## Tuesday, November 2, 2010

### Carbon Price vs Technology (R&D) Initiatives

This coming in a few days late, but Rob Stavins continues with his series of excellent posts on environmental economics and policy instruments. In his most recent column, he discusses the need for substantive climate policy to go beyond the view that we should either establish a carbon price or pump money into technology R&D. Instead of being seen as substitutes, these two policy alternatives should be viewed as compliments to achieve meaningful emissions reductions...

Both are necessary but neither is sufficient:
For many years, there has been a great deal of discussion about carbon-pricing – whether carbon taxes or cap-and-trade – as an essential part of a meaningful national climate policy. It has long been recognized that although carbon-pricing will be necessary, it will not be sufficient. Economists and other policy analysts have noted that policies intended to foster climate-friendly technology research and development (R&D) will also be necessary, but likewise will not be sufficient on their own.
Stavins then lists some of the key elements that make a carbon price and technology polices, respectively, important.

For the former, his basic argument is that a carbon price (i.e. carbon tax or cap-and-trade) internalises the negative externalities of CO2 at the least cost to society; something widely agreed on by economists. It does this by establishing a level playing field that allows for decentralised decision-making by firms on how best to reduce their own emissions, while also overcoming problems of pollution heterogeneity. (In economics jargon, a carbon tax or cap-and-trade can ensure that marginal costs of abatement are equalised across producers... Which basically just means that we cut our pollution as efficiently as possible.)

However, while a carbon price is the most cost-effective means of reducing CO2 emissions, it falters in other areas... most importantly "R&D market failure". This essentially refers to the fact that firms are unwilling to make the necessary (i.e. efficient) levels of investment in R&D, because they won't capture the spillover effects that accrue to other firms from pioneering new technology. To bring it back to economic jargon, this time we are faced with a positive externality that is not sufficiently exploited. Or, as one of the top executives at Statoil put it when referring specifically to Carbon Capture and Storage (CCS): "There is a first-mover disadvantage, as the one who builds (later) will not make the same mistakes and learn from others."

In other words, we probably need active technology polices that aim to foster innovation and R&D directly. Stavins doesn't readily name many examples in his post, but they include things like targeted investment support and government research, as well as feed-in schemes for alternative energy sources. These issues all fall within the category of innovation economics, which is a very interesting field. (Unfortunately, the wiki entry on innovation economics that I've linked to here is pretty poor in my opinion. Nothing on lock-in and path dependencylearning effects and learning-by-doing, spillovers and network effects,...)

Before wrapping this post up, I'll say that focusing on direct technology support and investment has become increasingly popular recently. To name one prominent example, controversial environmental commentator Bjørn Lomborg raised more than a few eyebrows when he called for the establishment of a $100bn climate fund in late August... to be funded by a$250bn carbon tax, no less. (No matter how some sceptics were trying to frame it, this was certainly a stark departure from his previous position that climate change did not seem to warrant dramatic mitigating action, as this wouldn't yield a profitable return on investment.)

THOUGHT FOR THE DAY: Sometimes two weapons are better than one. Just ask He-Man...

 Gun? Check! Sword? Check!

1. I think it would be difficult to use the "first mover disadvantage" argument, considering that most national politicians tend to argue for R&D investment on a "first mover advantage" argument, saying that "we must do it now in order to not be left behind." After all, if the first mover disadvantage effect really outweighs the first mover advantage, could not an opposition politician then argue that it makes sense for their own country to sit back and let some other country pay for the R&D?

2. John,

Thanks for your comments. I don't wish to speak on behalf of politicians; who, of course, can be a fickle bunch and will try to sell the argument in any number of ways. However...

Your point hints to one of the biggest problems inherent in the climate debate: The problems of free-riding in the global commons. Witness the blame-game being played out between US and China during the recent Kyoto and Copenhagen talks, which have gotten us nowhere. For their part, EU nations have taken a largely ethical stance in proposing ambitious climate policies. In other words, developed countries have historically produced most of the world's carbon and should therefore take the lead in coming up with solutions... Even if others stand to benefit from their efforts.

Of course, diffusion of technology could be thought of as one way to combat the problems of carbon leakage, which will always be a reality in a world where some countries refuse to implement a national carbon price. (Incidentally, that is actually a primary focus of this paper... search for the discussion of North-South policy co-ordination.)

So, yes, I certainly agree that people can - and do - make the argument that we should simply sit back and let others do the hard work in developing breakthrough, low-carbon technologies. That is the unfortunate nature of common-pool resources and it leads to ruin... Unless you establish some level of co-ordination to overcome it. That is why ethics features so highly in the climate debate and also why public-private R&D partnerships will be so crucial in moving forward.

No anonymous comments please. (Pseudonyms are fine.)