Environmental Policy and the Direction of Technical Change

AuthorTom‐Reiel Heggedal,Mads Greaker,Knut Einar Rosendahl
Date01 October 2018
DOIhttp://doi.org/10.1111/sjoe.12254
Published date01 October 2018
Scand. J. of Economics 120(4), 1100–1138, 2018
DOI: 10.1111/sjoe.12254
Environmental Policy and the Direction of
Technical Change*
Mads Greaker
Statistics Norway,NO-0033 Oslo, Norway
madsg@oslomet.no
Tom-Reiel Heggedal
BI Norwegian Business School, NO-0442 Oslo, Norway
tom-reiel.heggedal@bi.no
Knut Einar Rosendahl
Norwegian University of Life Sciences, NO-1432 Ås, Norway
knut.einar.rosendahl@nmbu.no
Abstract
Should governments direct research and development (R&D) away from “dirty” technologies
towards “clean” ones? How important is this compared to carbon pricing? We address these
questions with the introduction of two model features to the literature on directed technological
change and the environment. We introduce decreasing returns to R&D, and allow future carbon
taxes to influence current R&D decisions. Our results suggest that governments should prioritize
clean R&D. Dealing with major environmental problems requires an R&D shift towards clean
technology. However, in the case where most researchers are working with clean technology,
both productivity spillovers and the risks of future replacement increase. Consequently, the gap
between the private and social valuesof an innovation is greatest for clean technologies.
Keywords: Directed technological change; environment; innovationpolicy
JEL classification:O30; O31; O33
Also affiliated with Oslo Metropolitan University.
*David Hemous generously shared his program files with us. We are grateful for constructive
comments from twoanonymous referees, Inge van den Bijgaart, Reyer Gerlagh, Cathrine Hagem,
and B˚ard Harstad, participants at the departmental seminars at BI Norwegian Business School,
Statistics Norway, the Frisch Centre, NHH (Norwegian School of Economics), and participants
at the EEA-ESEM conference in Gothenburg 2013 and the EAERE conference in Toulouse in
2013. Whilst carrying out this research, M. Greaker and K. E. Rosendahl were associated with
the Oslo Centre for Research on EnvironmentallyFriendly Energy (CREE), which acknowledges
financial support from the Research Council of Norway.
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The editors of The Scandinavian Journal of Economics 2017.
M. Greaker, T.-R. Heggedal, and K. E. Rosendahl 1101
I. Introduction
Reducing the percentage of fossil fuels in the energy mix is a major
challenge for climate change policy.1On the one hand, research and
development (R&D) drives down costs and improves technologies, and
thus facilitates the diffusion of new, clean technologies. On the other
hand, this mechanism also exists for dirty technologies. For instance, recent
improvements in fracking technology have made it profitable to extract oil
from underground shale layers, putting downward pressure on the price of
oil and thus reducing the relative attractiveness of electric vehicles.
Economists generally argue that putting a tax on carbon emissions
is the single most important instrument for tackling climate change.
Moreover, although most economists agree that the R&D of new carbon-
free technologies should be subsidized, few advocate prioritizing public
R&D funds for clean technologies. However, this point of view has been
challenged in the recent body of literature linking climate and R&D policy;
see, for instance, Acemoglu et al. (2012) and Dechezleprˆetre et al. (2017).
Our paper builds on this body of literature, and groups technologies into
either “clean” or “dirty”.2We then pose the following research questions.
Under what circumstances should governments actively direct research
effort away from dirty technologies towards clean technologies? To what
extent can a clean research subsidy replace a carbon tax?
Although it is difficult to find data on the total global R&D spending
on dirty and clean technologies, several sources indicate that the former
greatly outperforms the latter.3Because public spending on R&D tends
to follow private spending (e.g., as a result of tax rebates in proportion
to R&D spending), turning this around might require drastic intervention.
1In order to keep global warming below the 2C limit, a third of all oil reserves, a half of gas
reserves, and more than 80 percent of coal reserves must stay in the ground (McGlade and Ekins,
2015), while the International EnergyAgency (2014) predicts a 50 percent growth in total energy
demand in the next 25 years. Hence, the production of clean energy must increase dramatically.
2“Dirty” technologies can be defined as having a point of departure in the fossil fuel value chain,
that is, discovering and extracting fossil fuel resources, and improving end-use technologies
utilizing fossil fuels such as road transport and coal or gas power plants. Clean technologies are
mainly defined as renewable energy, from solar and wind, for example, and transport based on
electricity and hydrogen.
3Aghion et al. (2016) find that the number of new patents registered for dirty transportation
technologies is higher than for clean ones. The EU Industrial R&D Investment Scoreboard
(European Commission, 2014) lists companies according to their R&D spending. Typical clean
technologycompanies such as Vestas(wind turbines), First Solar (solar panels), and Tesla(electric
vehicles) are wellbelow oil companies and traditional car producers on this list. Finally, the use of
fossil fuels is also more heavily subsidized. The International EnergyAgency (2014) estimated
consumer subsidies for fossil fuels at US$548 billion in 2013, while subsidies for renewable
energy amounted to US$121 billion.
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The editors of The Scandinavian Journal of Economics 2017.
1102 Environmental policy and the direction of technical change
Hence, a greater understanding of the potential mechanisms leading to
the underprovision of clean R&D seems essential. Another policy-relevant
question is to what extent a clean research subsidy can replace carbon
pricing. The implementation of a global price on carbon has proved very
difficult, and thus concerted global action on supporting clean R&D might
be an alternative.
A central analysis of the competition between clean and dirty
technologies is the contribution by Acemoglu et al. (2012) (henceforth
AABH). They analyse optimal R&D subsidies and carbon taxes in a model
with clean and dirty technologies in which the latter technology starts off
as being more advanced. They argue that a targeted subsidy for clean R&D
should be used to shift all R&D effort from dirty R&D to clean R&D,
either immediately or within a few years.
In our opinion, it is not clear whether AABH’s results are robust to
other modelling choices for the innovation sector. First, AABH assume that
a scientist only enjoys current-period monopoly profits, which implies that
climate policies of the future are unable to redirect research effort today.4
Second, in the AABH model, there are constant returns to R&D within a
period. As a result, they obtain a corner solution for the allocation of the
R&D effort: either all scientists do dirty R&D, or they all do clean R&D.
Third, in their numerical simulations they only consider high elasticities of
substitution between clean and dirty inputs.
We use the AABH model with clean and dirty inputs to final goods
production as a starting point for our own model. However, we model
the innovation sector differently. First, we let scientists retain profits on an
innovation until it is replaced by an innovation of better quality. Second, we
introduce duplication effects by having decreasing returns to the number of
scientists innovating in a technology.5Third, we run simulations with both
high and moderate elasticities of substitution between clean and dirty inputs.
At first glance, all these changes should make targeted R&D support
less crucial, given that optimal carbon taxes are implemented. Innovators
will expect future environmental policies to be more stringent, and will thus
redirect their research in accordance with their expectations. Furthermore,
decreasing returns to R&D within a period and lower elasticities of
substitution between clean and dirty inputs make it profitable to do R&D
in both sectors independent of the level of accumulated productivity.
Surprisingly, both our theoretical results and our numerical simulations
4In their numerical simulations, each period lasts for five years. In the body of literature on
economic growth (e.g., Romer, 1990; Grossman and Helpman, 1991;Aghion and Howitt, 1992;
Acemoglu, 2002, 2009), innovators typically enjoy monopoly profits for an extended period of
time.
5emous(2013) also allows for decreasing returns to scale in innovation effort.
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The editors of The Scandinavian Journal of Economics 2017.

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