The Porter hypothesis suggests that there will be few losers from any government introduced measures to curb

carbon emissions. What is the basis for his argument and to what extent do you think Michael Porter is right?

Adji Hafiz Sjadzali 560018036 Introduction

The debate that surrounds the Porter hypothesis and its practicality has been around since the mid-1990s. At a time when organisations began to feel threatened by the policies made to protect the environment Michael Porters ideas were a welcome alternative to understand the impact of regulations. In this essay we will look at these ideas that Porter contributed to the discourse in environmental economics. Of course, these ideas are not without their critics. We will also look at these critics and try to understand the opposite view to Porters ideas. Finally, from the discussions brought up in this essay we will try come to a conclusion as to the extent of the Porter hypothesis legitimacy.

Porter Hypothesis
The reason why Porter hypothesis received much attention from practitioners was because at the time of its publication his idea was rather radical. Traditionally the policies that were set up by governments with respect to the environment were seen, and justifiably so in many cases, as cost barriers that would potentially hinder competitiveness across wide range of industries. Between environmental concerns and the economic gains the traditional view was that there was a trade-off whereby it is only possible of having only one or the other. This is problematic as on one hand there is the interest of society in protecting the environment while at the same time the economy needs to exploit these areas in order to grow and keep the industry growing. For Porter this frame in which the relationship between environment and competitiveness is viewed is incorrect (Porter & van der Linde, 1995). He believes that this relationship is derived from what he claimed to be a static view

of

environmental

regulation,

in

which

technology,

products,

processes and customer needs are all fixed (Porter & van der Linde, 1995), and that in fact a win-win situation is possible. In the academic world of business studies, if not as well in the business world, Porter is known for his understanding of competitiveness in industries. He classified three generic strategies that he argued could create a sustainable competitive advantage for companies. There was a cost leadership strategy whereby a firm tries to maintain their position as the firm that can produce the product at a lower overall cost in the industry, there was a differentiation strategy whereby the value of the product a firm produces is different to the others in the industry, and finally there was the focus strategy in which a firm tries to target a particular market segment and tailor their business for that segment (Johnson, Scholes, & Whittington, 2008). In all three of these strategies, innovation is at the very core. In order for firms to maintain or develop their foothold in the market they need to innovate to ensure that they are in line with the strategies they chose to follow in the face of the ever-changing market environment (Frohwein & Hansjrgens, 2005). This understanding backs Porters idea that competitive advantage lies in innovation. As such, instead of treating environmental policies as having a negative correlation with competitiveness, Porter argues that on the contrary environmental regulations can encourage innovations. His central argument is that properly designed environmental standards can trigger innovation that may partially or more than fully offset the costs of complying with them (Porter & van der Linde, 1995). Porter went on to explain that these innovation offsets could come in two different forms. First he refers to product offsets, whereby the regulations imposed not only reduces pollution output but also result in an increase in the value and efficiency of the product. Secondly the

process offsets in which a firm produces less pollution but also operates in a more efficient, more productive ways. There are some examples that can support this view. In his paper Porter gave examples of both product and process offsets. As an example of product offset Hitachi benefitted from the Japanese recycling law put up in 1991. They redesigned their products to comply with these regulations and benefitted by being able to reduce parts in their products by as much as 30% (Porter & van der Linde, 1995). As a result, their marginal costs are decreased. Stationery giant 3M benefitted from process offset when they tried to meet the regulations they faced. By 1995, 3M, who intensively used solvents in its production, managed to find a solution when they were told to reduce their use by 90%. Instead of reducing solvents they avoided it altogether and developed a safer alternative (Porter & van der Linde, 1995). In a wider, more international economic context, the use of environmental regulations can still create potent competitive advantages that emerge from innovations. When a government passes an environmental regulation in the country the local industry will have to respond by innovating to find solutions. These innovations would have been born under a unique industrial context, which could in fact be revolutionary in terms of global environmental policy making. With this background, when these regulations are adopted globally, firms from the local industry would be able to gain from the first-mover advantage by already being in a process of innovation and by having the knowledge in the area, which competitors coming from different local industries might not possess. An example of this is the recycling standards in Germany that were adopted earlier compared to other countries. These standards imposed locally gave German firms competitive advantages by allowing them to be first-movers in reducing packaging on their products (Porter & van der Linde, 1995).

Against Porter Hypothesis

Not everyone, however, is convinced with the validity of Porter Hypothesis. The main writers who have strongly gone against Porter Hypothesis were Palmer, Oates, and Portney. They strongly disagree with Porters view that the cost of complying to regulations, when one weighs the economic implications, not only can be recouped but can also, in some instances, eclipse the costs. They argued that If environmental regulations are essentially costless (or even carry a negative cost!), then it is unnecessary to justify and measure with care the presumed social benefits of environmental programs (Palmer, Oates, & Portney, 1995). The ideas that Palmer et al explained in their paper are quite mathematical, although they also offered significant amount of examples. They went on to argue that Porters case studies that were offered in Porter and van der Linde paper had mainly been a few isolated, unique cases. Palmer et al talked to companies such as 3M that featured in the examples provided by Porter and found that particular regulatory requirement may have cost less than had been expected, or perhaps even paid for itself on the whole, environmental regulation amounted to a significant net cost [to their companies] (Palmer, Oates, & Portney, 1995). Some researches have been done by industry analysts in an attempt to adopt Porter Hypothesis in the context of their specific industry. Rassier and Earnhart provided empirical evidence within the context of how the Clean Water Act regulation affects the future financial performance of chemical manufacturing firms. Their approach was similar to Palmer et al in that it is highly mathematical. Their conclusion on the matter was that more stringent clean water regulation induces investors 2009). As such their findings were consistent to revise critics downward their expectations of future profits (Rassier & Earnhart, with arguments against the Porter hypothesis. Another study in the

chemical industry was done by Torsten Frohwein and Bernd Hansjrgens, which focused on the regulations of the EU. They have found that regulations that were established in response to negative environmental effects caused by certain production technologies did indeed improved innovation. In other words, when one regards the innovation from a perspective of enhancing resource productivity the Porter Hypothesis is valid (Frohwein & Hansjrgens, 2005). They found, however, that when it comes to the new regulations, which concerns the dumping of chemicals into the environment, Porter hypothesis does not work. They even went as far as claiming that it will cause certain areas in the industry to suffer negatively from competition and innovation. But these are exactly the issues that Porter tried to reframe with his papers. The main critics of Porter Hypothesis have been trying to understand the idea from the end-of-pipe treatment of waste. Instead, Regulations should encourage product and process changes to better utilize resources and avoid pollution early, rather than mandating end-of-pipe or secondary treatment, which is almost always more costly (Porter & van der Linde, 1995). He developed this concept in a later paper by emphasizing that production waste, be it harmful substances, loss of energy or scraps, in economic context, is an indication of inefficiencies in the production process (Porter & van der Linde, Green and Competitive: Ending the Stalemate, 1999). Following this, additional costs from inefficiencies enter the economy in which the outputs are introduced. First of all, the firm would have to bear the cost of disposing these wastes, where it would have been cheaper to focus on minimizing the waste in the first place. Further in the supply chain, hidden costs are being burdened on the customers in the form of, for example, packaging discards, which can be classified as a waste of resource and an addition of costs. In addition, it is also worth noting that what Porter prescribed

was strictly policies that are properly designed [that] can trigger innovations that lower the total cost of a product or improve its value (Porter & van der Linde, Green and Competitive: Ending the Stalemate, 1999). Researchers looking to apply the hypothesis in their study should consider this to a great extent. If a study is conducted simply by choosing an environmentally related policy, that is, policies that are not necessarily geared or designed towards encouraging innovations, then the findings are in peril of turning into sets of data not of value to the discourse.

Conclusion
It is very difficult to measure the extent of validity of either Porters ideas or his critics. The main reason is that the discussion failed to occur at the same level of understanding within the discourse. Each proponent is trying to make sense of his or her own view in the context of the matter and as such failed to come up with common grounds for a clear discussion to follow. Evident in Porters writings, he again and again had to emphasize that the debate in the relationship between competitiveness and environmental goals had been framed incorrectly. He also added that the innovation that he hopes to see should be a result of, firstly, regulations that are properly designed and implemented to encourage innovation, and secondly, an approach towards environmental economics from the process stage of the production and not the end-of-pipe treatment approach that many of his critics had been pushing for. In this situation, we have on one side Porter, who has an excellent hypothesis and ideas but lacking in rigid, mathematical study of his model, and on the other hand we have his critics that have approached the matter mathematically and with great examples but unfortunately missing some of the points Porter tried to discuss. Porters points are valid in terms of strategy and the implications of regulations in pressuring firms to have to innovate. However, studies need to be further conducted, making sure that

the design of the research as well as the policy in question is right for the theory. As it stands though, it is difficult to find a winner between two boxers fighting in different rings.

Bibliography
Frohwein, T., & Hansjrgens, B. (2005). Chemicals Regulation and the Porter Hypothesis: A Critical Review of the New European Chemicals Regulation. Journal of Business Chemistry , 2 (1), 19-36.

Johnson, G., Scholes, K., & Whittington, R. (2008). Business-Level Strategy. In G. Johnson, K. Scholes, & R. Whittington, Exploring Corporate Strategy (pp. 222-253). Essex: Pearson Education Limited. Palmer, K., Oates, W. E., & Portney, P. R. (1995). Tightening Environmental Standards: The Benefit-Cost or the No-Cost Paradigm? Journal of Economic Perspectives , 9, 119-132. Porter, M. E., & van der Linde, C. (1999). Green and Competitive: Ending the Stalemate. Journal of Business Administration and Policy Analysis . Porter, M. E., & van der Linde, C. (1995). Toward a New Conception of the Environment-Competitiveness Relationship. Journal of Economic Perspectives , 9, 97-118. Rassier, D. G., & Earnhart, D. (2009, August 12). Does the Porter Hypothesis Explain Expected Future Financial Performance? The Effect of Clean Water Regulation on Chemical Manufacturing Firms. Environmental and Resource Economics .