February 6, 2011

Climate Policy and Innovation in the Absence of Commitment

by Ashokankur Datta and E. Somanathan

- It is well-recognized that new technology is a crucial part of any solution to the problem of climate change. But since investments in research and development take time to mature, price and quantity instruments, i.e., carbon taxes and cap-and-trade, run into a commitment problem. We assume that the government cannot commit to the level of a policy instrument in advance, but sets the level to be optimal ex-post. Under these assumptions, we show that when the supply curve of dirty energy is flat, then an emissions tax is ineffective in promoting R&D into green energy while an emissions quota can be effective. A subsidy to R&D is welfare-reducing. More realistically, when the supply curve of dirty energy is upward-sloping, then both tax and quota regimes can be effective in promoting R&D into emission-free technology. In this case, a tax generally induces more R&D than a quota.

Datta, A. and E. Somanathan (2011). "Climate Policy and Innovation in the Absence of Commitment." Discussion Paper 11-45, Harvard Project on International Climate Agreements, Belfer Center for Science and International Affairs, Harvard Kennedy School, Jan 2011.