Optimal Timing of Climate Change Policy: Interaction Between Carbon Taxes and Innovation Externalities

This paper addresses the impact of endogenous technology through research and development (R&D) on the timing of climate change policy. We develop a model with a stock pollutant (carbon dioxide) and abatement technological change through R&D, and we use the model to study the interaction between carbon taxes and innovation externalities. Our analysis shows that the timing of optimal emission reduction policy strongly depends on the set of policy instruments available. When climate-specific R&D targeting instruments are available, policy has to use these to step up early innovation. When these instruments are not available, policy has to steer innovation through creating demand for emission saving technologies. That is, carbon taxes should be high compared to the Pigouvian levels when the abatement industry is developing. Finally, we calibrate the model in order to explore the magnitude of the theoretical findings within the context of climate change policy.      

Endogenous technology and tradable emission quotas

We study an international climate agreement that assigns emission quotas to each participating country. Unlike the simplest models in the literature, we assume that abatement costs are affected by R&D activities undertaken in all firms in all countries, i.e. abatement technologies are endogenous. In line with the Kyoto agreement we assume that the international climate agreement does not include R&D policies. We show that for a second-best agreement with heterogeneous countries, marginal costs of abatement differ across countries. In other words, the second-best outcome cannot be achieved if emission quotas are tradable.     

Carbon Abatement and International Spillovers

Carbon abatement policies in large open economies affect both the allocation of domestic resources and international market prices. A change in international prices implies an indirect secondary burden or benefit for all trading countries. Based on simulations with a large-scale computable general equilibrium model of global trade and energy use, we show that international spillovers have important welfare implications for carbon abatement policies designed to meet exogenous emission reduction targets. We present a decomposition of the total welfare effect of carbon abatement policies into a primary domestic market effect (at constant international prices) and a secondary international spillover impact as a result of changes in international prices. This decomposition reveals the extent to which domestic abatement costs are increased or decreased as a result of the impact of carbon abatement on international prices.     

Is Embodied Technology the Result of Upstream R&D? Industry-Level Evidence

This paper provides an exploratory analysis of whether data on the research and development (R&D) spending directed at particular technological/product fields can be used to measure industry-level capital-embodied technological change. Evidence from the patent literature suggests that the R&D directed at a product, as the main input into the “innovation” production function, is proportional to the value of the innovations in that product. I confirm this hypothesis by showing that the decline in the relative price of a good is positively correlated with the R&D directed at that product. The hypothesis implies that the technological change, or innovation, embodied in an industry's capital is proportional to the R&D that is done (“upstream”) by the economy as a whole on each of the capital goods that a (“downstream”) industry purchases. Using R&D data from the National Science Foundation, I construct measures of capital-embodied R&D. I find they have a strong effect on conventionally measured total-factor productivity growth, a phenomenon that seems to be due partly to the mismeasurement of quality change in the capital stock and partly to a positive correlation between embodied and disembodied technological change. Finally, I find the cross-industry variation in empirical estimates of embodied technological change accord with the cross-industry variation in embodied R&D. Journal of Economic Literature Classification Number: O3.     

Global Warming and Endogenous Technological Change: Revisiting the Green Paradox

One of the most pressing policy challenges facing the world today concerns how to mitigate global warming while improving people’s well-being. The green paradox argues that increasing taxes on CO₂ emissions exacerbates global warming in the present because firms have the incentive to bring forward the extraction and sale of fossil fuels. This paper shows that whenever technological progress allows the extraction costs of fossil fuels to be reduced over time and a positive R&D subsidy is paid, a growing tax on CO₂ emissions reveals a welfare maximizing policy.     

Do technology externalities justify restrictions on emission permit trading?

International emission trading is an important flexibility mechanism, but its use has been often restricted on the ground that access to international carbon credits can undermine the domestic abatement effort reducing the incentive to innovate and, eventually, lowering the pace of climate policy-induced technological change. This paper examines the economics that is behind these concerns by studying how a cap to the trade of carbon offsets influences innovation, technological change, and welfare. By using a standard game of abatement and R&D, we investigate the main mechanisms that shape these relationships. We also use a numerical integrated assessment model that features environmental and technology externalities to quantify how limits to the volume, the timing, and the regional allocation of carbon offsets affect climate policy costs and the incentive to invest in innovation and low-carbon technologies.Results indicate that, for moderate caps on the amount tradable emissions permits and sufficiently high technology spillovers, global innovation and technical change would increase and that this additional innovative effort could lead to economic efficiency gains. The numerical analysis confirms that when constraints are close to 15% of domestic abatement, efficiency losses are small because they are partly compensated by more technological spillovers and lower energy prices. Under a broad range of parameters, restrictions are costly for the constrained countries, but always beneficial for unconstrained ones.     

Climate Policy,Uncertainty, and the Role of Technological Innovation

We study how uncertainty about climate change severity affects the relative benefits of early abatement and a portfolio of research and development (R&D) in lowering future abatement costs. Optimal early abatement depends on the curvature of the marginal benefit and marginal abatement cost (MAC) functions and how the uncertain parameter affects marginal benefits. R&D in a particular technology depends on whether uncertainty increases early abatement; whether investment lowers marginal costs for that technology; whether R&D lowers the slope of that technology's MAC function; and the shape of that technology's MAC function. We illustrate, focusing on the role of backstop technologies.     

Environmental Policy with Endogenous Technology from a Game Theoretic Perspective: The Case of the US Pulp and Paper Industry

The merits of different types of regulatory tools in eliminating pollution and at the same time inducing innovation have long been an interest of researchers in both environmental economics and industrial organization. Although there is a substantial theoretical literature investigating the potential for various environmental policies to attain these dual goals, this is a challenging empirical problem because every industry has its own inherent characteristics that play an important role in determining the performance of different regulatory tools. The majority of the work to date focuses on pollution abatement while leaving pollution prevention understudied. In most of the literature firms are also assumed to be symmetric. Asymmetries among firms add another degree and level of complexity to their strategic interactions, and affect the performance of different regulatory tools. This paper investigates the performance of two alternative regulatory tools, an emissions performance standard and an emissions tax, in reducing pollution and inducing pollution prevention and abatement R&D in the US pulp and paper industry. We construct a model representing the industry in an asymmetric Cournot duopoly framework, calibrate the model to disaggregated industry data, and run scenarios to replicate the behavior of the firms in an imperfectly competitive output market. Our results suggest that pollution prevention R&D can respond quite differently than abatement R&D to different policy instruments. The results indicate that R&D spillovers among firms play crucial role in technology development and strategies of the firms. Our results also suggest that strategic interactions between firms in an imperfectly competitive industry can have significant impacts of the levels of both types of R&D.      

Implications of incorporating domestic margins into analyses of energy taxation and climate change policies

In most applied general equilibrium (AGE) analyses, the domestic transportation, wholesaling, and retailing services that facilitate the flow of goods and services from producers to consumers are not identified by commodity or use. Because the margins on energy commodities can be substantial, ignoring these domestic margins has important consequences when analyzing the impacts of policies designed to limit greenhouse gas emissions. This paper incorporates domestic trade and transport margins into the GTAP-E model, which has previously been used to analyze climate change policies. Models that do not explicitly incorporate domestic margins over-estimate the reduction in CO₂ emissions from a given carbon tax or under-estimate the level of a carbon tax needed to achieve a specific abatement target when domestic margins are fixed or when the carbon tax is treated as a consumption tax with variable domestic margins. However, this result can be reversed when the carbon tax is treated as an output tax with variable domestic margins.     

Technology variation vs. R&D uncertainty: What matters most for energy patent success?

R&D is an uncertain activity with highly skewed outcomes. Nonetheless, most recent empirical studies and modeling estimates of the potential of technological change focus on the average returns to research and development (R&D) for a composite technology and contain little or no information about the distribution of returns to R&D – which could be important for capturing the range of costs associated with climate change mitigation policies – by individual technologies. Through an empirical study of patent citation data, this paper adds to the literature on the outcomes of energy R&D by focusing on the behavior of the most successful innovations for six energy technologies, allowing us to determine whether uncertainty or differences in technologies matter most for success. We highlight two key results. First, we compare the results from an aggregate analysis of six energy technologies to technology-by-technology results. Our results show that existing work that assumes diminishing returns but assumes one generic technology is too simplistic and misses important differences between more successful and less successful technologies. Second, we use quantile regression techniques to learn more about patents that have a high positive error term in our regressions – that is, patents that receive many more citations than predicted based on observable characteristics. We find that differences across technologies, rather than differences across quantiles within technologies, are more important. The value of successful technologies persists longer than those of less successful technologies, providing evidence that success is the culmination of several advances building upon one another, rather than resulting from one single breakthrough. Diminishing returns to research activities appear most problematic during rapid increases of research investment, such as experienced by solar energy in the 1970s.     

Technology variation vs. R&D uncertainty: What matters most for energy patent success?

R&D is an uncertain activity with highly skewed outcomes. Nonetheless, most recent empirical studies and modeling estimates of the potential of technological change focus on the average returns to research and development (R&D) for a composite technology and contain little or no information about the distribution of returns to R&D – which could be important for capturing the range of costs associated with climate change mitigation policies – by individual technologies. Through an empirical study of patent citation data, this paper adds to the literature on the outcomes of energy R&D by focusing on the behavior of the most successful innovations for six energy technologies, allowing us to determine whether uncertainty or differences in technologies matter most for success. We highlight two key results. First, we compare the results from an aggregate analysis of six energy technologies to technology-by-technology results. Our results show that existing work that assumes diminishing returns but assumes one generic technology is too simplistic and misses important differences between more successful and less successful technologies. Second, we use quantile regression techniques to learn more about patents that have a high positive error term in our regressions – that is, patents that receive many more citations than predicted based on observable characteristics. We find that differences across technologies, rather than differences across quantiles within technologies, are more important. The value of successful technologies persists longer than those of less successful technologies, providing evidence that success is the culmination of several advances building upon one another, rather than resulting from one single breakthrough. Diminishing returns to research activities appear most problematic during rapid increases of research investment, such as experienced by solar energy in the 1970s.     

A simple theory and evidence on the determinants of firm R&D

This paper derives a simple, but informative, model of firm R&D to figure out key factors that determine firm R&D effort. The model suggests a demand-pull, technology-push theory of R&D by showing that a firm's profit-maximizing R&D expenditure is determined jointly by both demand-side factors and technology-side factors. The former includes demand size (firm sales) and consumer preference over quality and price and the latter includes R&D cost structure or the production-cost effect of product R&D and firm-specific technological competence. In addition, the model shows that other things being equal, the stock of exogenous technological knowledge, including the firm's previously accumulated technological knowledge, relevant to current R&D which is negatively related with current R&D effort. An empirical analysis of firm R&D intensities and technological capabilities of more than 1600 firms in nine industries across six countries provides supportive evidence for the theory. Further, the theory implies that R&D intensity or the R&D-to-sales ratio is independent of firm size unless firm size affects technological competence and that given consumer preference and R&D cost structure facing all firms in the same industry, the distribution of firm-specific technological competence among firms determines the distribution of firm R&D intensities within the industry.     

Optimal Climate Change Policies When Governments Cannot Commit

We analyse the optimal design of climate change policies when a government wants to encourage the private sector to undertake significant immediate investment in developing cleaner technologies, but the relevant carbon taxes (or other environmental policies) that would incentivise such investment by firms will be set in the future. We assume that the current government cannot commit to long-term carbon taxes, and so both it and the private sector face the possibility that the government in power in the future may give different (relative) weight to environmental damage costs. We show that this lack of commitment has a significant asymmetric effect: it increases the social benefits of the current government to have the investment undertaken, but reduces the private benefit to the private sector to invest. Consequently the current government may need to use additional policy instruments—such as R&D subsidies—to stimulate the required investment.     

CO2 abatement policy with learning-by-doing in renewable energy

This paper analyzes the implications of CO₂ abatement when there is endogenous technological change in renewable energy. A multi-sector numerical general equilibrium model for Denmark is proposed to reflect two basic assumptions about technological progress in renewable energy. First, there is learning-by-doing and unit costs of production are a decreasing function of cumulated output. Second, technological progress only benefits new vintages of capital. The learning-by-doing process is calibrated to match current projections for technological progress in wind-based electricity. The implications are a marked reduction in the total and marginal cost of abatement and a decline in the optimal level of near-term abatement.     

Timing and Commitment of Environmental Policy,Adoption of New Technology,and Repercussions on R&;D

We investigate the interplay between environmental policy, incentives to adoptnew technology, and repercussions on R&D. We study a model where a monopolistic upstream firm engages in R&D and sells advanced abatement technology to polluting downstream firms. We consider four different timing and commitment regimes of environmental tax and permit policies: ex post taxation (or issuing permits), interim commitment to a tax rate (a quota of permits) after observing R&D success but before adoption, and finally two types of ex antecommitment before R&D activity, one with a unique tax rate (quota of permits), the other one with a menu of tax rates (permit quotas). We study the second best tax and permit policies and rank these with respect to welfare. In particular, we find that commitment to a menu of tax rate dominates all other policy regimes.     

Testing a model of UK growth: A role for R&D subsidies

R&D is a main driver of growth, whether by generating new ideas for production or increasing technological transfer. However, R&D itself is risky and faces numerous barriers which may reduce its marginal return. Direct R&D subsides are intended to counteract such barriers, but whether they lead empirically to increased economic growth is unclear. In our structural model of the UK, subsidies offset the frictional costs associated with R&D, incentivising innovation and so stimulating productivity growth. We estimate and test this structural model by indirect inference, a method not previously used in work on R&D. We find that even temporary cuts to R&D funding have long-lasting impacts on UK economic growth. The power of the test allows us to calculate tight accuracy bounds for our results and for policy reform impacts calculated using the model. These findings are of high relevance to the ongoing debate around the future UK innovation environment.     

Investment and emission control under technology and pollution externalities

This paper studies incentives to develop advanced pollution abatement technology when technology may spillover across agents and pollution abatement is a public good. We are motivated by a variety of pollution control issues where solutions require the development and implementation of new pollution abatement technologies. We show that at the Nash equilibrium of a simultaneous-move game with R&D investment and emission abatement, whether the free rider effect prevails and under-investment and excess emissions occur depends on the degree of technology spillovers and the effect of R&D on the marginal abatement costs. There are cases in which, contrary to conventional wisdom, Nash equilibrium investments in emissions reductions exceed the first-best case.     

Environmental regulations and innovation activity in UK manufacturing industries

We examine the relationship between environmental regulations and innovation, using data from UK manufacturing industry during 2000-2006. We estimate a dynamic model of innovation behaviour, and explicitly account for the likely endogeneity of our measure of the stringency of environmental regulations (pollution abatement costs). Our results indicate that while on the one hand environmental R&D and investment in environmental capital are stimulated by greater pollution abatement pressures, on the other hand there is not a positive impact of environmental regulation on total R&D or total capital accumulation. We find some evidence that this is because more stringent environmental regulations directly lower the optimal expenditure on non-environmental innovations. In addition, we find that environmental R&D may crowd out non-environmental R&D, although there is no evidence that environmental capital crowds out non-environmental capital.     

Climate policy in Western Europe and avoided costs of air pollution control

Abatement of CO₂ emissions will be accompanied by reduced air pollutant emissions such as particulate matter (PM), SO₂, and NO_x. This, in turn, will reduce the need for end of pipe (EOP) pollution control technologies to meet future air quality targets. This dynamic could put more stringent air quality goals within reach, and increase the political feasibility of climate policy. This paper presents a CGE model that has been modified to include the emissions and EOP abatement of PM, SO₂, and NO_x from stationary sources in the EU-17. Emissions of pollutants are modeled as fixed-factor complementary inputs to their associated source. Abatement in each sector is modeled as a substitution between the pollutants and discrete abatement technologies, each of which is sector-specific and characterized by a marginal abatement cost and technical capacity constraint. Scenarios are run to 2020, to assess the costs and co-benefits of simultaneous air quality and climate policies. We find that under the Kyoto Protocol in 2010, the welfare cost of pollution control is reduced by 16% compared to the baseline, effectively offsetting the cost of CO₂ abatement by 15%. The co-benefit results depend heavily on policy choices, and their magnitude relative to total costs is likely to decline as greenhouse targets become more ambitious. In our scenarios, pollution control cost savings range from 1.3 to 20% in 2020, yielding a climate cost offset range of 0.2 to 3.9%. The CO₂ credit imports allowed by the EU via the Clean Development Mechanism (CDM) offer a total savings of $9.7bn in 2020, but only need to be compensated by an additional $0.3–0.4bn in domestic pollution control from stationary sources.     

The meta-technology cost ratio: An indicator for judging the cost performance of CO2 reduction

This paper constructs an innovative ratio of meta-technology cost (MTCR) by combining the meta-frontier framework and shadow price model. This ratio is not only an indicator to account for country-specific technology heterogeneity or technology heterogeneity across a group of countries to measure improvement toward the meta-frontier. This ratio also computes the absolute value difference between the real and ideal minimum marginal abatement costs for the non-market good CO₂ to achieve specific emission reduction. An equally weighted combination of technological readiness and innovation is used to classify countries into groups. The value of the MTCR via the computation of the meta marginal abatement cost (MAC^meta) and group marginal abatement cost (MAC^group-k) allows us to identify the possible improvement of marginal abatement cost (MAC) in absolute value. That is, observation of the MTCR, along with its components the MAC^meta and MAC^group-k, provides more intuitive and comprehensive information for commanding the cost performance of CO₂ reduction than the traditional meta-technology ratio alone.