Directing environmental innovation toward radical clean technologies for sustainable transitions: Market-based vs. command-and-control policies

Environmental regulations present firms with two innovation pathways: developing abatement technologies that mitigate pollution from existing processes or investing in clean technologies that do not produce pollution by design. Achieving disruptive sustainability requires radical clean technologies—fundamental departures from established trajectories that enable system-level shifts. However, pursuing radical clean innovation demands substantial financial investment, organizational restructuring, and operational flexibility. While existing research examines how policy instruments affect the rate of environmental innovation, we lack an understanding of how they shape direction—whether they steer firms toward clean rather than abatement technologies, and whether they foster more radical clean innovation. We argue that market-based instruments provide long-term incentives and technological flexibility that enable transformative innovation, while generating market-size effects that shrink demand for polluting technologies and expand markets for clean alternatives. This creates strategic incentives for radical innovation. In contrast, command-and-control policies impose fixed compliance thresholds without altering market structures or generating continuous pressure for innovation. We test these hypotheses using environmental patenting data from manufacturing firms across 17 EU countries from 1991 to 2020. Results demonstrate that market-based policies significantly enhance clean technology innovation and increase technological radicalness, while command-and-control policies show no significant effect on environmental innovation. These findings contribute to research on disruptive sustainability and policy-induced innovation by demonstrating how market-based instruments catalyze radical clean technologies and support sustainability transitions.