Incentivizing environmental investments: The contest-based subsidy allocation mechanism

Abstract

Governments often provide subsidies to incentivize investments that are considered important for the society. The question is how to distribute those subsidies in the most efficient way. This paper proposes two novel contest-based subsidy mechanisms and evaluates their effectiveness in terms of firms’ environmental investments, profits, consumer and producer surplus, environmental damage and social welfare. In the product green features (PGF) subsidy mechanism firms compete in terms of investment in product green features in order to obtain the highest amount of subsidy. In the CO2 abatement (ABA) subsidy mechanism firms compete in terms of investment in CO2 abatement in order to obtain the highest amount of subsidy. Among other results, we found that the PGF subsidy mechanism is more effective to promote investments in product green features and to increase consumer surplus. However, the ABA subsidy mechanism is found to be more effective in industries or technologies in which the level of emissions is relatively low. However, such environmental policies may lead to inflation, and may not always improve social welfare. This paper opens new avenues of research and thinking in terms of environmental subsidies and policy.