Cross-border Porter hypothesis: Does environmental policy stringency induce innovation across borders?

According to the Porter hypothesis, environmental policy (EP) creates incentives for innovation that compensate for the costs of compliance with more stringent regulations. We extend the hypothesis to investigate cross-border regulatory spillovers stemming from foreign EP. We test whether the EP stringency of a given country induces innovation in its neighbouring countries by applying a Spatial Durbin Model and data from 19 European Union (EU) countries (from 2001 to 2020). We utilise the EU’s renewable energy and energy efficiency policy as an example of an international EP that has been adapted nationally with varying stringency levels. Our results support the Porter hypothesis in cross-border settings: the innovation performance of a given country is influenced positively by the EP regulatory environment of its neighbours. The result is driven mostly by non-market-based policy instruments (emission and content limits). Finally, our results suggest that environmentally very stringent energy policy targets turn out to be counterproductive for innovation, particularly in countries that are far from meeting them. The results suggest that there are trade-offs in the attempts of the EU to cohesively foster both the renewable energy and energy efficiency of all member states and its economic performance based on an innovation forerunner status in the energy sector.