Economic growth and environmental regulation: What is the role of regulation?
Introduction: the role of regulation in the growth process The People’s Republic of China (PRC) has now been experiencing rapid growth for more than two decades. At the same time, its environment has experienced rapid degradation, in terms of air, water, ecosystems and all other resources imaginable. For this reason, it might seem that there is an obvious connection between economic growth and the environment – one in which growth continues to drive resource degradation. The object of this chapter is to investigate this relationship a bit more comprehensively in order to examine more generally how economic growth and economic regulation interact within economies. What is the role of environmental regulation in respect to economic growth? This question has been debated since at least the time of the initial statement of the “Porter hypothesis” (Porter and van der Linde 1995 and 2005). In one respect, the simple Porter hypothesis posited the unlikely idea that more regulation might be good for an economy, by inducing innovation and encouraging growth and competitiveness. This seems unlikely in an economy such as the PRC after two decades experience of unregulated growth, where industries achieve increasing market shares by out-competing firms and industries in more regulated countries. The PRC needs to consider very carefully the ways in which environmental regulation might impact upon its nascent economy, both positively and negatively. For this reason, this chapter will consider the question within the broader context of technological change. A more complex view of the Porter hypothesis would place it firmly within the boundaries of the literature on the economics of growth and technological change (Stoneman 1995). In this view, governments must intervene within economies in many ways in order to encourage innovation and growth (e.g. policies on intellectual property rights). Such intervention is important as a means for inducing innovation, and for directing the process. Then environmental regulation may be seen within this context as just one more instrument in society’s toolkit of economy-directing interventions. Intervention is critically important for these purposes. It has been known, since at least the time of the seminal work of Arrow (1962a and 1962b) and the structural work of Kamien and Schwartz (1982), that competitive firms and
competitive markets need not produce the optimal amount of innovation and growth within an economy. Governments must intervene in industries in order to provide incentives for investment in research and development (R&D). This is because industries in competitive markets have few incentives to invest in technological change or even in product innovation, since any returns would be immediately competed away. This is one of the best-known examples of market failure in the context of competitive markets, and provides the rationale for various forms of interventions (Blair and Cotter 2005). So, some manner of intervention is required in order to encourage growth and technological change, at least at some point in the development process. Of course, firms and industry off the technological frontier may be able to grow via “catching up” processes for a very long period of time. In the 1950s and 1960s, the governments of Japan and the Republic of Korea primarily sponsored domestic innovation and technological change by importing them (Teece 1981). These governments accomplished this via the requirement that foreign firms license technologies to domestic firms, in exchange for the opportunity to invest in domestic markets (Mowery 1995). In Japan, during this period, the Ministry of International Trade and Industry (MITI) was responsible for drawing up the terms for licensing technologies from foreign firms, in return for providing access to Japanese productive capacity and Japanese markets. For two or three decades of growth, the experiences of Japan and the Republic of Korea demonstrate that it is possible to rely upon the importation of technology, and upon imitation over innovation. After a couple of decades, the growth and development of an economy must rely increasingly upon its own capacity for technological change and innovation. Again, this is borne out by the more recent experiences of Japan and the Republic of Korea. By the 1970s, Japan was one of the leading economies in the world in terms of R&D investment, and as the succeeding case studies illustrate, many of these investments were going into environment or energy-related industries. By 1987, Japan was the world leader in R&D per unit gross domestic product (GDP) at 2.8 percent, and the world leader in the proportion of income spent on energyrelated R&D at 23 percent (Mowery 1995). In Japan, the transition from imitation to innovation was completed in a couple of decades. Why did Japan undertake this shift in investment priorities? Experience tells us that the process of catching up (through imitation and investment) can last only for a limited time, and that as a country approaches the technological frontier, imitation-based growth must continue to fade away (Gomulka 1990). Then the country concerned needs to become more focused upon its own innate capacities for innovation, growth and development. This implies a shift in priorities away from imitation and toward policies focused on encouraging internal processes of innovation and technological change. As the PRC follows in the footprints of its Asian neighbors, it will come to recognize that it will soon enter this transition phase and begin to focus more on innovation and less on imitation. Policies will soon need to take a central role in guiding the growth and development process of the country.