Despite growing empirical evidence of the link between environmental policy and innovation, most economic models of environmental policy treat technology as exogenous. For long-term problems such as climate change, this omission may be significant. In this paper, I modify the DICE model of climate change (Managing the Global Commons: the Economics of the Greenhouse Effect, MIT press, Cambridge, MA, 1994; Warming the World: Economic Models of Global Warming, MIT press, Cambridge, MA, 2000) to allow for induced innovation in the energy sector. Ignoring induced technological change overstates the welfare costs of an optimal carbon tax policy by 9.4%. However, cost savings, rather than increased environmental benefits, appear to drive the welfare gains, as the effect of induced innovation on emissions and mean global temperature is small. Sensitivity analysis shows that potential crowding out of other R&D and market failures in the R&D sector are the most important limiting factors to the potential of induced innovation. Differences in these key assumptions explain much of the variation in the findings of other similar models.
- Climate change
- Endogenous technological change
- Induced innovation
ASJC Scopus subject areas
- Economics and Econometrics
- Management, Monitoring, Policy and Law