Innovation and Climate Change Policy

Abstract

This paper examines the notion that more stringent climate change policies will induce innovation in environmentally friendly technologies. While past work has raised the concern that such policies may stimulate such innovation at the expense of innovation elsewhere in the economy, the model presented here challenges the presumption that environmentally friendly innovation will advance without additional assistance. This paper demonstrates that a tighter emissions cap will reduce the scale of fossil fuel usage and that this effect will diminish incentives to improve fossil fuel efficiencies. At the same time, while such policies may stimulate the relative demand for innovations that improve the efficiency of alternative energy, carbon scarcity may diminish innovation incentives overall. Only for offsetting technologies that directly abate carbon pollution will there be an unambiguously positive impact on the rate of innovation. These results have implications for the setting of climate change targets and the design of climate change policy.

Keywords: innovation, technological change, emission caps, carbon tax, Porter hypothesis

JEL Classification: Q55, Q58