Regulation, external R&D, and strategic diffusion of pollution abatement technology

Abstract

We analyze licensing of a new abatement technology by an outside innovator to an imperfectly competitive polluting industry of a general size that faces an emission tax. In particular, we analyze the effect of regulatory stringency on the diffusion of the new abatement technology. We show that full diffusion can only occur when regulation is weak whereas partial diffusion occurs when regulation is stringent. Moreover, we endogenize the decision of the innovator on R&D in the new technology and study the effect of change in environmental regulation on the innovator’s incentive to develop the new abatement technology. We show that the relationship between the stringency of environmental regulation and R&D incentives is positive and monotonic when the existing old technology is sufficiently efficient; otherwise, an increase in the level of environmental regulation may reduce the innovator’s incentive to invest in the development of the new abatement technology. We then calculate the welfare-maximizing emission tax. The optimal emission tax induces full (partial) diffusion when the R&D level is exogenously (endogenously) determined.