A note on environmental policy and innovation when governments cannot commit

It is widely accepted that one of the most important characteristics of an effective pollution control policy is to provide firms with credible incentives to make long-run investments in R&D that can drastically reduce pollution. Recognizing that a government may be tempted to revise its policy design after innovations become available, this note shows how the performance of two policy instruments-prices (uniform taxes) and quantities (tradeable pollution permits)-differ in such a setting. I also discuss the gains from combining either instrument with subsidies to adopting firms.

► An effective pollution control policy should be credible for R&D investments in cleaner technologies to take place. ► Price and quantity instruments may differ in the situation where governments cannot commit to their policies. ► It is sometimes optimal to combine permits with subsidies to adopting firms.