Effect of policy uncertainty on environmental innovation

Abstract

Uncertainty in economic policies and regulations incentivizes firms to delay investments in environmental research and developments (R&D) or postpone environmental projects that are costly to undo. A consequence of those decisions is that firms innovate less for the environment. Using 1026 U.S. firm data (equivalent to 13,241 firm-year observations) this study shows that a negative effect of policy uncertainty – a drop in environmental innovation – does not surface in the short term but in the longer term, i.e., in 5–6 years’ time. The negative effect, nevertheless, dissipates after six years. These findings are of relevance to other developed countries as well as emerging countries that have a relatively higher uncertainty in their economic policies and regulations. In sum, the results call for attention from governments and regulators around the world: uncertainty in policies and regulations are detrimental to combating climate change and promoting environmental sustainability.