Environmental Policy and Induced Technological Change: A Two-Region Model Analysis

Abstract

This paper employs a cost-effectiveness criterion to examine the impact of policy-induced technological change on optimal abatement and emission taxes in a two-region dynamic model of transboundary pollution. We conduct theoretical and numerical simulation analysis to examine the effect of pollution abatement technology through learning by doing (LBD) and knowledge spill-over on optimal abatement and emission taxes in each region. The government in each region chooses an abatement level that minimizes costs under the presence of induced technological change (ITC) in aggregate, and for individual regions. We examine this effect on optimal abatement level and tax rate in first-best and regional optimality scenarios. Analysis reveals that ITC and LBD reduce abatement costs. Case-specific optimal abatement and costs vary with the presence of ITC and transboundary pollution. Also, spill-over effects result in different optimal tax rates in each region. We verify optimal abatement and emission tax paths for regions through numerical simulation.