Environmental Regulations and Technological Change in the Offshore Oil and Gas Industry Shunsuke Managi, James J. Opaluch, Di Jin, and Thomas A. Grigalunas ABSTRACT: Technological progress can play a key role in raising standards of living while improv- ing environmental quality. Well-designed environ- mental regulations encourage innovation, while poorly designed regulations can inhibit progress. The Porter hypothesis goes further to suggest that tougher environmental regulations could spur in- novation, leading to increased productivity of mar- ket outputs. We apply frontier production analysis to measure various components of total factor pro- ductivity within a joint production model, which considers both market and environmental outputs. We test the causality between technological innova- tion and environmental regulation and find sup- port for a recast version of the Porter hypothesis. (JEL O38, L71) I. INTRODUCTION Substantial efforts have been made to regulate pollution in most industrialized countries, and the stringency of pollution reg- ulations have continued to increase world- wide. Technological progress can play a key role in maintaining a high standard of living in the face of these increasingly stringent environmental regulations. However, the extent of the contribution of technological progress depends on how well environmen- tal policies are designed and implemented. Successful environmental policies can con- tribute to technological innovation and dif- fusion (e.g., Jaffe, Newell, and Stavins 2003), while poor policy designs can inhibit inno- vation. Traditionally, economists have subscribed to the idea that painful consequences of environmental regulations cannot easily be avoided, and environmental regulation necessarily involves additional cost to in- Land Economics • May 2005 • 81 (2): 303–319 ISSN 0023-7639; E-ISSN 1543-8325  2005 by the Board of Regents of the University of Wisconsin System dustry (Jaffe et al. 1995; Palmer, Oates, and Portney 1995). Within this context, the key issue is how to design environmental regulations to attain environmental goals while minimizing productivity loss, and thereby controlling the adverse impact on industry to the extent feasible. Recently, however, researchers have chal- lenged this conventional view with an alter- native hypothesis that tougher environmen- tal regulations can stimulate innovation and motivate increases in x-efficiency, poten- tially increasing productivity and profit- ability. 1 This is the well-known Porter hy- The authors are, respectively, associate professor of Bio- Applications and Systems Engineering at Tokyo Uni- versity of Agriculture and Technology; professor of En- vironmental and Natural Resource Economics at the University of Rhode Island; associate scientist at the Marine Policy Center, Woods Hole Oceanographic In- stitution; and professor of Environmental and Natural Resource Economics at the University of Rhode Island. The authors thank two anonymous referees, an editor, Rolf Fa ¨ re, Kristiaan Kerstens, Akira Hibiki, Samuel Bwalya, and participants at the Second World Congress of Environmental and Resource Economists for helpful comments. This research was funded by the United States Environmental Protection Agency STAR grant program (Grant Number Grant Number R826610-01) and the Rhode Island Agricultural Experiment Station (AES Number 3933), and is Woods Hole Contribution Number 10704. The results and conclusions of this paper do not necessary represent the views of the funding agencies. The usual disclaimers apply. 1 Note that productivity improvement in a compara- tive static sense is not sufficient to guarantee increased profits. For example, the presence of short-run, fixed capital can imply that adoption of new, productivity en- hancing technologies could reduce the present discounted value of profits (see Alpay, Buccola, and Kerkvliet 2002). In this case, it may be economically rational for incumbent market leaders to resist new technologies, potentially yielding a comparative advantage to new entrants. Additionally, productivity improvements may shift output supply and/or input demand functions, which might affect prices in some markets, possibly re- sulting in lower profits.