Environmental Policy Instruments and the Long-Run Management of a Growing Stock of Pollutant

Abstract

Most environmental damage can be reduced through investments in the management of the pollutants that cause this damage. In the case of climate change, for instance, the harmful effects of the accumulated stock of greenhouse gases depend on the adaptation effort. Our aim is to analyze which economic policy schemes can restore the social optimum in such contexts. We consider a simple endogenous growth model with a polluting non-renewable resource and directed technical change, in which the environmental damage (and unique externality) depends on the accumulated stock of pollutant as well as on a stock of green knowledge dedicated to its management. Here, the socially optimal policy consists in a tax on the environmental damage, which provides the right incentives to (a) invest in green knowledge and (b) mitigate pollutant flows. More usual—and more easily implementable—environmental policies like taxes on pollution flows (e.g., carbon tax) cannot yield first-best outcomes in this context since they do not provide the right incentives to invest in the management of the emitted pollutants. We nevertheless show how coupling such a type of policy tool with a subsidy to green R&D can restore the social optimum.