15 Environmental Regulation and Firms’ Innovation Activities- An Econometric Study Using Patent Data -（*）
Research Fellow: Kazuma Edamura
It is generally said that Japanese environmental technology is superior to that of other countries. In
this study, we assume that environmental regulation is a factor that may have encouraged Japanese firms topursue innovation activities in environmental technology, and conduct an empirical analysis to study the
relationship between the two. In conducting this analysis, we propose a hypothesis that the greater the
impact of the enforcement and/or strengthening of environmental regulation, the higher the incentive forfirms to pursue innovation in environmental technology.
There is a hypothesis which claims that environmental regulation encourages innovation activities byfirms (Porter hypothesis). Several empirical studies in support of this hypothesis have been conducted but
they left unresolved many issues due to limitations of data etc.
In this study, the relationship between firms’ innovation activities in environmental technology andenvironmental regulation is statistically analyzed, using patent data, financial data, and environmental
administration-related data. In performing the study, we assume that the impact which environmental
regulation may have on firms varies depending on the firm size and industry type. By controlling thesefactors, we statistically identify the impact which environmental regulation may have on firms’ innovation
activities.
From the results of the analysis, we draw a conclusion that the hypothesis of this study cannot berejected, which suggests that there is a possibility that the Porter hypothesis may be true in Japan.

Ｉ Introduction
It is said that Japan possesses environmental
technology that is superior to that of othercountries. Meanwhile, the attention of theinternational community has been focused on
global-scale environmental problems such as
global warming and there is a tendency toward amore strict enforcement of environmental
regulation. When Japanese firms engage in global
economic activities under such international
environment, Japan’s superior environmental
technology can be used as a means of gaining acompetitive advantage.
Therefore, it is meaningful to study thefactorsthatfacilitatedthesuccessful
implementation of innovation in environmental
technology in Japan in designing industrial policy
as well as environmental policy. In this study weassume that Japanese environmental regulation,
which is considered to be stricter than in othercountries, is a factor that has allowed thesuccessful implementation of innovation inenvironmental technology in Japan. We analyze

whether there is a relationship between thestrictness of environmental regulation and firms’
innovation activities in environmental technology.
The relationship between environmental
regulation and firms’ innovation activities was
first studied by Porter and van der Linde (1995)(*1).
Citing the examples of the Dutch flower-growing
industry, the Japanese automobile industry, andthe Nordic paper and pulp industry, etc., theyargue that environmental regulation will stimulateinnovation activities by firms and contribute totheimprovementof
theirinternational
competitiveness. This hypothesis is referred to as
the Porter hypothesis.
Based on the Porter hypothesis, we propose
in this study a hypothesis that the greater the
impact of the enforcement and/or strengtheningof environmental regulation, the higher the
incentive for firms to engage in innovation inenvironmental technology. It is considered thatfirms’ cost structure will change if environmental
regulation is enforced and/or strengthened. Thisis because, due to the enforcement and/or
reinforcement of environmental regulation, theThis is an English translation of the summary of the report published under the Industrial Property Research
Promotion Project FY2009 entrusted by the Japan Patent Office. IIP is entirely responsible for any errors in
expression or description of the translation. When any ambiguity is found in the English translation, the original
Japanese text shall be prevailing.
(*1) Porter, M. E. and C. van der Linde (1995) “Toward a New Conception of the Environment-Competitiveness
Relationship,” Journal of Economic Perspectives 9(4), 97–118.
(*)

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cost of environmental measures will increase inrelative terms. The cost of environmental
measures is expected to increase as the degree of
the impact of the enforcement and/or strengtheningof environmental regulation increases. It is thoughtthat environmental regulation provides an incentive
for firms to offset the increased cost ofenvironmental measures due to environmental
regulation, and as a result engage in innovation
activities in environmental technology.
In order to test the hypothesis, we constructin this study a model that analyzes the influencewhich the degree of impact of the enforcement
and/or strengthening of environmental regulation
may have on the decision-making by firms as towhether or not to engage in innovation activities
in environmental technology. We constructanother analysis model to determine whether or
not the degree of impact of the enforcement
and/or strengthening of environmental regulationencourages firms’ innovation activities inenvironmental technology. In the analysis of thesemodels, we use patent application data as anindicator of firms’ innovation activities. We alsouse data on the volume of toxic substance releaseas an indicator that measures the degree of
impact of the enforcement and/or strengtheningof environmental regulation.
From the results of the analysis, we draw aconclusion that the hypothesis that the greater
the impact of the enforcement and/or
strengthening of environmental regulation, thehigher the incentive for firms to pursue innovationin environmental technology cannot be statisticallyrejected. This suggests that there is a possibility
that the Porter hypothesis may be true in Japan. It
can be said that environmental regulation can beused as an optional technology policy tool forencouraging innovation as well as an environmental
policy tool for preserving the environment.

Ⅱ Previous Literature
Concerning the impact of environmental
regulation on firms’ innovation activities, thetraditional theory asserts that environmental
regulation stifles firms’ innovation activities. It
can certainly be argued that environmental
regulation will increase firms’ costs, and as aresult would stifle firms’ innovation activities.
It was Porter and van der Linde (1995) who,on the other hand, pointed out the possibility thatenvironmental regulation could encourage firms’
innovation activities. Citing examples from theDutch flower-growing industry, the Japanese

automobile industry, and the Nordic paper andpulp industry, they discussed environmental
regulation, innovation, and competitiveness. They
argued that, when appropriate environmental
regulation is put in place, firms accelerateinnovation to open up new opportunity for profits.
They argue that innovation in response toenvironmental regulation will lower the cost of
manufacturing and product costs (cost offsets),
and increase resource productivity, and as a result
the international competitiveness of firms will be
improved. This statement is called the Porter
hypothesis.
In previous empirical studies that haveanalyzed the relationship between environmental
regulation and innovation activities, there aremainly two problems that have not been
investigated. They are accumulation of analysis at
the level of the firm and accumulation of studies
using patent data as an indicator of firms’
innovation activities. In light of the previous
studies and abovementioned two main problems,
we conduct in this study an empirical analysis onenvironmental regulation and innovation activities
in environmental technology.

Ⅲ Hypotheses of This Study
This study is to verify the relationshipbetween environmental regulation and firms’
innovation activities. For that purpose, we test
the hypothesis that the greater the impact of theenforcement
and/orstrengtheningofenvironmental regulation, the higher the
incentive for firms to pursue innovation inenvironmental technology.
If environmental regulation is enforced and/or
strengthened, the cost structure of firms is
expected to change, and in such a case, the costs ofenvironmental measures will increase in relative
terms because firms must respond to the regulation.
Also, it is conceivable that the greater the impact of
the enforcement and/or strengthening ofenvironmental regulation for firms, the higher thecosts of the environmental measures.
It can be thought that, if the cost structurechanges, firms will engage in innovation activities
to cut down the costs that have increased inrelative terms (induced innovation hypothesis). In
other words, if the firms’ cost structure changes
due to environmental regulation and the costs ofenvironmental measures increase in relative
terms, they will engage in innovation activities inenvironmental technology to cut down theincreased costs.
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Therefore, firms that will be significantly
affected by the enforcement and strengthening ofenvironmental regulation have higher incentives
to pursue innovation activities in environmental
technology than those that will be less affected.
In this study, we use the volume of toxic
substance release as an indicator for measuring
the impact which enforcement and strengtheningof environmental regulation may have on firms. If
environmental regulation is enforced and therelease of toxic substances is restricted, firms
must respond to the environmental regulation tocontinue their business activities. Therefore, thevolume of toxic substance released by firms canserve as an indicator for measuring the potential
impact of environmental regulation.
We use patent application data as an indicatorof innovation activities in environmental
technology. Patent application data can be suitably
used as an indicator of innovation activities inenvironmental technology as we can obtain
information on the results, timing, and technicalfield of firms’ innovation activities from the data.
To specifically test the hypothesis (thegreater the impact of the enforcement and/or
strengthening of environmental regulation, thehigher the incentive for firms to pursue
innovation in environmental technology) using
the abovementioned two indicators, we propose
the following two hypotheses:
Hypothesis 1: Firms file applications forenvironmental technology-related patents if theirvolume of toxic substance release increases.
Hypothesis 2: Firms increase applications forenvironmental technology-related patents if theirvolume of toxic substance release increases.

Ⅳ Model and Data
In this study, we construct a model for
analyzing firms’ behavior concerning theapplication of environmental technology-related
patents and a knowledge production function
model regarding environmental technology. We
use data on environmental technology-related
patent applications, data on the volume of toxic
substance release, and financial data as input data
for the analysis of these models.
In the model for analyzing firms’ behavior
concerning the application of environmental
technology-related patents, we analyze therelationship between the degree of impact which
environmental regulation may have on firms andfirms’ decision-making as to whether or not to fileapplications for environmental technology-related
patents at the level of the firm. This is a model totest Hypothesis 1 (i.e., firms file applications forenvironmental technology-related patents if theirvolume of toxic substance release increases).
In the knowledge production function model
regarding environmental technology, we analyze
the relationship between the degree of impact
which environmental regulation may have on
firms and the number of applications forenvironmental technology-related patents at thelevel of the firm. This is a model to test
Hypothesis 2 (i.e., firms increase applications forenvironmental technology-related patents if theirvolume of toxic substance release increases)．In
conducting the analysis, we constructed not onlya model in which the explained variable is thetotal number of patent applications forenvironmental technology but also a model inwhich we focused on the numbers of patentapplications related to water quality control
technology, air pollution control technology, andsoil pollution control technology.
We gathered environmental technology-related
patent application data by referring to a reportpublished by the Japan Patent Office(*2). The
report defines six broad technical fields ofenvironmental technology, such as global
environment and regional environment, and 25
sub-technical fields, such as reduction of CFC
emissions and environmental monitoring, andlists search queries for searching patents related
to respective technologies in these fields. Using
this information, we collected patent data withpriority dates between 1993 and 2006 from theIndustrial Property Digital Library (IPDL).
We classified the number of applications forenvironmental technology-related patents bypriority date and examined their changes overtime, and found that the number of applications
for environmental technology-related patents wason an upward trend until 2001-2002, andthereafter showed a downward trend. We also
found that many of the applicants are firms
belonging to the automobile, electrical equipment,or machinery industry and that these firms areleading the innovation activities in environmental
technology in Japan.
The number of applications for environmental
technology-related patents filed by listed firms
increased until 2002 and thereafter showed adownward trend. However, the ratio of the(*2) Japan Patent Office (2009) “Heisei 20 Nendo Juten 8 Bunya no Tokkyo Shutugan Jokyo Chosa Houkokusho - Kankyo
hoka 4 Bunya-“ (Research Report on the Situation of Patent Applications in the 8 Priority Fields FY2009).
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number of applications for environmental
technology-related patents to the total number ofpatent applications has been on an upward trend
since 1993. This indicates that listed firms havebeen increasing the ratio of patent applications forenvironmental technology.
By comparing the total number of patentapplications per listed firm between the firms thathave filed patent applications for environmental
technology-related patents and those that haven’t,
we find that the firms that have filed patentapplications for environmental technology-related
patents have filed more patent applications overall.
As for data on the volume of toxic substancereleased by firms, we use data published from the
Pollutant Release and Transfer Register (PRTR).
From the published PRTR data, we can obtain therelease volume data and movement volume data
concerning 354 substances by place of business.
The toxicity of each of these substances has
already been evaluated from the viewpoints ofcarcinogenicity, mutagenicity, etc.
In order to use the data available from PRTR
in the analysis, we must aggregate them at the levelof the firm. In doing so, consideration must be
given to the toxicity of substances, for it is likelythat firms releasing a strongly toxic substance will
have more difficulty in treating the substancecompared to those releasing the same volume of a
weakly toxic substance. In other words, it can be
expected that, if environmental regulation isenforced, firms releasing a strongly toxic substancewill be affected more. Therefore, in aggregating
PRTR data to create an indicator for the degree of
impact of environmental regulation at the level ofthe firm, we must create an indicator that takes into
account the degree of toxicity of each substance.
We refer to the method of King and Lenox(2000, 2002) (*3) to aggregate the release volumedata and movement volume data by substance andby place of business at the level of the firm. First,
we aggregate the volume of toxic substancerelease by place of business and by toxicity, taking
into account the degree of toxicity. We use theinverses of the tolerable daily intake (TDI) and noobserved effect concentration (NOEC) describedin the PRTR data as values that represent thedegree of toxicity.
Next, we normalize weight and aggregatedrelease volumes so that the average is 50 and thestandard deviation is 10 for respective toxicity,and perform a principal component analysis using
the normalized release volumes and create acomposite indicator of the release volume.
Using the indicator of toxic substancerelease thus calculated, we estimate a model that
explains the indicator of toxic substance releaseby the size of the place of business to calculate anindicator of waste generation and an indicator ofwaste prevention.
Then, using the indicator of toxic substancerelease regarding release volume and movement
volume, we calculate an indicator of relative
waste treatment and an indicator of relative wastetransfer for each place of business of the firm.
Other factors that may influence firms’
behavior concerning the application of patents are
the amount invested in innovation activities, thetime trend, and industry characteristics. In thisstudy, we use R&D expense as an indicator of theamount invested in innovation activities. Whenusing R&D expense data in the analysis, wedeflate the data by using R&D deflators of Japan(business enterprises, etc.) published by the
Ministry of Education, Culture, Sports, Scienceand Technology (2009) (*4). We also use the year
dummy variables and industry dummy variables
to account for the time trend and industry
characteristics.

Ⅴ Estimation Results and Discussion
In this chapter, we show the results of theregression analysis performed using the models
and data described in the previous chapter. The
regression analysis covers 1,022 firms for theperiod between 2001 and 2006 when patent data
and PRTR data could be combined. We performed
the regression analysis using panel data by year
and by firm.
In the regression analysis of the model for
analyzing firms’ behavior concerning the applicationof environmental technology-related patents, it wassuggested that the more wastes a firm generates,
the more likely it will file applications forenvironmental technology-related patents. In otherwords, it can be considered that firms that generatea large amount of wastes and thus have a higher
potential impact from environmental regulation are
more likely to engage in innovation activities inenvironmental technology to prepare themselves
for possible enforcement of environmental(*3) King, A. and M. Lenox (2000) “Industry Self-Regulation Without Sanctions: The Chemical Industry's Responsible Care
Program,” Academy of Management Journal; King, A. and M. Lenox (2002) “Exploring the Locus of Profitable Pollution
Reduction,” Management Science 48(2).
(*4) MEXT, Ministry of Education, Culture, Sports, Science and Technology ed. “Kagaku Gijutsu Binran Heisei 21 Nendo
Ban” (Indicators of Science and Technology FY2009 Edition) (Nikkei Printing, 2009).
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regulation in the future.
Further, it was suggested that the more toxic
substances a firm releases, the more applications forenvironmental technology-related patents it will file.
In other words, it can be considered that firms that
release a large amount of toxic substances and thus
have a higher potential impact from environmental
regulation are likely to engage in innovation
activities in environmental technology morevigorously than firms that do not, in order toprepare themselves for possible enforcement ofenvironmental regulation in the future.
In the regression analysis of the knowledge
production function model regarding environmental
technology, it was suggested that firms releasing a
relatively higher amount of toxic substances in theirplace of business are filing more applications forenvironmental technology-related patents. That is,
firms releasing a relatively higher amount of toxic
substances in their place of business are expected toincur higher costs in responding to environmental
regulation on their own, if environmental
regulation is enforced in the future, and therefore
engage in innovation activities more vigorously
than the firms releasing relatively less.
Further, in the regression analysis that
focused on the numbers of patent applications
related to water quality control technology, air
pollution control technology, and soil pollution
control technology, it was suggested that firmsthat release more toxic substances to therespective place of release (waters, atmosphere,soil) file more applications for patents related to
the respective environmental technologies (water
quality control, air pollution control, and soil
pollution control). Therefore, through the analysisof the relationship between the degree ofenvironmental regulation and innovation activities
in environmental technology performed from themicro viewpoints of waters, atmosphere and soil,
it can be said that firms that release a large
amount of toxic substances and thus have a higher
potential impact from environmental regulation
are more likely to engage in innovation activities
in environmental technology to prepare
themselves for possible enforcement ofenvironmental regulation in the future.

Ⅵ Conclusion
Through the regression analysis of the model
for analyzing firms’ behavior concerning theapplication of environmental technology-related
patents, it was shown that the more toxic
substance wastes a firm generates, the more

likely that it will file applications forenvironmental technology-related patents. We
also found that the more toxic substances a firm
releases, the more likely that it will fileapplications for environmental technology-related
patents. From these results it could be said thatthe more a firm will be affected by environmental
regulation, the more likely that it will engage ininnovation activities in environmental technology.
Therefore, Hypothesis 1 (i.e., firms fileapplications for environmental technology-related
patents if their volume of toxic substance release
increases) is statistically supported.
Through the regression analysis of theknowledge production function model regarding
environmental technology, it was shown thatfirms releasing a relatively higher amount of toxic
substances in their place of business are filing
more
applicationsforenvironmental
technology-related patents compared to thosereleasing relatively less. Further, through theregression analysis performed from theviewpoints of waters, atmosphere and soil byfocusing on the numbers of patent applications
related to water quality control technology, air
pollution control technology, and soil pollution
control technology, it was shown that firms that
release more toxic substances will file more
applications for environmental technology-related
patents. From these results it could be said thatthe more a firm will be affected by environmental
regulation, the more vigorously it will pursue
innovation activities in environmental technology.
Therefore, Hypothesis 2 (i.e., firms increase
applications for environmental technology-related
patents if their volume of toxic substance release
increases) is statistically supported.
As the two hypotheses of this study aresupported statistically, the hypothesis that thegreater the impact of the enforcement and/or
strengthening of environmental regulation, thehigher the incentive for firms to pursue
innovation in environmental technology cannot berejected. This suggests that there is a possibility
that the Porter hypothesis may be true in Japan.
Environmental regulation is used as anenvironmental policy tool for preserving theenvironment, etc., but it could also be used as an
optional technology policy tool for promoting
innovation. Moreover, if a similar study can be
carried out in Europe and America as well as inJapan using data similar to those from PRTR andpatent data, it would be possible to clarify theconditions when environmental regulation canfunction as a technology policy and when it cannot.
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