Emissions pricing, spillovers, and public investment in environmentally friendly technologies

In a second-best world of below-optimal pollution pricing, the public return to R&D may be greater than under Pigouvian pricing, due to excess benefits of increasing abatement, or it may be lower, since private actors lack the incentives to take full advantage of the new, cleaner technologies. This paper uses a simple model to demonstrate the interaction between environmental policies, R&D externalities, and the social return to innovation. The results indicate that strong public support for innovation in abatement technologies is only justified if at least a moderate emissions policy is in place and spillover effects are significant. If emissions policy can adjust to cost changes, the public role may be enhanced, since private actors will prefer to avoid ratcheting. Social gains from innovation increase only if innovation can allow emissions to be more fully priced. Technology policy is more effective with fuller emissions pricing and is better viewed as a complement to than a substitute for mitigation policy.