Green Technology Development and Adoption: Competition, Regulation, and Uncertainty - A Global Game Approach

Abstract

When a government agency considers tightening a standard on a pollutant, the agency often takes into account the proportion of firms that are able to meet the new standard (what we refer to as the industry's index), because a higher proportion indicates a more feasible standard. We develop a novel model of regulation in which the probability of a stricter standard being enacted increases with an industry's capability index. In addition, in our model, the benefit of a new green technology is both uncertain and correlated across firms, and firms' decisions exhibit both strategic substitutability (because the marketing benefit of a new green technology decreases as more firms adopt it) and complementarity (because the stricter standard is more likely to be enforced as more firms adopt it). To analyze such strategic interaction among firms' decisions under correlated uncertain payoffs, we use the global game framework recently developed in economics. Our analysis shows that regulation that considers an industry's capability index, compared with regulation that ignores it, can more effectively motivate development of a new green technology. Surprisingly, uncertainty in the payoff can also help promote development of a new green technology. Finally, we find that more stringent regulation (a higher probability of enforcing a stricter standard for a given capability index) encourages more firms to adopt a green technology once the technology becomes available, but may discourage a firm from developing it in the first place when facing intense competition. Therefore, for an industry with intense competition, a government agency should caution against enforcing too stringent regulation that may stifle innovation.