Mandates and the Incentives for Innovation

One prominent feature of the US biofuels sector is its reliance on mandates to enforce use. The performance of this policy tool has been mixed, with corn-based ethanol production successfully meeting targets but cellulosic ethanol falling well short of them. A crucial difference in this setting is that corn-based ethanol relies on a mature technology whereas the prospect of meeting cellulosic ethanol mandates was always predicated on the development of new technologies. Is it reasonable to expect that mandates would work well as an incentive for innovation? To address this question, we develop a partial equilibrium model with endogenous innovation to examine the incentives for innovation in production under a mandate and compare this policy to two benchmark situations: laissez-faire and a carbon tax. We find that a mandate creates relatively strong incentives for investment in R&D in low-quality innovations, but relatively weak incentives to invest in high-quality innovations. Moreover, mandates are likely to underperform carbon taxes in welfare terms.