Optimal Climate Policy with Directed Technical Change, Extensive Margins and a Decreasing Elasticity of Substitution between Clean and Dirty Energy

Abstract

This paper uses a benchmark climate model with endogenous technical change to consider the effects of three extensions on optimal policy under a clean transition. First, the movement of workers between non-energy and energy sectors lowers the cost of abatement by more than an order of magnitude, favouring taxes over subsidies. Second, the free movement of researchers between non-energy and energy sectors increases the power of policy to avert environmental disaster and leads to a period of intense research in the clean sector above the long-run share, as productivity in the clean sector catches up to the non-energy sector. Third, a decreasing elasticity of substitution between clean and dirty inputs as the share of clean energy rises is considered, reflecting the increasing difficulty of integrating intermittent clean energy supply in electricity. A decreasing elasticity increases the initial optimal tax on dirty energy and therefore lowers the subsidies required to direct technical change towards clean energy.