Environmental regulations and innovation activity in UK manufacturing industries Richard Kneller a , Edward Manderson b, * a University of Nottingham, Sir Clive Granger Building, University Park, Nottingham NG7 2RD, United Kingdom b University of Wyoming, Department of Economics and Finance, College of Business Building, Laramie, WY 82071, United States 1. Introduction ‘‘... we have used a variety of market-based policies...to reduce carbon emissions in the most cost-effective way, stimulating technological innovation, and harnessing entrepreneurialism.’’ Chancellor of the Exchequer Gordon Brown (2005). Policymakers often put forward the argument that environmental regulation can foster innovation. As the environmental impact of economic activity is largely determined by technology, this possible link could be crucial to the progression of society towards environmental sustainability. In fact, the Resource and Energy Economics 34 (2012) 211–235 ARTICLE INFO Article history: Received 10 January 2011 Received in revised form 6 December 2011 Accepted 10 December 2011 Available online 20 December 2011 JEL classification: L6 O3 Q2 Keywords: Innovation Pollution abatement expenditures Panel data ABSTRACT We examine the relationship between environmental regulations and innovation, using data from UK manufacturing industry during 2000–2006. We estimate a dynamic model of innovation behaviour, and explicitly account for the likely endogeneity of our measure of the stringency of environmental regulations (pollution abatement costs). Our results indicate that while on the one hand environ- mental R&D and investment in environmental capital are stimulat- ed by greater pollution abatement pressures, on the other hand there is not a positive impact of environmental regulation on total R&D or total capital accumulation. We find some evidence that this is because more stringent environmental regulations directly lower the optimal expenditure on non-environmental innovations. In addition, we find that environmental R&D may crowd out non- environmental R&D, although there is no evidence that environ- mental capital crowds out non-environmental capital. ß 2011 Elsevier B.V. All rights reserved. * Corresponding author. E-mail addresses: richard.kneller@nottingham.ac.uk (R. Kneller), ecejmm@hotmail.com (E. Manderson). Contents lists available at SciVerse ScienceDirect Resource and Energy Economics journal homepage: www.elsevier.com/locate/ree 0928-7655/$ – see front matter ß 2011 Elsevier B.V. All rights reserved. doi:10.1016/j.reseneeco.2011.12.001