11.5.4 Modelling policies that induce technological change

Most of the studies discussed so far consider only how endogenous technological change affects the cost associated with correcting the market failure of damaging GHG emissions through market-based approaches to carbon taxes and/or emissions trading schemes. However, when spillovers from low-carbon innovation are introduced into the modelling of ETC, for example where the social rate of return exceeds the private rate of return from R&D because innovators cannot capture all the benefits of their investment, there is a second market failure. This implies that at least two instruments should be included for policy optimization (Clarke and Weyant, 2002, p.332; Fischer, 2003; Jaffe et al., 2005). Even without the spillover effect, however, the advantage of models with endogenous technological change is their potential to model the effect of technology policy, distinct from mitigation policy, or in tandem. As discussed in Chapter 13, there has been increasing interest in such policies.

Surprising, few models have explored this question of mitigation versus technology policies, and they have focused instead on the cost assessments reviewed above. Those studies that have looked at this question find that technology policies alone tend to have smaller impacts on emissions than mitigation policies (Nordhaus, 2002; Fischer and Newell, 2004; Popp, 2006b; Yang and Nordhaus, 2006). In other words, it is more important to encourage the use of technologies than to encourage their development. On the other hand, with the existence of spillovers, technology policies alone may lead to larger welfare gains (Otto et al., 2006). However, the same study points out that an even better policy (in terms of improving welfare) is to fix the R&D market failure throughout the economy. Given the difficulty in correcting the economy-wide market failure (e.g., through more effective patent protection or significantly increased government spending on research), it may be unrealistic to expect successful correction within the narrow area of energy R&D. This is true despite our ability to model such results.

However, this does open up the possibility of portfolios of policies utilizing some of the revenues from emission permit auctions to provide incentives for low-carbon technological innovation. An example is the approach of Masui et al. (2005) for Japan discussed in 11.3.4. Weber et al. (2005), using a long-run calibrated global growth model, conclude that ‘…increasing the fraction of carbon taxes recycled into subsidizing investments in mitigation technologies not only reduces global warming, but also enhances economic growth by freeing business resources, which are then available for investments in human and physical capital’ (p. 321).

Unlike the studies that assess the effects of technology and mitigation policies on emissions and welfare in a simulation model, Popp (2002) examines the empirical effect of both energy prices and government spending on US patent activities in 11 energy technologies in the period 1970–1998. He finds that while energy prices have a swift and significant effect on shifting the mix of patents towards energy-related activities, government-sponsored energy R&D has no significant effect. While not addressing efforts to encourage private-sector R&D, this work casts doubt on the effectiveness of government-sponsored low-GHG research by itself as a mitigation option.