How can Europe balance climate ambitions and economic competitiveness in the transport sector?
5 June 2025
AIRE Annnual Conference
10 June 2025
By Aleksejs POPOVS
This essay is the first-prize winner of the 2025 Spring Semester Chair’s Essay Competition. This essay challenge, coordinated in partnership with the European Investment Bank, focused on the topic: ‘Competitiveness in a low-carbon economy: the role of innovation and green technologies in maintaining the competitive advantage’.
The green transition of the economic landscape – a necessity dictated by the climate emergency and perhaps one of the greatest collective challenges faced by humankind – is associated not only with significant static costs, but also with considerable dynamic threats to firm competitiveness. The latter arise from the former: confronted with environmental regulations and direct carbon pricing, firms may not only experience reduced profit margins, but also cease operations altogether or relocate to jurisdictions with more lenient climate policies. This phenomenon, known as the pollution haven hypothesis (Dechezleprêtre & Sato, 2017), highlights how global asymmetries in mitigations strategies can affect firm behaviour. Such relocation would lead to carbon leakage – the transfer of production facilities and the associated greenhouse gas emissions to countries with less stringent standards. Theoretical estimates suggest that carbon leakage from the EU could reach up to 25%, with sectors exposed to intense foreign competition and high emission intensity – such as the metal and chemical industries – being disproportionately affected (Fragkos et al., 2021). This presents serious concerns not only for the socio-economic conditions of certain regions, but also for the effectiveness of global mitigation efforts.
There is, however, a different point of view famously proposed by Porter & van der Linde (1995). Rather than framing the green transition as a trade-off between social benefits and private costs, the Porter hypothesis states that it can, in principle, boost competitiveness by decreasing resource inefficiency, exposing cost-saving opportunities, spurring innovation and improving product quality. The net effect of green innovation is therefore a priori ambiguous. In this essay, I will provide a very brief summary of empirical studies examining the relationship between green innovation and competitiveness over recent decades. I will then present original findings that cast doubt on the pessimistic scenario.
In the European context, the effects of environmental regulation and green innovation on competitiveness are generally found to be insignificant or inconclusive. Verde (2020) and Naegele & Zaklan (2019), among others, find no evidence that the EU Emissions Trading Scheme has impacted the competitiveness of regulated firms, nor any proof of carbon leakage. However, when focusing on the short run, Dechezleprêtre & Sato (2017) show that there are significant adverse effects on productivity and other measures of competitiveness (particularly in energy-intensive sectors, as further supported by Saussay & Sato (2024)), though these effects tend to be small. They also find the potential positive impact on innovation to be limited. Similarly, OECD (2024) estimates based on global plant-level data for heavy industries suggest a relatively modest carbon leakage rate of 13%.
A different perspective emerges when examining China’s largely successful approach focused on supporting strategic industries (Bloomberg, 2024). The “Made in China 2025” strategy, for instance, had competitiveness at its core and interpreted it broadly – not only in terms of prices and productivity, but also in relation to economic security, geopolitical leverage and ecological priorities. Recent empirical studies using Chinese data support the Porter hypothesis, finding that the benefits of green innovation often offset the negative competitiveness effect (Cao et al., 2024). Other research shows that productivity growth induced by green regulation can increase firm markups (Chen et al., 2022) and promote greater product differentiation (Li et al., 2019), thereby enhancing export performance and helping firms overcome the regulatory burden imposed by environmental policies.
So, what does the data tell us? To examine the effect of green technology on competitiveness, a country-level panel dataset was assembled, covering 32 European and other economies during 1990-2022. To distinguish between different dimensions of competitiveness, both productivity competitiveness (proxied by labour productivity and total factor productivity) and price competitiveness (proxied by real effective exchange rates and unit labour costs) were analysed. The effect induced by green regulation was proxied by production-based CO2 intensity, environment-related patents, as well as environment-related government R&D expenditures. The analysis employed several regression techniques including fixed effects (FE), instrumental variable (IV) and dynamic panel models. Rich controls were also included to account for potential confounding factors.
The results, presented in Table 1, suggest that green technology has had a positive impact on measures of productivity competitiveness, providing support for the Porter hypothesis. For instance, the preferred IV estimates show that an increase of one percent in environment-related patents per capita was associated with a 0.16 percent increase in labour productivity. Regarding price competitiveness, no negative effects from green innovation variables were observed, casting doubt on the pollution haven hypothesis. Moreover, higher CO2 intensity was found to be associated with higher unit labour costs – possibly reflecting resource inefficiencies and/or the impact of carbon pricing schemes active in many of the sampled countries. The estimated effect is large: a one percent increase in CO2 intensity was associated with an 8.1 percentage point increase in labour cost growth rate.
These findings may be explained by the long-term nature of the panel, potentially indicating that the Porter effect becomes more pronounced over time. Still, the limits of such analysis should be acknowledged. These include potential endogeneity concerns only partially addressed by IV estimations, reliance on proxies and aggregate data, as well as the lack of consideration for sector heterogeneity and specific mechanisms. As such, these estimates should be interpreted as suggestive rather than conclusive. More robust conclusions could be made based on disaggregated firm-level data.
Overall, the regression results offer some evidence that green innovation and regulation may have improved both productivity-based and price-based competitiveness over the past three decades. A recent business case from the vehicle manufacturer Scania can provide an insight into this mechanism. By adopting a more circular production process, the company drastically reduced resource inefficiencies and costs, while also addressing challenges related to input price volatility and value chain security – all while lowering emissions (Jessen, 2024). These changes, in turn, further lowered the company’s exposure to regulation, carbon pricing and the associated compliance costs.
A more conservative assessment of regression results would be that no negative effect on competitiveness was found. By transforming production processes to reduce both emissions and operational costs, green innovation enables industries to maintain competitiveness while contributing to climate goals. As showcased by China’s experience, industries that proactively invest in such technologies will be better positioned to thrive in a carbon-constrained future, turning what initially appears as a competitive burden into a strategic opportunity for leadership in the green industrial revolution.
References
Bloomberg. (2024, October 30). US Efforts to Contain Xi’s Push for Tech Supremacy Are Faltering. Bloomberg.Com. https://www.bloomberg.com/graphics/2024-us-china-containment/
Cao, Y., Lin, S., Li, M., Shan, Y., & Wang, P. (2024). Green taxes: Productivity effects of tax-based environmental regulations on heavily polluting firms. Economic Modelling, 140, 106834. https://doi.org/10.1016/j.econmod.2024.106834
Chen, X., He, J., & Qiao, L. (2022). Does environmental regulation affect the export competitiveness of Chinese firms? Journal of Environmental Management, 317, 115199. https://doi.org/10.1016/j.jenvman.2022.115199
Dechezleprêtre, A., & Sato, M. (2017). The Impacts of Environmental Regulations on Competitiveness. Review of Environmental Economics and Policy, 11(2), 183–206. https://doi.org/10.1093/reep/rex013
Fragkos, P., Fragkiadakis, K., & Paroussos, L. (2021). Reducing the Decarbonisation Cost Burden for EU Energy-Intensive Industries. Energies, 14(1), Article 1. https://doi.org/10.3390/en14010236
Jessen, J. (2024, September 30). How Scania is Making Automotive Manufacturing Circular. https://sustainabilitymag.com/articles/how-scania-is-making-automotive-manufacturing-circular
Li, G., Wang, X., Su, S., & Su, Y. (2019). How green technological innovation ability influences enterprise competitiveness. Technology in Society, 59, 101136. https://doi.org/10.1016/j.techsoc.2019.04.012
Naegele, H., & Zaklan, A. (2019). Does the EU ETS cause carbon leakage in European manufacturing? Journal of Environmental Economics and Management, 93, 125–147. https://doi.org/10.1016/j.jeem.2018.11.004
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Porter, M. E., & van der Linde, C. (1995). Toward a New Conception of the Environment-Competitiveness Relationship. The Journal of Economic Perspectives, 9(4), 97–118.
Saussay, A., & Sato, M. (2024). The impact of energy prices on industrial investment location: Evidence from global firm level data. Journal of Environmental Economics and Management, 127, 102992. https://doi.org/10.1016/j.jeem.2024.102992Verde, S. F. (2020). The Impact of the Eu Emissions Trading System on Competitiveness and Carbon Leakage: The Econometric Evidence. Journal of Economic Surveys, 34(2), 320–343. https://doi.org/10.1111/joes.12356