The existing economic literature lacks consensus on an appropriate method to quantify the strictness of environmental regulations. The objective of creating a stringency index for environmental regulations in this study was to understand the evolution of incrementally strict regulations to reduce vehicular emissions and fuel consumption. The empirical results provide preliminary evidence of an inducement effect of regulatory stringency to innovation activity as measured by weighted patent counts. The hypothesis that domestic regulatory stringency positively affects innovation was not rejected. Only in India and China, domestic stringency was found to stimulate domestic innovation. The finding reaffirmed that key emission norms implemented in the year 2000 and 2005 did induce innovation in both of these developing countries. These results support the Porter hypothesis that regulations can lead to more innovation. The results of this study are in line with Newell et al. (1999) who found that the direction of innovation was positive (inducement) for products covered under energy efficiency standards. The results also corroborate with findings of Popp (2006) who studied the effect of emission standards for NO x and SO2 on patenting in three countries including Germany between 1970 and 2000. He found that the innovators responded to environmental regulation of their home country but not to regulations of foreign countries. In the same year, Johnstone and Labonne (2009) also found that perceived stringency of environment regulation is a very strong driver of innovation. Hence, the results corroborate the argument that environment policy has a discernible (positive) impact on the direction of technological change and innovation. Based on the findings and background research of this study, some managerial and public policy implications are suggested below.
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