The Cost of Environmental Policy Under Induced Technical Change

29 Pages Posted: 20 Jul 2012

See all articles by Sjak Smulders

Sjak Smulders

Tilburg University - Tilburg University School of Economics and Management; University of Calgary - Department of Economics

Corrado Di Maria

University of East Anglia

Date Written: July 19, 2012

Abstract

Conventional wisdom argues that environmental policy is less costly if environmental policy induces the development of cleaner technologies. In contrast to this argument, we show that the cost of environmental policy (a reduction in emissions) may be larger with induced technical change than without. To explain this apparent paradox, we analyze three main issues. The first key issue is whether the new technology increases or reduces the marginal cost of abatement. While most analyses in environmental economics consider it natural that marginal abatement costs fall as new technology is developed, we argue that technological change may instead increase the productivity of polluting inputs, and thus marginal abatement costs. The second issue is whether environmental policy increases or decreases total investment and innovation. Even when stricter environmental policy induces some pollution-saving technological change, it may do so at the cost of a reduced overall rate of innovation, which crowds out production and consumption, and thus makes environmental policy more costly. Finally, the presence of additional distortions drive wedges between the social and private valuation of investment and pollution that may provide incentives for induced technological change with welfare-deteriorating effects.

Keywords: environmental policy, innovation policy, induced technical change, pollution-saving technical change, pollution-using technical change, crowding-out, second-best policy

JEL Classification: H23, O38, Q55, Q58

Suggested Citation

Smulders, Jacobus (Sjak) A. and Di Maria, Corrado, The Cost of Environmental Policy Under Induced Technical Change (July 19, 2012). CESifo Working Paper Series No. 3886. Available at SSRN: https://ssrn.com/abstract=2112952

Jacobus (Sjak) A. Smulders (Contact Author)

Tilburg University - Tilburg University School of Economics and Management ( email )

P.O. Box 90153
Tilburg, 5000 LE
Netherlands
+31 13 466 2920 (Phone)
+31 13 466 3042 (Fax)

HOME PAGE: http://www.uvt.nl/webwijs/english/show.html?anr=801585&lang=en

University of Calgary - Department of Economics ( email )

2500 University Drive, NW
Calgary, Alberta T2N 1N4
Canada

Corrado Di Maria

University of East Anglia ( email )

Norwich Research Park
Norwich, Norfolk NR4 7TJ
United Kingdom
441603592866 (Phone)

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