Innovation under cap-and-trade programs

Abstract

Policies incentivizing the private sector to reach its innovative potential in "clean" technologies are likely to play a key role in achieving climate stabilization. This article explores the relationship between innovation and cap-and-trade programs (CTPs)-the world's most prominent climate policy instrument-through empirical evidence drawn from successful CTPs for sulfur dioxide and nitrogen oxide control. The article shows that before trading began for these CTPs, analysts overestimated the value of allowances in a pattern suggestive of the frequent a priori overestimation of the compliance costs of regulation. When lower-thanexpected allowance prices were observed, in part because of the unexpected range of abatement approaches used in the lead-up to trading, emissions sources chose to bank allowances in significant numbers and reassess abatement approaches going forward. In addition, commercially oriented inventive activity declined for emissions-reducing technologies with a wide range of costs and technical characteristics, dropping from peaks before the establishment of CTPs to nadirs a few years into trading. This finding is consistent with innovators deciding during trading that their research and development investments should be reduced, based on assessments of future market conditions under the relevant CTPs. The article concludes with a discussion of the results and their implications for innovation and climate policy.climate change | emissions trading | technological change | invention | clean technology F acilitating innovation in "clean" technologies may be the key to achieving climate change stabilization without dampening economic productivity. Theory and experience indicate, however, that the private sector-apt to be the most significant source of this innovation-will not reach its full innovative potential without well-considered public policies. The pollution market failure involved in greenhouse gas (GHG) emissions implies that the development of emissions-reducing technologies will have less private value than the societal optimum. The market failure associated with innovators' difficulty in fully appropriating returns to research and development (R&D) investments-because of imitation and spillover, for example-implies that private incentives to innovate in clean technologies will be suboptimal. Another drag on private sector innovation stems from the trouble that capital markets and firms regularly have in predicting the risks and rewards of R&D investments, which can have uncertain outcomes and lengthy payback periods. Finally, there are significant challenges involved in displacing existing "dirty" technologies, which benefit from cost and performance advantages that accrue through the use of a technology over time, as well as from network externalities and the human reluctance to abandon sunk costs.Addressing the pollution market failure should spur demand for clean technology and related private sector innovation (see ref. 1 for an introduction to policies exerting a "demand-pull" on ...

Reviewing the evidence on the innovation impact of the EU Emission Trading System

“…This increasing pattern of low-carbon innovation is in contrast to Taylor's (2012) observation of declining inventive activity after the introduction of permit trading schemes for sulfur dioxide and nitrogen oxide control in the US. 91 But if it is not the EU ETS which is driving this positive development, the question remains what else is behind it.…”

A Rejoinder to Matthew Paterson and Peter Newell

“…(We have seen the price of European Union Allowances slump from € 30 to little more than € 6 and of Kyoto Protocol offsets from € 23 to a bit more than € 3 in less than four years -with financial-sector analysts unanimously predicting that prices will remain at a level meaningless for any kind of environmental improvement, to say nothing of efforts to keep fossil fuels in the ground, for the foreseeable future.) They would also need to take on Margaret Taylor (2012), who notes dryly in a recent study of previous systems of pollution trading that what with 'downward pressure on allowance prices' (in keeping with carbon trading's 'strength in marshalling market dynamism in the service of emissions reductions'), 'commercially-oriented inventive activity declined during trading'. They would need to explain when and how the rent-seeking, cost passthroughs and permit banking which have massively rewarded fossil fuel intensity throughout the years of the EU ETS's operation could realistically be halted; under what circumstances squabbling governments beholden to an industrial structure for which fossil fuels are essential to labour productivity and global market construction might become either inclined or equipped to enforce a progressive long-term programme of shrinking global emissions caps; how the contradictions of a unique market structure in which, to quote the words of Deutsche Bank analyst Mark Lewis, 'demand varies in real time but supply is fixed years in advance' are likely to be resolved (Environmental Finance, 2012); and why competitive carbon offset producers should not obey capitalist logic in seeking the greatest cost-savings through the mass production of carbon pollution rights by virtually any means possible.…”

Confronting Regulatory Cost and Quality Expectations. An Exploration of Technical Change in Minimum Efficiency Performance Standards

“…The first contention is that innovation can be induced to both public and private benefit by well-designed regulation (see, e.g., the "Porter Hypothesis," as articulated in Porter and Van der Linde 1995). The empirical literature has demonstrated that several aspects of regulatory design can influence innovative activities; these include how stringent a regulation is over time, how neutral a regulation is to the various alternative technologies that can potentially achieve any given target, and how responsive a regulation is to new developments in science and 2 technology (see, e.g., Taylor, Rubin et al 2005, del Rio Gonzalez 2009, Kemp and Pontoglio 2011, Taylor 2012. The second contention is that information asymmetry between regulators and the regulated regarding private sector business operations, including innovation management, implies that regulation should be expected to hinder innovative activities (see, e.g., Stewart 1981).…”