Low-Carbon Investment and Credit Rationing

Abstract

This paper offers a novel theoretical approach to analyse the impacts of emission externalities and credit market failures on low-carbon investments. We use a principal-agent model with information asymmetries between borrowing firms and lenders. Firms can choose between a carbon-intensive technology and a low-carbon technology requiring an externally funded initial investment. We find that an emission tax alone is not sufficient to achieve the first-best outcome if the low-carbon technology is immature and risky and thus results in credit rationing. Combining the emission tax with interest subsidies or loan guarantees can eliminate credit rationing. If a carbon price is (politically) not feasible, intervention on the credit market alone can promote low-carbon development. However, such a policy yields a second-best outcome. Our dynamic analysis shows that any intervention on credit markets is finite, as knowledge spillovers reduce the risk of low-carbon technologies. Without such intervention, there are social costs of delay.

Keywords: low-carbon investment, credit rationing, emission tax, information asymmetry, interest rate subsidy, loan guarantee

JEL Classification: G20, H23, H81, Q50