A Model of Emission Reduction Activity and Cost Reducing R&D

Abstract

In this paper, we have studied the links between (the timing of) innovation policies and abatement policies under different assumptions of innovation policies such as the possibilities to use patent life time as a policy instrument. We study the timing and interdependence between optimal innovation policy and environmental policy in a model with emission reduction (abatement) activity and cost-reducing R&D through increasing variety numbers. Our analysis is based on an R&D model supplemented with emission-abatement-pollution dynamics, and four imperfections related to innovations; too little production of patented abatement equipment due to monopolistic competition, positive spillovers of innovations due to finite patent lifetime, negative spillovers through crowding out effects within the abatement technology sector, and crowding out effects in other sectors. We find that optimal emission prices and R&D subsidies are substitutes over time. R&D subsidies for clean innovation should start high and fall over time, while optimal emission prices start low and go up. If the lifetime of patents is infinite, we replicate earlier results that suggest R&D policy to be independent of the stage of the environmental problem. Our main result demonstrates that the positive spillovers of innovations due to finite patent lifetime are particularly strong at the early phase of an environmental problem, and to account for this, optimal innovation policy needs to adjust dynamically.