Second-Best Renewable Subsidies to De-Carbonize the Economy: Commitment and the Green Paradox

30 Pages Posted: 8 Mar 2016

See all articles by Armon Rezai

Armon Rezai

Vienna University of Economics and Business

Rick van der Ploeg

University of Oxford

Date Written: January 26, 2016

Abstract

Climate change must deal with two market failures: global warming and learning by doing in renewable use. The first-best policy consists of an aggressive renewables subsidy in the near term and a gradually rising and falling carbon tax. Given that global carbon taxes remain elusive, policy makers have to use a second-best subsidy. In case of credible commitment, the second-best subsidy is set higher than the social benefit of learning. It allows the transition time and peak warming close to first-best levels at the cost of higher fossil fuel use (weak Green Paradox). If policy makers cannot commit, the second-best subsidy is set to the social benefit of learning. It generates smaller weak Green Paradox effects, but the transition to the carbon-free takes longer and cumulative carbon emissions are higher. Under first-best and second best with pre-commitment peak warming is 2.1-2.3 °C, under second best without commitment 3.5°C, and without any policy temperature 5.1°C above pre-industrial levels. Not being able to commit yields a welfare loss of 95% of initial GDP compared to first best. Being able to commit brings this figure down to 7%.

Keywords: first-best and second-best policy, commitment, Markov-perfect, Ramsey growth, carbon tax, renewables subsidy, learning by doing, directed technical change

JEL Classification: H21, Q51, Q54

Suggested Citation

Rezai, Armon and van der Ploeg, Frederick, Second-Best Renewable Subsidies to De-Carbonize the Economy: Commitment and the Green Paradox (January 26, 2016). CESifo Working Paper Series No. 5721, Available at SSRN: https://ssrn.com/abstract=2743112 or http://dx.doi.org/10.2139/ssrn.2743112

Armon Rezai (Contact Author)

Vienna University of Economics and Business ( email )

Welthandelsplatz 1
Vienna, Wien 1020
Austria

Frederick Van der Ploeg

University of Oxford ( email )

Manor Road Building
Manor Road
Oxford, OX1 3BJ
United Kingdom

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