Executive Summary

Induced Technological Change and Climate Policy

A central goal of climate policy is to avoid potential changes in climate and associated adverse biophysical impacts by slowing or avoiding the atmospheric build-up of greenhouse gases (GHGs).  Technological change will crucially influence the extent to which nations achieve this goal.  The direction and extent of technological change over the next century has profound implications for emissions and atmospheric concentrations of GHGs over time, the extent of future climate change, and associated impacts on human welfare. 
Climate policy can alter the future by influencing the rate and direction of technological change.  “Induced technological change” (ITC) here refers to the additional technological change that is brought about by policy.  This report explores how climate policy can induce technological change and examines the implications of ITC for the effective design of climate policy.

Some of the main findings are:

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. Although considerable technological change occurs in the absence of policy intervention, climate policy can induce additional technological change by providing incentives for additional research and development (R&D) and by stimulating additional experience with alternative technologies or processes, thereby generating “learning-by-doing.”  Analysts offer contrasting views as to how ITC alters the optimal timing of emissions abatement compared to a case where climate policy does not affect the rate of technological change (that is, the case with no ITC).  Does ITC justify more extensive near-term emissions reductions, or does it justify postponing reductions?  Recent analyses indicate that insofar as technological change results from R&D, the presence of ITC justifies somewhat less abatement in the near-term, and more abatement in the future (when technological change has lowered the costs of abatement).  On the other hand, if ITC primarily results from learning-by-doing, greater emphasis on abatement in the short term may be called for, since early abatement efforts accelerate the learning process and can thereby lower costs.

4.  In the presence of ITC, announcing climate policies in advance can reduce policy costs. Announcing policies in advance can lower the cost of meeting given targets for cumulative abatement or reductions in GHG concentrations.  Illustrative results indicate that announcing a $25 per ton carbon tax 10 years in advance can reduce discounted economic costs (as measured by changes in gross domestic product or GDP) 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 investment in R&D nor the extent of future learning-by-doing can be precisely predicted.  As a result, one cannot estimate with precision the cost savings from ITC or pinpoint the optimal timing of abatement.  Moreover, while prior announcements of climate policies will yield cost-savings, uncertainties about costs of adjustment make it impossible to accurately forecast these savings.  Despite these uncertainties, two key market failures provide a strong rationale for public policy to stimulate ITC.  These are: (1) the “spillover benefits” to society as a result of R&D investments by individual firms and (2) the presence of negative “externalities” – adverse impacts that are not accounted for in the market prices of carbon based fuels.

6.  To promote ITC and reduce GHG emissions most cost-effectively, two types of policies are required:  policies to reduce emissions and incentives for technological innovation. This study emphasizes that two types of policies are necessary to address the two market failures noted above and to achieve, at least-cost to society, a given target for cumulative reductions in emissions or GHG concentrations.  Technology incentives can deal with the market failure created by firms’ inabilities to capture all the returns on their R&D investments.  Direct emissions policies (such as carbon caps or carbon taxes) can deal with the market failure created by climate-related externalities.  Attempting to address the climate change problem with only one of these policy approaches cannot fully correct both market failures.  As a result, adopting one approach is likely to involve higher costs than utilizing the two approaches in tandem.  To date, direct GHG emissions policies have had little political success at the federal level.  But there is a strong need for these policies, along with technology incentives, to deal with the prospect of climate change in a cost-effective manner.