To build or not to build? Capital stocks and climate policy∗

Abstract

We investigate how irreversibility in "dirty" and "clean" capital stocks affects optimal climate policy, from both theoretical and numerical perspectives. An increasing carbon tax will reduce investments in assets that pollute, and so reduce emissions in the short term: our "irreversibility effect". As such the "Green Paradox" has a converse if we focus on demand side capital stock effects. We also show that the optimal subsidy increases with the deployment rate: our "acceleration effect". Considering second-best settings, we show that, although carbon taxes achieve stringent targets more efficiently, in fact renewable subsidies deliver higher welfare when policy is more mild.

Capital Accumulation, Green Paradox, and Stranded Assets: An Endogenous Growth Perspective

“…As the clean capital as an imperfect substitute is accumulated to a larger stock, it will generate the reciprocal effect that help improves the productivity and market values of dirty capital which in turn encourage investment in dirty capital and hence avoid asset stranding of dirty capital. This result thus provides a helpful supplement to the existing studies on stranded dirty capital (Baldwin et al, 2018;van der Ploeg and Rezai, 2018).…”

“…Accumulation of the clean capital with pollution-saving effects will offset the polluting impacts of dirty capital, thus stabilizing the emission trend and reversing the Green Paradox (i.e., the solid red line is well below the dashed blue one in Figure 4a. The reverse Green Paradox effect through the accumulation of clean capital as an imperfect substitute to dirty capital thus contributes to the existing literature on Green Paradox (e.g., Gerlagh, 2011;Withagen, 2012a, 2014;Long, 2014;van der Meijden, 2014;Baldwin et al, 2018;van der Ploeg and Rezai, 2018).…”

“…First, if capital accumulation is irreversible (i.e., the accumulated dirty capital cannot be directly used in clean sectors), then it is optimal to stop investing into dirty capital earlier and make a shift to investment into the clean sector to avoid later stranding of dirty capital assets. Second, it is demonstrated that investment irreversibility on the demand side, by stopping investment in the dirty capital earlier, enhances the effect of environmental regulations and reduces emissions in the short term, thus leading to a reverse Green Paradox effect (Baldwin et al, 2018;van der Ploeg and Rezai, 2018).…”

“…Our model thus provides the simultaneous analysis of both effects. Furthermore, following Baldwin et al (2018), irreversibility of investment is described as non-negativity constraints on capital investment, but here we distinguish capital investment between direct and indirect irreversibility. In our model, the conditions I D ≥0 and I C ≥0 given in (2) correspond to the direct irreversibility.…”

“…Climate geoengineering is quicker for decreasing atmospheric carbon dioxides, and cheaper than mitigation especially when looking at direct costs alone. Direct costs are estimated to be in the order of billions of dollar a year to turn down global average temperatures to pre-industrial levels, compared to trillions for mitigation (e.g., National Research Council, 2015a,b) cannot be converted into clean one, 3 then it is optimal to stop investing in dirty capital earlier and make a shift to investment into the clean sector to avoid later stranding of assets in dirty production sectors, and capital irreversibility on the demand side enhances the effect of environmental regulations on emission reductions in the short term, thus leading to reverse Green Paradox (Baldwin et al, 2018;van der Ploeg and Rezai, 2018). As a departure, our works in this paper distinguish irreversibility between direct and indirect channels: while dirty capital cannot be directly converted to clean one, there might exist a channel of indirect convertibility through which dirty capital can be used to produce final goods which in turn provide resources for clean capital investment.…”