Innovation and environmental protection: An EU perspective

The objective of this paper is to explore how environmental protection expenditures (EPE) affect innovation and investigate the potential causal relationship between the two variables. The novelty and main contribution of our paper to the literature stems from the fact that we look at total environmental protection expenditures from both the public and private sectors, and distinguishing between corporations and households in the private sectors. We also consider both inputs and outputs of innovation and address potential endogeneity issues in this relationship, which are both lacking in the current literature. Using a panel of EU countries over the period 2006–2020, this study generally finds a positive impact of EPE on innovation after controlling for the effects of trade, credit, education and inflation on innovation, and using the System GMM estimator to treat endogeneity. Moreover, EPE from the government sector drives the bulk of this positive impact. The core results are robust to alternative measures of innovation, alternative estimation techniques that address endogeneity (i.e., the Lewbel 2SLS, Mundlak, and Hausman-Taylor estimators) and the moderation effects of Climate Change Performance (CCPI). This study also provides a useful guide to policy makers engaged in environmental planning.