reader Might Ask: An Interview
    with David Gardiner", EPA Journal Vol. 20, No. 3, pp. 14-15.

[^56]: Clean Water Act §301(d).