The Supreme Court’s recent ban on BS-III vehicles has sent the Indian auto industry into a tizzy. The Society of Indian Automobile Manufacturers has called the ban unfortunate and Tata Motors termed the move “unexpected and unprecedented”. Firms have announced that there might also be labour-market implications, with contractual labour especially feeling the pinch. But are these environmental bans really bad for the industry? To understand, one needs to appreciate that there is a short- and long-run aspect to this story and also that the dynamic gains in the long run might actually outweigh the static losses today.
In fact, prior scholarly research indeed points to such possibilities, especially if one considers a nuanced explanation of how regulation can actually encourage innovation (rather than mute it), following the classic debate on this issue provoked more than two decades ago by Harvard economist Michael Porter. Writing in 1995 in Journal Of Economic Perspectives, Porter and his co-author Van der Linde contested the traditional intuition that regulation is detrimental to innovation. Termed now as the controversial Porter’s hypothesis, they noted that in contrast, more stringent and properly designed environmental regulations can actually “trigger innovation that may partially or in some instances more than fully offset the costs of complying with them”.
The Porterian arguments arise from a few channels which follow-on research has examined and thereafter documented in various contexts in the EU and US, both empirically and theoretically. The first is a behavioural one in which researchers have supported the Porterian assertion by arguing that firms are composed of rationally bounded managers taking decisions on behalf of a profit-maximizing entity. They are therefore more likely to be present-biased, postponing investments on costly innovation for which benefits occur later. This strand of research therefore argues that an external environmental regulation could actually reduce the information asymmetry that is inherent in such principal-agent settings and promote innovation overlooking the rationally bounded manager.
A second explanation stems from organizational factors. Scholars have argued that if managers have “private information about the real costs of technologies which enhances productivity and environmental performance, they can potentially use this information opportunistically by exaggerating these costs, thereby extracting rent from the firm”. In these cases, governmental regulation reduces the rent spillage to managers, helping in resetting the relationship between regulation and innovation.
A final explanation could be from what regulation can do to upstream innovation, especially in the context of developing economies like India. In a recent paper, now forthcoming in an innovation journal, Research Policy, we draw from historical data in India and show empirically in another context how a 1994 cross-border Azo dye ban from Germany targeted at the focal leather and textile exporting firms from India, actually induced a positive innovation effect on the upstream suppliers of dyes from the chemical industry in India. Using both in-house R&D and technology transfer mechanisms, Indian chemical dye-makers played a pivotal role in upgrading downstream leather and textile exporting firms to using more environment-friendly green dyes. Findings with a similar flavour were also documented just last year by economists from the London School of Economics when Raphael Calel and Antoine Dechezleprêtre, in a Review Of Economics And Statistics article showed that the European Union emissions trading system increased low-carbon innovation among regulated firms by as much as
10%, while not crowding out patenting for other technologies.
The import of these research findings cannot be missed for the Indian automobile industry, especially with what might transpire tomorrow given the BS-III ban. First, this was certainly not as unexpected. A BS-III ban was always in the offing, with India starting to pivot towards the Euro emission norms since 2000. Firms thus had ample time to adjust for such regulations. Second, a domestic ban such as this might actually be great news for the co-creation of new emission technologies with the ecosystem of upstream auto-component suppliers in the Indian automobile industry. In fact, one can expect more intense technology transfer partnerships between domestic and foreign firms. Third, this BS-III ban could actually trigger a flurry of environmentally friendly technologies and entrepreneurial experiments in this sector given India’s fast growing but fuel-guzzling, emission-spewing automobiles.
Sure, we are still far from the widespread adoption of electric cars or biking to our offices, but BS-III norms should go beyond the immediate short-term pains for the industry and augur well in the long-run for aggregate upstream and downstream innovation productivity of suppliers in India’s auto market.
Beyond the immediate considerations of consumer health, such a ban that the Supreme Court has fallen back on while giving the verdict can thus be great news for the technological upgradation of the domestic Indian auto industry in the long run.
Chirantan Chatterjee and Pavel Chakraborty are, respectively, assistant professor in economics and public policy at the Indian School of Business, and assistant professor in international economics and trade at the Jawaharlal Nehru University.