The Positive Role of Governance in the Way Environmental Policies Impact Technological Innovation

Li Shiqi

(Nanjing University Business School,Nanjing Jiangsu 210093)

Ⅰ.Introduction

Since the Industrial Revolution,the global economy has been on rapid growth,and along with it came the high demand for resources.The industrial pollution that came after has severely damaged the environment and led to climate change.According to the report issued by World Meteorological Organization,2016 was the hottest year since 1880 when we first had our meteorological record.How to alleviate the pressure of resources and the environment and to achieve the sustainable development of the economy in the era of a global economic transformation has become a global agenda.Since the reform and opening up policy,China has maintained rapid economic growth,which,however,was at the cost of our environment and resources.Therefore,to protect the environment and to drive economic development through technological innovation is the only option for China if it is to grow sustainably.

Environmental pollution is termed an externality in economics,which makes it crucial for the government to make proactive policies to solve pollution problem while maintaining fast economic growth.In 2002,China started a cap and trade pilot program on the emission of sulfur dioxide in four provinces including Shandong,Shanxi,Jiangsu and Henan,three cities including Shanghai,Tianjin and Liuzhou and a corporation,China Huaneng Group Co.,Ltd..In August,2010,China started a low-carbon pilot program in five provinces and eight cities.In October,2011,the NDRC (National Development and Reform Commission) issued Notice Regarding Carbon Trading Pilot Scheme to implement pilot carbon markets in seven cities and provinces including Beijing,Shanghai and Tianjin.However,the impact of environmental pollution is regional,so after environmental policies are made by the central government,it is up to local governments to implement them.These policies can also urge enterprises to start technological innovation to meet the requirement.Through technological innovation,corporations can not only reduce their costs of pollution management,but also raise their productivity and profits by developing new products and optimizing manufacturing process.〔1〕

Through statistics and analysis,I proved that environmental policies and technological innovation have a negative correlation.However,after the introduction of governance,it turns into a positive correlation.This can be of help to local governments in China to drive technological innovation while implementing environmental policies.

Ⅱ.Research Hypotheses

1.The Relationship between Environmental Policies and Technological Innovation

At present,due to the increasingly serious environmental pollution problems,the government has introduced environmental protection policies and expects to promote corporation technological innovation through environmental policies.The impact of the introduction and implementation of environmental policies on related technological innovation has always been a focus of study.There are mainly three views:(1) Environmental policies are conducive to technological innovation.Proper environmental regulation will stimulate enterprises to invest in technology,which can improve the production efficiency of enterprises and quality of products,thereby reducing their production costs.In this way,enterprises may gain a competitive advantage in the market and at the same time it is possible to promote technological innovation in the whole industry.〔2〕Hamamoto used expenditures on pollution control and R&D investments as two variables to study the relationship between environmental regulations and technological innovation in Japan and found that pollution control is an incentive for enterprises to make R&D investment.〔3〕(2) Environmental policies weaken competitiveness of enterprises and have a negative impact on technological innovation.The traditional neoclassical economic theory holds that while environmental policies can bring about an overall improvement in social welfare,they impose extra costs on enterprises,thus reducing the capability of enterprises to make technological innovation.Jaffe〔4〕did an empirical research on the relationship between environmental regulations and the competitiveness of enterprises.He believed that environmental regulations raise production costs and seriously weaken the ability of enterprises to make technological innovation.Brannlund〔5〕studied the pulp and paper industry of Sweden,found evidence more convincing than the study by Jaffe et al.and demonstrated that strict environmental regulations can have a negative impact on technological innovation of enterprises subject to the regulations.(3) The Porter Hypothesis disagrees with the view of Brannlund.At the same time,based on a series of rigorous premises,it holds that neither viewpoint is absolute.Chinese scholar Jiang Fuxin et al.studied 28 panel data from the manufacturing industry in Jiangsu province between 2004 and 2011.They used two-step GMM estimation and found that the curve modelling the relationship between environmental regulation and technological innovation was a U-shaped curve.〔6〕Li Yongyou,〔7〕Tu Zhengge〔8〕et al.proved that China’s current emissions trading scheme was not effective.

To sum up,although there have been studies on the impact of environmental policies on technological innovation,no unanimous view has yet emerged.The second view mentioned above is more in line with the actual situation in China.Therefore,hypothesis 1 of this paper is that China’s current environmental regulations have a negative effect on technological innovation.

2.The relationship between governance and technological innovation

Since the term “innovation” was coined by Schumper,it has been regarded as a key driving force for an organization’s success and survival.However,compared to developed countries,China’s enterprises are generally not as enthusiastic about innovation or making investment in it.A popular explanation for this is that the government does not make much effort in urging enterprises to innovate.At the same time,the patent markets in different places are developing unevenly.The number of patent applications each year varies significantly from one region to another.In some places,the number of patent applications is on the rise while in others it has been sluggish for years.That is why local governments need to take responsibility and to encourage enterprises to innovate actively.The R&D investments enterprises not only make profits themselves,but also has a positive externality.The return a company receive from innovation,in either profits or any other forms will affect its motivation in innovating.Therefore,better governance can guarantee a good policy environment for companies and allow them to have high return from R&D investments,thereby encouraging them to make further innovation.In a word,how well the government governs determines what enterprises will do and how innovative they can be.Technologies,especially clean energy ones benefit the society more than it does to enterprises,which may discourage enterprises to invest in R&D,because their investments may not bring profits.In such cases,local governments need to take measures to stimulate innovation by raising their personal profits and social benefits.To that end,a common policy instrument is intellectual property protection.Research has proven both theoretically and empirically that intellectual property can significantly influence innovation.Intellectual property is also critical to developing countries to gain foreign expertise and investments and to boost domestic economy.〔9〕Based on this,hypothesis 2 is that local governance can encourage technological innovation.

3.The government’s role in how environmental policies impact technological innovation

In the last few decades,China has made extraordinary economic achievements.The cities that have seen the greatest economic growth all have local governments behind the curtain that virtually boost local economy.Despite that,some local governments do not effectively enforce the environmental policies introduced by the central government.This may be because local governments lag behind in terms of shifting their working focus.Moreover,different places have different environmental problems,so local governments also act differently.If local governments do not impose enough restrictions on pollutant emissions,enterprises will rather choose to pay for emissions (which is less costly) than invest in innovation.Therefore,So local governments play an important role in implementing environmental policies,and how they do that will impact the effectiveness of these policies directly.To sum up,if local governments can effectively implement environmental policies introduced by the central government,improve their capacity to govern,protect intellectual property rights,strictly enforce laws,provide enterprises with quality public services,create business environment and lower external uncertainties for businesses,enterprises will work on innovation that can help reduce emissions or improve energy efficiency.Therefore,hypothesis 3 is that governance plays a positive role in how environmental policies impact technological innovation.

Ⅲ.Research Method

1.Variables and data

This paper is an empirical study based on data from 30 provinces in China between 2008 and 2014.(Due to lack of accessibility,Tibet is not included in this study.) Most data is from China Statistical Yearbook,Marketization Index of China’s Provinces and National Bureau of Statistics of China (NBS) or collected and calculated by me based on initial data from the NBS.Variables include number of authorized patents,intensity of environmental regulation,and governance capacity of the government,human resources,local economy and openness.

(1)Technological innovation (PATENT)

Technological innovation usually refers to innovation in products and production methods.Innovation in products means putting new products into business operation,the design or functions of which can bring new or better user experience.Innovation in production methods refers to the adoption of new or improved production methods.〔10〕Researchers often measure the level of innovation using two indicators:the number of authorized patents and expenditure in R&D.Considering that an innovation ends up as a new patent in most cases,this paper takes the number of patents to measure the level of technological innovation.I have referred to the international classification guideline of renewable energy patents that Johnstone (2009) published.By searching patents in the database of China’s State Intellectual Property Office (SIPO),I have collected renewable energy patent statistics and tried to relate clean energy innovation to regulations and governance.But this attempt was a failure.This may be attributed to the fact that China’s clean energy industry is at an early stage and enterprises do not invest much in the R&D of clean energy.The market is not mature enough.

(2)Environmental regulation (ER)

Gray〔11〕measured the intensity of environmental regulation by the ratio of pollution control investment to the total cost or output value of a company.Low〔12〕created the concept “green index”,which refers to the number of environmental policies and rules a local government enacts,to measure the intensity of environmental regulation.Levinson (1996) measured the intensity of environmental regulation with the revenue from sewage charges of a government.Antweiler et al.(2001)〔13〕adopted per capita GDP as a proxy for environmental regulation,believing that as people’s income rises,environmental regulation also becomes stricter.Cole and Elliott〔14〕(2003)measured the intensity of environmental regulation with the density of discharged pollutants.Chinese researchers based their studies more often on the costs and expenditure of a government when in implementing environmental policies.Because of different production scales in different regions,the same cost in pollution control may bring different social return.Therefore,researchers must consider the difference of production scales in different regions when measuring the intensity of environmental regulation.This paper divides the operating costs of wastes treatment facilities by year-end employment to exclude the influence of production scales and uses this figure to measure the intensity of environmental regulation.In order to compare data from different years,the data from 1978 are used as benchmark.

(3)Governance (GOVERN)

Due to the difficulty in measuring how well a government governs,this paper referred to the research of Fan et al.〔15〕(2001) and adopted an index demonstrating the relationship between the government and the market in Wang Xiaolu et al.’s (2011) Marketization Index of China’s Provinces.This paper used the reciprocal of this index as a proxy for the quality of governance.The larger the reciprocal is,the better the government governs.

(4)Human capital (EDUC)

Human capital is essential for technological innovation.Technological innovation is not only an indicator for the creativeness of technicians,but also measures the innovativeness and economic potential of a region.This paper adopts average years of schooling to measure human resources.Primary school,secondary school,high school and college as the highest level of education take 6,9,12 and 16 years respectively.EDUC in this paper is the result of years of schooling multiplied by each population group,divided by sample population.

(5)Local economy (GDP)

This paper uses GDP to measure the economy of a region.The GDP in 1978 is used as the benchmark.

(6)Openness

The openness of a region can also influence its technological innovation.Competition from abroad encourages local enterprises to cut costs by innovating.This paper refers to the research method of Liu Jinlin〔16〕et al.Openness is measured by the ratio of the total import and export of goods according to the destination and country of origin to the number of employees at the end of the year in each region.

2.Research model

In order to examine the hypothesis proposed in the previous section,this paper constructs three basic panel data models based on C-D production function.In order to reduce the volatility caused by different data units and the multicollinearity between the variables and the heteroscedasticity of the equations,I take the natural logarithm of all the variables to ensure the accuracy of the results.“i” stands for region,and “t” stands for time.

Model 1:The Relationship Model between Technological Innovation and Environmental Regulation

lnPATENTi,t=β0+β1lnERi,t+β2lnEDUCi,t+β3lnGDPi,t+β4lnOPENNESSi,t+εi,t

Model 2:The Relationship Model between Technological Innovation and Governance

lnPATENTi,t=β0+β1lnGOVERNi,t+β2lnEDUCi,t+β3lnGDPi,t+β4lnOPENNESSi,t+εi,t

Model 3:The Relationship Model between Technological Innovation,Environmental Regulation and Governance

lnPATENTi,t=β0+β1lnERi,t+β2ln(ERi,t×GOVERNi,t)+β3lnEDUCi,t+β_4lnGDPi,t+β5lnOPENNESSi,t+εi,t

Ⅳ.Empirical analysis result

Due to the lag effect of environmental regulation and local governance on technological innovation,this paper examines the impact regulation and local governance on the number of patents in the current period and lagged period.All controlled variables are the same as explanatory variables to avoid endogenous problems.Our analysis tool is Stata12.0.

1.Panel unit root test

False regression may occur if data is not stable.Therefore,it is necessary to conduct a unit root test before regression to ensure the credibility of the result.Root test methods are LLC,ADF-Fisher,PP-Fisher,IPS.To take a traditional approach,this paper uses two panel data unit root test methods,namely the LLC test under the same root condition and the IPS test under different root conditions.If unit root in is rejected in both tests,the data is stable.Test result is in Table 1.It can be seen that all variable sequences are stationary sequences,so now we can move to regression analysis.

Table1ResultofPanelDataUnitRootTest

Note:Variables at the level of 1%,5%,10% are marked with ***,**,* respectively.Probability is given in brackets.

2.Empirical analysis of environmental regulation,governance and technological innovation

This paper analyzes panel data from 30 provincial-level administrative divisions in China between 2008 and 2014 to find out the role of local governance in how environmental regulations impact technological innovation.The results are presented in Table 2.This paper uses fixed effect model to analyze for Hausman test.

(1)The result of empirical analysis of environmental regulation,governance and technological innovation

It can be concluded from Table 2 that environmental regulation is negatively correlated with technological innovation,which backs our hypothesis.This happens probably because the cost of production will increase due to regulations.On seeing this,some enterprises will invest in pollution control rather than innovation.In China,although the central government has paid attention to environmental regulations,local governments haven’t implemented them well.Also,under the current regulation,enterprises do not have to pay too much price for polluting the environment,which emboldens short-sighted enterprises to invest in cutting emission instead of in innovation,which is high-risk yet more beneficial in the long run.However,the elasticity of the current period is -0.073 while the lagged one is -0.061,which means that the negative impact of environmental regulation will wear off in the long run and turn beneficial to innovation in the end.

Controlled variables such as EDUC,openness and GDP are facilitators of technological innovation.In the era of knowledge economy,human capital is an indispensable factor for an enterprise to improve its technological innovation,which is illustrated by the fact that its elasticity value is the highest of all variables.More talent and investment in R&D are needed to fuel innovation,whether it is a local innovation or an introduced one.Talent determines the result of innovation.The higher the level of human capital and the capability to absorb new technologies,the more likely an enterprise is to innovate further through introduced technologies.Chinese enterprises are innovating by themselves as it stands,but imitating and introducing technologies from overseas companies are also effective ways to promote their technologies.The level of regional development is another factor that determines technological innovation because the more developed a region is,the more it can invest in R&D.The same applies to openness.An open environment will provide enterprises with more choices of overseas technologies that they can absorb.Moreover,openness brings more competition in local regions,which means enterprises will have to innovate their technologies to lower the cost of production.

Table2Resultofempiricalresearch

Note:T value is significant at the level of 1%,5%,10% when marked with ***,**,* respectively.T statistic is given in brackets.

The result of the regression analysis (Model 2) supports Hypothesis 2.The degree of governance is positively correlated with technological innovation,which means that China is still in a catch-up stage.Technological innovation in China calls for government support and an effective market that allows full competition.This suggests that the higher the quality of local governance is,the more local enterprises will invest in technological innovation.In this way,local enterprises will focus on long-term development and pay attention to technological innovation instead of finding a quick fix to reduce pollution.As investment in R&D increases,these enterprises will be more enthusiastic in technological innovation because it is the only way to lower their cost of production.It can be seen from Model 2 that like governance,all other controlled variables have the same positive correlation with technological innovation.

(2)Governance can play a role between environmental regulations and technological innovation

According to Model 3,the coefficients of cross-items of “environmental regulation” and “governance” are positive on a national scale.This indicates that governance plays a positive role in how environmental policies impact technological innovation.Better governance will ensure that policies won’t become a barrier to technological innovation,and this supports Hypothesis 3.Technology innovation has strong externalities and is likely to face market failures,which means that it cannot rely solely on market mechanisms to allocate resources,and this is where governance has its role.To be specific,on one hand,enterprises usually have to check the central environmental regulation policy and market demand to form its own innovation strategy,while local government’s job is to implement these policies to reduce pollution and protect the environment.On the other hand,enterprises lack motivation because they need to spend money on both pollution control and innovation.Also,individuals are not interested in technological innovation because there is no incentive for them.Local governments should incentivize enterprises through subsidies to encourage innovation.Other controlled variables in Model 3 have similar results with those in Model 1.

3.Robustness test

In order to verify the robustness of the model,the legal environment system index (IP) is added as another variable because the level of marketization in different places will influence government intervention in enterprises.All data is from the Marketization Index Report of China,and IP constitutes 3 aspects-- the maturity of intermediary organizations (such as market lawyers,the maintenance of the legal environment and intellectual property protection.

Model 4

lnPatenti,t+1=β0+β1lnERi,t+β2lnEDUCi,t+β3lnGDPi,t+β4lnOPENNESSi,t+β5lnIPi,t+εi,t

Model 5

lnPatenti,t+1=β0+β1lnGOVERNi,t+β2lnEDUCi,t+β3lnGDPi,t+β4lnOPENNESSi,t+β5lnIPi,t+εi,t

Model 6

lnPatenti,t+1=β0+β1lnERi,t+β2ln(ERi,t×GOVERNi,t)+β3lnEDUCi,t+β4lnGDPi,t+β5lnOPENNESSi,t+β6lnIPi,t+εi,t

Table 3 is the result.From Table 3,it can be concluded that environmental regulations have a negative impact on technological innovation while regulations under government intervention has a positive one.IP law is a facilitator of innovation because innovation often comes from high-risk and long-term projects that costs large sums of money and human capital.Given the fact that the product of innovation is often intangible and vulnerable to plagiarism,progress in legal protection will encourage more innovation.Therefore,local governments should formulate policies based on local development and establish an IP protection system to clear the way for local innovation.A good legal system and an IP protection system will safeguard innovation against plagiarism.If innovative individuals and enterprises are rewarded with what is worth their investment,they will be motivated to innovate more.The new normal of China’s economic growth is that it is slowing down with its driving force changing in a structural reform.With this in mind,IP is bound to play an important role in promoting innovation as well as in transforming intangible scientific and technological achievements into real productivity.The lagged value of the IP index declines more rapidly than the current value,which indicates that the legal environment benefits technological innovation more in the current period.

Table3Resultofrobustnesstest

Ⅴ.Conclusion

To discuss the relationship between environmental regulations and technological innovation,governance is a factor that we need to take into consideration.In this paper,statistics is analyzed to check how governance can change the way environmental policies impact technological innovation.It is found in the result that governance plays a positive role in how environmental policies impact technological innovation,and the way local governments implement national policies matters significantly.In view of this finding,here are some suggestions for governance.

First,China should consolidate its resources and environmental protection regulations to promote technological innovation.According to statistics,although environmental regulation is negatively correlated with technological innovation,its negative effects wear off in the long run.Subsidy for environmental innovation has not yet spurred innovation,so we must further develop our environmental protection system and raise our environmental standards.We need to push forward market-based environmental policy reform,achieve pollution control objectives and encourage technological innovation.

Second,we need to streamline the administration and delegate real powers to lower levels to improve the quality of governance.According to statistics,better governance quality will lead to more innovation.Streamlining the administration is not equal to taking no responsibility.It is about cutting red tapes and providing better service.Also,the coordination among the central and local governments as well as the one between different departments is of same importance.Sometimes policies do not have intended effects just because one part of the coordination chain is broken.At the same time,the Ministry of Environmental Protection should strengthen law enforcement and crack down on environmental violations.Enterprises should be encouraged to invest in R&D and clean energy.Local governments should see to it that all social entities bear legal liability if it violates any environmental regulations.

Third,we need an environmental assessment mechanism led by local governments.Local governments should implement the environmental policies and make local development strategy that is suitable for its own to provide an innovation platform for local enterprises.We need a whole management system to maintain market order,protect intellectual property rights and encourage innovation.Communication between government and enterprises should be strengthened to pool resources,exchange technical information and provide services.We must support the development of high-end,deep-processing,high tech,high- added-value and environmentally friendly industries.By increasing investment in R&D,we can breed new technologies and new products that have an edge in the international market to export more high-tech,clean,capital-intensive and technology-intensive products.〔17〕

Fourth,more talent should be introduced and trained to improve human capital.According to statistics,the level of human capital is always a major facilitator in technological innovation in any circumstances,and as society progresses,it will be of greater importance.Therefore,local governments should encourage the introduction of talent and offer more professional training projects.Enterprises should also be encouraged to cultivate talent and maintain their innovative vitality to guarantee the sustainable development of the economy.

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