Grantee Research Project Results
2000 Progress Report: Carbon Abatement Policies and Technological Innovation
EPA Grant Number: R826153Title: Carbon Abatement Policies and Technological Innovation
Investigators: Parry, Ian , Toman, Michael A. , Pizer, Billy , Fischer, Carolyn
Current Investigators: Parry, Ian , Pizer, Billy , Fischer, Carolyn
Institution: Resources for the Future
EPA Project Officer: Chung, Serena
Project Period: October 1, 1997 through September 30, 2000
Project Period Covered by this Report: October 1, 1999 through September 30, 2000
Project Amount: $240,000
RFA: Exploratory Research - Social Science (1997) RFA Text | Recipients Lists
Research Category: Environmental Justice
Objective:
The objective of this research project is to explore how endogenous technological change affects the appropriate choice among, design of, and economic gains, from environmental policy instruments with a particular focus on carbon abatement policies.Progress Summary:
During this fiscal year, we completed work on two discussion papers, which are discussed in this section. Three new papers are discussed in the Future Activities section.Environmental policies can improve economic efficiency through two channels. First, by curbing excessive amounts of pollution and, second, by simulating the development of new technologies that will reduce the costs of pollution control in future years. A number of people have suggested that the gains from promoting innovation are much more important than the gains from just controlling pollution over time. Thus, they argue that when choosing among different environmental policy instruments, such as pollution taxes and emissions permits, we should pick the instrument that is most effective at stimulating innovation. In addition, they argue that potentially it is important to have supplementary policies, such as tax credits or subsidies for research and development (R&D), to ensure adequate incentives for innovation.
Moreover, if the gains from innovation are large, then economists have greatly underestimated the overall benefits from environmental regulations (e.g., regulations to limit air pollutants under the Clean Air Act, regulations limiting water pollutants under the Clean Water Act, and proposed policies to reduce greenhouse gas emissions). In the past, economists only focused on the gains from controlling pollution and ignored the gains from inducing innovation.
In the paper "How Important is Technological Innovation in Protecting the Environment?" by Carolyn Fischer, Ian Parry, and William Pizer, we assess whether the economic gains from promoting innovation are, in fact, large or not. We provide a general treatment of this issue, using a dynamic social planning model in which the control variables in each period are the amount of pollution abatement and the amount of R&D investment. R&D enhances a knowledge stock, which reduces the costs of future abatement. The analysis allows for flow pollutants (like sulphur dioxide) and stock pollutants (like carbon dioxide), and for linear and convex environmental damage functions. The paper makes use of both analytically solved models to provide intuition, and numerically solved models to gauge the quantitative importance of technological innovation.
In general, we find that the economic gains from innovation are not as dramatic as people have speculated?in special cases, they can be very important; typically, they are probably less important than the economic gains from just curbing excessive amounts of pollution over time. This result was initially surprising to us, but it makes sense when we think about the factors that limit the potential economic gains from innovation. First, there is simply a limit to what innovation can achieve?at best, it can reduce pollution abatement costs by 100 percent. We show that, even if innovation reduces abatement costs by a substantial amount over time, the gains from this are not necessarily that much larger than the gains from achieving the initially optimal amount of pollution control. Second, the benefits from R&D occur in the future. It takes a while, maybe 10 years, for firms to invent and then adopt major new techniques for pollution control. In contrast, the benefits from reducing pollution occur today. When we discount future benefits, this reduces the gains from current R&D activity relative to the gains from current pollution control. Third, innovation is costly rather than free. Firms have to pay for scientists, engineers, research labs, etc., in order to develop new technologies. These costs have to be subtracted from the benefits in order to obtain the net economic gains from innovation
The one case when the economic gains from innovation could be relatively more important than the economic gains from pollution control is when abatement costs are initially "large" relative to environmental damages, and there is potential to realize fairly rapid cost savings from innovation. Our results apply equally for flow and stock pollutants, and for linear and convex environmental damage functions. In general, they also are robust to comparing economic gains from innovation and abatement over shorter periods within the planning horizon.
In summary, this paper's contributions are to: (1) provide a framework for illustrating what the economic gains from technological innovation are; (2) illustrate the types of situations where the gains from innovation can be important and when they are relatively small; and (3) explain why the net gains from innovation are typically somewhat smaller than environmental economists had previously suggested.
The paper "Instrument Choice for Environmental Protection When Technological Innovation is Endogenous" is co-authored by Carolyn Fischer, Ian Parry, and William Pizer of Resources for the Future. The paper presents an analytical and numerical comparison of the economic gains from alternative instruments for environmental protection in the presence of endogenous technological innovation. We focus on emissions taxes and both free (grandfathered) and auctioned emissions permits. The paper shows that under different sets of circumstances each of the three policies may induce a significantly higher net gains than the other two policies. In particular, the relative ranking of policy instruments can crucially depend on the ability to appropriate innovation rents, the costs of innovation, the slope and level of the marginal environmental benefit function, and the number of firms producing emissions. Moreover, although in theory the economic gains from policies differ in the presence of innovation, sometimes these differences are empirically small. This is more likely when firms anticipate that policies will be adjusted over time in response to innovation. In short, there is no clear-cut case for preferring one policy instrument over another.
The paper builds on earlier literature in a number of respects. First, the paper provides a quantitative comparison of policy instruments. This is important for identifying the circumstances when there can be significant discrepancies in net gains between the policy instruments and where?for practical purposes?these discrepancies are unimportant. Previous studies [with the exception of Parry (1998), which is discussed below] have been theoretical and, therefore, do not explore whether the differences between policies are significant or not. Second, the analysis focuses on net economic benefits (i.e., it ranks policies on innovation benefits net of the costs of innovation). In contrast, most previous studies rank policies according to how much innovation they might induce; however, it is important to look at the net gains (e.g., in some cases, we find that emissions taxes induce the highest amount of innovation but the net gain to society can be lowest). Third, the paper provides a more rigorous treatment of the technology adoption decision at non-innovating firms. In particular, we allow for non-innovating firms to have the option of choosing alternative technologies to the new innovation (such as imitations of the new innovation). This modeling extension is important and crucially affects the relative incentives for innovation under auctioned permits.
Finally, Parry's earlier paper, "Pollution Regulation and the Efficiency Gains from Technological Innovation," which has now been published, used analytical models and simulations to demonstrate two main points. First, prior studies suggest a preference for emissions taxes over (non-auctioned) emissions permits and performance standards based on their potential for promoting technological innovation. This paper casts some doubt on the empirical importance of this assertion?it shows that the economic gain induced by an emissions tax is significantly larger than that induced by other policies only in the case of very major innovations. Second, the paper also finds that the presence of technology spillovers per se does not necessarily imply large inefficiencies. In part, this is because competition for a given amount of innovation rent can be excessive and this tends to offset, to some extent, the inadequate incentives due to imperfect appropriation of innovation rents. Thus, despite spillovers, the net economic gain from additional policies to promote innovation (such as R&D subsidies) may be limited.
Future Activities:
In fiscal year 2001, work will be completed on the following three papers."On the Dynamic Interaction Between Optimal Pollution Control and Technological Innovation" by Ian Parry. This work is exploring the dynamic interaction between optimal pollution abatement and technological innovation that reduces the costs of pollution abatement in future periods. In particular, it addresses two questions. First, to what extent does the potential for endogenous technological change affect the optimal path of emissions abatement over time? Should emissions abatement be smoothed out over time? Or should we worry less about pollution control today, and delay abatement until future periods when innovation will have reduced the costs of emissions control? Second, what does the optimal time path for innovation look like? Should R&D be bunched in near-term periods in order to generate a rapid reduction in the costs of emissions abatement? Or should innovation be smoothed out over time?
"Interactions Between Environmental and Innovation Policies" by Carolyn Fischer. In practice, environmental policies may not be set to optimally internalize environmental externalities (e.g., the government may care about the distributional effects of policies as well as the impacts on economic efficiency). This paper considers situations where the stringency of environmental regulations is either set too high or too low from the perspective externality mitigation. The paper analyzes the resulting implications for the net economic benefits from innovation, and the appropriate design of innovation-promoting policies.
"On the Implications of Technological Innovation for Environmental Policy" by Ian Parry. The purpose of this paper is to summarize the implications of technological innovation for environmental policy. In particular, the paper discusses how innovation affects the net benefits to society from environmental regulations, how innovation affects the appropriate choice among, and optimal stringency of, environmental policy instruments, and whether environmental regulations need to be buttressed by additional instruments to directly stimulate innovation, such as research subsidies and prizes for developing cleaner technologies. The paper is meant to be accessible to graduate and undergraduate students.
Journal Articles on this Report : 1 Displayed | Download in RIS Format
Other project views: | All 13 publications | 3 publications in selected types | All 3 journal articles |
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Type | Citation | ||
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Parry IWH. Pollution regulation and the efficiency gains from technological innovation. Journal of Regulatory Economics 1998;14(3):229-254. |
R826153 (1998) R826153 (1999) R826153 (2000) R826153 (Final) |
Exit Exit |
Supplemental Keywords:
global climate, clean technologies, pollution prevention, innovative technology, waste reduction, public policy, cost-benefit., RFA, Economic, Social, & Behavioral Science Research Program, Scientific Discipline, decision-making, Social Science, Economics & Decision Making, air pollution policy, carbon emissions, clean technologies, technical innovation, dynamic optimization, decision making, endogenous technical change, cost of pollution abatement, environmental policy, Research and Development, carbon abatement policies, compliance costs, public policy, benefits assessment, cost effectivenessRelevant Websites:
http://www.rff.org/proj_summaries/1998.htmProgress and Final Reports:
Original AbstractThe perspectives, information and conclusions conveyed in research project abstracts, progress reports, final reports, journal abstracts and journal publications convey the viewpoints of the principal investigator and may not represent the views and policies of ORD and EPA. Conclusions drawn by the principal investigators have not been reviewed by the Agency.