Timing of innovation policies when carbon emissions are restricted: an applied general equilibrium analysis
Abstract:This paper studies the timing of subsidies for environmental research and development (R&D) and how innovation policy is influenced by the costs of emissions. We use a dynamic computable general equilibrium (CGE) model with both general R&D and specific environmental R&D. We find two results that are important when subsidizing environmental R&D in order to target inefficiencies in the research markets. Firstly, the welfare gain from subsidies is larger when the costs of emissions are higher. This is because a high carbon tax increases the social (efficient) investment in environmental R&D, in excess of the private investment in R&D. Secondly, the welfare gain is greater when there is a falling time profile of the rate of subsidies for environmental R&D, rather than a constant or increasing profile. The reason is that the innovation externalities are larger in early periods.Keywords: Applied general equilibrium, endogenous growth, research and development, carbon emissions.
JEL classification: E62, H31, O38, Q55Acknowledgement: The authors would like to thank Birger Strøm for excellent computer assistance in coding and calibrating the model. We would also like to thank Geir H. Bjertnaes, Brita Bye, Taran Faehn, Snorre Kverndokk, and Knut-Einar Rosendahl for useful comments. Finally, we gratefully acknowledge financial support from the Norwegian Research Council programs SAMSTEMT and RENERGI. One expects that a variety of policy measures will be needed to achieve the cuts in GHGs.
AddressMost likely these will include a cap-and-trade system that gives a price to carbon emissions, like the European Trading Scheme, and a policy to improve clean energy technology like power production with carbon capture and storage (CCS). The most cost-efficient single policy to reduce emissions is an environmental policy that directly targets emissions, such as a tax or cap-and-trade system. 1 However, in the presence of induced technological change and market failures in R&D, a combination of environmental and innovation policies may be more cost effective.2 Jaffe et al. (2005) argue that market failures associated with environmental pollution interact with market failures associated with the innovation and diffusion of new technologies. These combined market failures provide a strong rationale for a portfolio of public policies to foster emissions reductions as well as the development and adoption of environmentally beneficial technology.Key arguments for subsidizing innovation activities are external spillovers from previous R&D and love of capital variety in demand, combined with inefficiencies arising from imperfect competition in the capital variety market.3 The market inefficiencies imply that the private returns from environmental R&D are lower than the social returns, which leads to underinvestment in environmental R&D. This underinvestment is the rationale for subsidizing R&D activity. Several environmental...