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Equilibrium incentives for adopting cleaner technology under emissions pricing


  • Kennedy, Peter W.
  • Laplante, Benoit


Policymakers sometimes presume that adopting a less polluting technology necessarily improves welfare. This view is generally mistaken. Adopting a cleaner technology is costly, and this cost must be weighed against the technology's benefits in reduced pollution and reduced abatement costs. The literature to date has not satisfactorily examined whether emissions pricing properly internalizes this tradeoff between costs and benefits. And if the trend toward greater use of economic instruments in environmental policy continues, as is likely, the properties of those instruments must be understood, especially for dynamic efficiency. The authors examine incentives for adopting cleaner technologies in response to Pigouvian emissions pricing in equilibrium (unlike earlier analyses, which they contend, have been generally incomplete and at times misleading). Their results indicate that emissions pricing under the standard Pigouvian rule leads to efficient equilibrium adoption of technology under certain circumstances. They show that the equilibrium level of adopting a public innovation is efficient under Pigouvian pricing only if there are enough firms that each firm has a negligible effect on aggregate emissions. When those circumstances are not satisfied, Pigouvian pricing does not induce an efficient (social welfare-maximizing) level of innovation. The potential for inefficiency stems from two problems with the Pigouvian rule. First, the Pigouvian price does not discriminate against each unit of emissions according to its marginal damage. Second, full ratcheting of the emissions price in response to declining marginal damage as firms adopt the cleaner technology is correct expost but distorts incentives for adopting technology ex ante. The next natural step for research is to examine second-best pricing policies or multiple instrument policies. The challenge is to design regulatory policies that go some way toward resolving problems yet are geared to implementation in real regulatory settings. Clearly, such policies must use more instruments than emissions pricing alone. Direct taxes or subsidies for technological change, together with emissions pricing, should give regulators more scope for creating appropriate dynamic incentives. Such instruments are already widely used: investment tax credits (for environmental research and development), accelerated depreciation (for pollution control equipment), and environmental funds (to subsidize the adoption of pollution control equipment). Such direct incentives could be excessive, however, if emissions pricing is already in place. All incentives should be coordinated.

Suggested Citation

  • Kennedy, Peter W. & Laplante, Benoit, 1995. "Equilibrium incentives for adopting cleaner technology under emissions pricing," Policy Research Working Paper Series 1491, The World Bank.
  • Handle: RePEc:wbk:wbrwps:1491

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    References listed on IDEAS

    1. Barnett, A H, 1980. "The Pigouvian Tax Rule under Monopoly," American Economic Review, American Economic Association, vol. 70(5), pages 1037-1041, December.
    2. Lee, Dwight R., 1975. "Efficiency of pollution taxation and market structure," Journal of Environmental Economics and Management, Elsevier, vol. 2(1), pages 69-72, September.
    3. Biglaiser, Gary & Horowitz, John K, 1995. "Pollution Regulation and Incentives for Pollution-Control Research," Journal of Economics & Management Strategy, Wiley Blackwell, vol. 3(4), pages 663-684, Winter.
    4. Downing, Paul B. & White, Lawrence J., 1986. "Innovation in pollution control," Journal of Environmental Economics and Management, Elsevier, vol. 13(1), pages 18-29, March.
    5. J-J. Laffont & J. Tirole, 1994. "A Note on Environmental Innovation," Working papers 95-10, Massachusetts Institute of Technology (MIT), Department of Economics.
    6. Requate, Till, 1998. "Incentives to innovate under emission taxes and tradeable permits," European Journal of Political Economy, Elsevier, vol. 14(1), pages 139-165, February.
    7. Glenn Jenkins & RANJIT LAMECH, 1992. "Fiscal Policies To Control Pollution: International Experience," Development Discussion Papers 1992-01, JDI Executive Programs.
    8. Cropper, Maureen L & Oates, Wallace E, 1992. "Environmental Economics: A Survey," Journal of Economic Literature, American Economic Association, vol. 30(2), pages 675-740, June.
    9. Bohm, Peter & Russell, Clifford S., 1985. "Comparative analysis of alternative policy instruments," Handbook of Natural Resource and Energy Economics,in: A. V. Kneese† & J. L. Sweeney (ed.), Handbook of Natural Resource and Energy Economics, edition 1, volume 1, chapter 10, pages 395-460 Elsevier.
    10. Milliman, Scott R. & Prince, Raymond, 1989. "Firm incentives to promote technological change in pollution control," Journal of Environmental Economics and Management, Elsevier, vol. 17(3), pages 247-265, November.
    11. Malueg, David A., 1989. "Emission credit trading and the incentive to adopt new pollution abatement technology," Journal of Environmental Economics and Management, Elsevier, vol. 16(1), pages 52-57, January.
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    Cited by:

    1. Raphael Calel, 2011. "Market-based instruments and technology choices: a synthesis," GRI Working Papers 57, Grantham Research Institute on Climate Change and the Environment.
    2. Ho Shirley, 2010. "Social norms and emission tax multiple equilibria in adopting pollution abatement device," Applied Economics, Taylor & Francis Journals, vol. 42(1), pages 97-105.


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