Macroeconomics of sustainability transitions: Second-best climate policy, Green Paradox, and renewables subsidies

A steeply rising carbon tax is the best way to stimulate the early switch from fossil fuel to renewables. If such a tax is infeasible and a subsidy on renewables is used instead, fossil fuel is pumped more vigorously and global warming exacerbated. However, this Green Paradox does not hold if it is not optimal to fully exhaust fossil fuel reserves as then the subsidy ensures that more fossil fuel is left in situ and brings forward the date of introduction of renewables. If there is learning by doing in using renewables, a high but falling subsidy is called for to kick-start green innovation. Society is in need of a rapid rather than a gradual sustainability transition driven by redirecting technical change towards clean technologies.