Conclusions

Induced Technological Change and Climate Policy

This report has examined the economics of policy-induced technological change and considered its implications for climate policy.  The main conclusions are listed below.

1.  The presence of ITC lowers the costs of achieving emissions reductions.  By stimulating additional technological change, climate policy can reduce the costs of meeting a given target for reductions in GHG emissions or concentrations.  Until recently, most economy-wide climate change policy studies ignored ITC.  Models that disregard policy-induced technological advances will tend to overestimate policy costs.

2.  The presence of ITC justifies more extensive reductions in GHGs than would otherwise be called for. Because ITC lowers the costs of achieving emissions reductions, the optimal extent of GHG reduction is greater than would be predicted by models that ignore ITC.  The net benefits from climate policy are larger as well.

3.  The presence of ITC alters the optimal timing of emissions abatement.  In general, technological change tends to justify increasing amounts of emissions abatement over time.  This result is supported by both theoretical analyses and simulation studies.  At the same time, available analyses offer contrasting views as to how the presence of induced technological change alters the optimal time-profile of abatement, relative to a situation where policy does not alter the rate of technological change.  Insofar as technological change results from R&D, the presence of ITC generally justifies less abatement in the near-term and relatively more abatement in the future (when R&D-based technological change has lowered the costs of abatement).  On the other hand, to the extent that ITC stems from learning-by-doing, more ambitious short-term abatement can be called for, since early abatement efforts accelerate the learning process and thereby lower costs.  The overall impact of ITC on the time-profile of optimal abatement paths depends on specific aspects of firms’ production technologies. 
 
4.  In the presence of ITC, announcing climate policies in advance can reduce policy costs.  Announcing policies in advance can lower the costs of meeting given targets for emissions abatement or reductions in GHG concentrations.  Illustrative results suggest that announcing a $25 per ton carbon tax 10 years in advance can reduce discounted GDP costs by about a third compared to the same climate policy imposed with no prior notice.

5.  Economic analysis offers a justification for public policies to induce technological change, even when the returns are highly uncertain.  Uncertainties surround many aspects of ITC.  Neither the returns to a given level of investment in R&D, nor the extent of future learning-by-doing, can be precisely predicted.  As a result, one cannot pinpoint the cost savings from ITC or the optimal timing of abatement.  Furthermore, uncertainties about costs of adjustment make it very difficult to gauge with precision the potential cost savings from prior announcements of climate policies.  Despite these uncertainties, the rationale for public policy to induce technological change remains strong.  So long as there are beneficial knowledge spillovers to other firms from increased R&D and negative externalities from the combustion of carbon-based fuels, investments in alternative energy technologies will be inefficiently low in the absence of policy intervention.  Direct emissions policies and technology-push policies can help raise R&D and learning-by-doing to efficient levels—that is, to levels consistent with maximizing social benefits net of the costs of increased R&D.

6.  To induce technological change and reduce GHG emissions most cost-effectively, both direct emissions policies and technology-push policies are required.  This study finds that both types of policies are necessary to achieve given abatement targets (whether expressed as reductions in emissions or GHG concentrations) at least cost to society.  The inability to appropriate all the knowledge from investments in R&D, and the climate-related externality from the combustion of fossil fuels, imply two market failures.  Technology incentives mainly deal with the inability of private investors’ to appropriate all the knowledge gains generated by R&D, while direct emissions policies mainly address the climate-related externalities of fossil fuel combustion and other GHG-generating activities.  Attempting to promote technological change (or, more broadly, to address the climate change problem) with only one of these policy approaches cannot correct both market failures.  As a result, sole reliance on one approach will usually involve higher costs than utilizing the two approaches in tandem.  To date, direct emissions policies have had little political success at the federal level.  But there is a strong need for these policies, along with R&D subsidies, to induce efficient levels of technological change and to deal with the prospect of climate change in a cost-effective manner.