More Birds than Stones – A Framework for Second-Best Energy and Climate Policy Adjustments

65 Pages Posted: 15 Apr 2020 Last revised: 29 Jun 2021

See all articles by Carolyn Fischer

Carolyn Fischer

Resources for the Future; Vrije Universiteit Amsterdam; University of Ottawa - Department of Economics

Michael Hübler

Leibniz Universität Hannover

Oliver Schenker

Frankfurt School of Finance & Management

Date Written: March 21, 2020


Tinbergen's seminal work showed that we need at least as many policy instruments as there are market failures to address. In practice, however, regulatory power is often constrained, making it difficult or impossible to implement the first-best policy portfolio. We analyze analytically and numerically how available policy instruments should be adjusted vis-a-vis the first-best to account for under-internalized secondary market failures. As a concrete example, consider the power sector: alongside the external costs of emissions, evidence suggests that consumers undervalue energy efficiency investments, and knowledge spillovers hamper R&D and learning-by-doing in low-carbon technologies. By exploring the potential and limits of policy instrument substitution, we provide suggestions for adjusting policies in second-best situations. We calibrate the theoretical model to the European electricity sector and find that, compared with the first-best policy portfolio, relying on CO2 pricing alone increases the policy cost of the EU CO2 emissions target by about 30%. Uninternalized R&D spillovers contribute the most to this increase, and are the most difficult to address indirectly, even with subsidies supporting learning-by-doing. By contrast, almost 40% of the additional cost created by the absence of optimal energy efficiency subsidies can be recuperated by a second-best electricity tax.

Keywords: second-best policy, climate and energy policy, multiple market failures

JEL Classification: C61, H21, H23, O33, Q41, Q48, Q54, Q55

Suggested Citation

Fischer, Carolyn and Fischer, Carolyn and Hübler, Michael and Schenker, Oliver, More Birds than Stones – A Framework for Second-Best Energy and Climate Policy Adjustments (March 21, 2020). Available at SSRN: or

Carolyn Fischer

Vrije Universiteit Amsterdam ( email )

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Resources for the Future ( email )

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University of Ottawa - Department of Economics ( email )

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Michael Hübler (Contact Author)

Leibniz Universität Hannover ( email )

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Oliver Schenker

Frankfurt School of Finance & Management ( email )

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