The Interplay Between Carbon Regulations and Green Technology Innovation: A Comparative Analysis

Abstract

This paper investigates the impact of government carbon regulations on firms' economic incentives in green technology innovation. We develop a stylized model that represents a competitive market consisting of oligopoly firms producing substitute products and generating carbon emissions. We compare the effectiveness of two commonly used regulatory policies: carbon tax and cap-and-trade policy. Our findings indicate that, under moderate regulation intensities, tax policy is generally preferable, while cap-and-trade policy generates stronger incentives when regulations are stringent. However, in cases where competition intensity is low, tax policy can outperform stringent regulation ranges. Additionally, we clarify that free allocation, while compensating firms for carbon costs, hampers innovation by restricting market share changes in a heterogeneous market. Furthermore, our study illuminates two counter-intuitive observations: "green paradox" indicates that enhancing green technology could result in increased emissions under stringent tax policies; "innovation paradox" shows it may generate negative economic incentives under loose cap-and-trade policies, necessitating prudent government oversight and intervention. Our study contributes to the debate on carbon regulation policy by providing insights into firms' economic incentives for green technology innovation and shedding light on the trade-off mechanisms involved in carbon policy design.

Keywords: Low carbon operations, competition, green technology innovation, green policy