Emissions abatement R&D and environmental policy

Abstract

n n nThis dissertation studies the interaction between environmental policy, market structure andfirmsr incentives to invest in emissions reduction technology or emissions abatement researchand development (RaD). It consists of three individual papers. The first paper examines howthe intensity of market competition may affect the environmental policy. The second paperstudies the conditions under which the design of an environmental policy can be beneficial forfirms and society. The third paper analyses the effect of environmental RaD organisationalstructures on firmsr innovation activities, profits, and social welfare when the RaD outcome isuncertain.n n nThe first paper investigates the optimal environmental policy (the mix of emissions tax andRaD subsidy) when two firms, producing differentiated products, compete in the output marketover time. Firms compete over supply schedules, which encompass a continuum of marketstructures from Bertrand to Cournot. While production generates environmentally damagingemissions, firms can undertake RaD, which has the sole purpose of reducing emissions. In additionto characterising the optimal policy, we examine how the optimal tax and subsidy, and theoptimal level of abatement change as competition intensifies, as the dynamic parameters changeand as the investment in abatement technology changes. In this setting, increased competitionno longer necessarily leads to an increase in welfare. Instead, there are two forces. Competitionincreases welfare through its impact on the final goods price. However, lower prices result inlarger quantities and more pollution. Our contribution is to show how this impact depends onthe extent of the market, the nature of preferences and the technology.n n nThe Porter Hypothesis, formulated by Michael Porter (1991), states that a well-designedenvironmental policy could encourage innovation and be beneficial for firms and society. In thesecond paper, we investigate the conditions under which the design of an environmental policycan align social and private interests. Results consistent with the Porter Hypothesis are derivedwithout any behavioural assumptions or bounded rationality arguments, as it is commonly thecase in the related literature. N symmetric firms compete in the output market by producing andselling homogeneous goods. Production entails the emission of a pollutant, which may be taxed.The general conditions for firmsr profits and social welfare to be higher under an emissions taxthan under no tax are determined. The key insight is that, for the representative firmrs profit toincrease with an increase in emissions tax, the emissions tax cost pass-through must be greaterthan the net emissions per unit of production, adjusted for the number of competing firms. Asthe intensity of competition increases, firms are more likely to benefit from an emissions tax, asthe tax facilitates the exercise of market power.n n nThe third paper analyses firmsr and social plannerrs choices of RaD cooperation when theinnovation outcome is uncertain. Two firms compete in the output market by producing andselling homogeneous goods. Production entails the emission of a pollutant, which is taxed andinduces firms to invest in emissions reduction RaD. It is assumed that the RaD outcome isuncertain and firms can either choose to fully protect or fully share their RaD results. UnderRaD uncertainty, the highest payoff for the firm is when it succeeds in its RaD efforts whilstits rival fails. Subsequent ex-post asymmetries can also lead to one firm exiting the market. Thisintroduces additional strategic elements for the firm, leading to new insights regarding firmsrand social plannerrs preferences. It is shown that for lower levels of marginal environmentaldamages, firms and the social planner always prefer cooperation in RaD and information sharingas this leads to the highest expected profit and social welfare. For higher levels of marginalenvironmental damages, firms always choose to cooperate but not to share information. Thesocial planner also prefers firms not to share information but only to cooperate when they areefficient in their abatement RaD; under inefficient abatement RaD conditions, no cooperationin RaD and no information sharing leads to the best social outcome. The private level ofinvestment in RaD is always smaller than the social optimum.