Environmental Economics and the International Economy / Economy & Environment Bd.25 (PDF)

the nature of the behavior of the firms, the market structure, the number of market participants or the composition of the capital stock – strict environmental standards (where strict means that the marginal costs of abatement exceeds the marginal environmental damage) will shift profits from foreign to domestic enterprises.
 
For instance, this will occur under an international duopoly setting, when enterprises compete in a Cournot fashion. The result can be obtained if asymmetric industry structures (Barrett 1994), innovative activities (Simpson and Bradford 1996, Stähler 1998), differentiated products and consumer preferences (Farzin 1996) or an X-inefficient management (Klein and Rothfels 1999) are introduced. Under these settings strong environmental regulation can raise the competitiveness of domestic firms.

As the above discussion shows a great part of the theoretical work on the validity of the Porter Hypothesis focuses on the regulation of production processes of firms acting in Cournot competition and producing homogenous products. However, in many product markets product differentiation prevails. This enables the government to use standards for environmental product qualities as policy instruments. Examples for product standards are the prohibition of CFC as a propellant gas or the use of catalysts in motor vehicles. These regulations alter the product qualities in the sense that the products become environmentally friendlier. A suitable framework for the analysis of the impact of environmental regulation on firm behavior is then to assume Bertrand competition.

Analyses of the impact of environmental policy instruments assuming Bertrand competition do exist, but they are less frequent. Motta and Thisse (1993) have shown that in the case of symmetric firms in the countries concerned environmental product standards can result in larger domestic profits and welfare. Strict emission standards will raise marginal costs of domestic firms and hence the price of the commodity. In response, foreign firms raise their prices as well, which results in higher demand for the domestically produced good and in higher profits for domestic firms.5 However, in a different theoretical setting we can get different results. Rauscher (1997) shows e.g. for the case of monopolistic competition with market entry, that environmental policies can be without any effect at all.