Environmental Regulation as a Coordination Device for the Introduction of a Green Product: The Porter’s Hypothesis Revisited

According to Porter’s hypothesis, environmental regulation increases the regulated firms’ profits. However, if a “greener” strategy is more profitable why does it need regulatory intervention in order to be implemented? Let a greener product increase the adopter’s marginal cost while providing no additional benefits during the first period. In the second period, when the product's environmental attributes become known and appreciated by consumers, the adopter enjoys higher demand. By adopting the green product alone, a firm loses profits in the first period due to a) its increased costs, and b) its reduced market share; in the second period, it enjoys additional profits due to c) its increased quality, and d) its increased market share. If both firms adopt the green product market shares remain unaffected, therefore b) and d) disappear. While simultaneously adopting the green product can be profitable for both firms, for a single firm to pioneer adoption may not be so. Environmental regulation acts, therefore, as a co-ordination device reducing market inertia. By inducing both firms to act simultaneously it allows them to pass from one Nash equilibrium to another one with higher profits.