Optimal Climate Change Policies When Governments Cannot Commit

Abstract

This paper examines the optimal design of climate change policies in the context where governments want to encourage the private sector to undertake significant immediate investment in developing cleaner technologies, but the carbon taxes and other environmental policies that could in principle stimulate such investment will be imposed over a very long future. The conventional claim by environmental economists is that environmental policies alone are sufficient to induce firms to undertake optimal investment. However this argument requires governments to be able to commit to these future taxes, and it is far from clear that governments have this degree of commitment. We assume instead that governments cannot commit, and so both they and the private sector have to contemplate the possibility of there being governments in power in the future that give different (relative) weights to the environment. We show that this lack of commitment has a significant asymmetric effect. Compared to the situation where governments can commit it increases the incentive of the current government to have the investment undertaken, but reduces the incentive of the private sector to invest. Consequently governments may need to use additional policy instruments -such as R&D subsidies -to stimulate the required investment.

Optimal Transition from Coal to Gas and Renewable Power under Capacity Constraints and Adjustment Costs

“…This may be challenging for actual agents willing to schedule or monitor investment in different types of power plants. For instance, it is recognized that governments have in general little capacity to commit, and in particular to commit to specific future carbon price levels (Helm et al, 2003;Golombek et al, 2010;Ulph and Ulph, 2013). …”

Carbon Lock-Out: Advancing Renewable Energy Policy in Europe

“…This is aggravated by the fact that the adjustment of the emissions cap from period to period is subject to a political bargaining process and per se unknown. Consequently, the EU ETS is unlikely to set sufficient long-term incentives to promote the necessary technology transition in the energy sector [15,57].…”

Climate Policies and Nationally Determined Contributions: Reconciling the Needed Ambition with the Political Economy

“…What matters for the transition is investment in long-lived capacity, but government cannot commit to future carbon prices (Brunner et al, 2012;Ulph and Ulph, 2013). It has been argued that the apparently high discount rates attributed to investors making energy conservation investments may result from uncertainty on future energy prices (Hassett and Metcalf, 1993).…”