Inducing Innovation in the Environmental Technology of Oligopolistic Firms

This paper characterizes environmental regulations which induce polluting Bertrand competitors to invest efficiently in environmental R&D. Post–innovation benefits to raising rivals' costs provide firms with incentives to innovate. Although optimal behavior cannot be elicited with pollution taxes alone, an optimum can be achieved by combining emission taxes with environmental performance standards that are higher for firms which reveal superior environmental technologies. Faced with this policy, successful innovators voluntarily reveal their technological discovery to the government, despite the apparent regulatory penalty that results. Implications for automotive fuel regulation are discussed.