Environmental Regulation Stringency and Allocation between R&D and Physical Capital: A Two-Engine Growth Model

56 Pages Posted: 31 Mar 2023 Last revised: 13 Aug 2023

See all articles by Juin-jen Chang

Juin-jen Chang

Academia Sinica

Chien-Yu Huang

International University of Japan

Chun Yee Wong

International University of Japan

Yibai Yang

University of Macau - Department of Economics

Date Written: August 10, 2023

Abstract

Many studies have identified the negative effect of environmental regulation on capital accumulation and the positive effect on innovation, but this observed capital-innovation tradeoff due to environmental regulation lacks theoretical underpinning. We fill this gap by developing a unified two-engine endogenous growth model with environmental regulation, and show that a stringent environmental policy (in terms of pollution tax) leads to a sectoral reallocation from dirty inputs to clean final-good sectors, which increases the demand for R&D and activates the innovation engine. The capital engine depends on the elasticity of substitution between polluting and capital inputs. If both are sufficiently complementary, capital accumulation slows down. Another novelty of our model is that the contrasting responses of the two growth engines can lead to an inverted-U relation between overall GDP growth and environmental taxation. Our calibration shows that a well-designed environmental regulation can achieve a "double dividend": both improving the environment and enhancing economic growth and social welfare. Our empirical analysis provides macro-level evidence to justify our model prediction by using cross-country panel data.

Keywords: Two growth engines; Environmental regulations; R&D; Capital accumulation

JEL Classification: O11; O44; Q20

Suggested Citation

Chang, Juin-Jen and Huang, Chien-Yu and Wong, Chun Yee and Yang, Yibai, Environmental Regulation Stringency and Allocation between R&D and Physical Capital: A Two-Engine Growth Model (August 10, 2023). Available at SSRN: https://ssrn.com/abstract=4396260 or http://dx.doi.org/10.2139/ssrn.4396260

Juin-Jen Chang

Academia Sinica ( email )

Economics
Nankang, Taipei 115
Taiwan

Chien-Yu Huang

International University of Japan ( email )

Yamato-machi
Niigata-ken 949-7277
United States

Chun Yee Wong

International University of Japan

Yamato-machi
Niigata-ken 949-7277
United States

Yibai Yang (Contact Author)

University of Macau - Department of Economics ( email )

Macau
China

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