Commitment and Time Consistency of Environmental Policy and Incentives for Adoption and R&D

In this paper we survey recent developments on the incentives through environmental policy instruments to adopt advanced abatement technology. We further investigate repercussions on R&D. First we study the case where the regulator makes long-term commitments to policy levels and does not anticipate the arrival of new technology. We show that taxes provide stronger incentives than permits,auctioned and free permits offer identical incentives,and standards may give stronger incentives than permits. Second,we investigate scenarios where the regulator anticipates new technologies. We show that with taxes and permits the regulator can induce first-best outcomes if he moves after firms have invested,whereas this does not always hold if he moves first. Third,we consider a model where a polluting downstream industry is regulated either by emission taxes or by tradable permits. A separate monopolistic or duopolistic upstream industry engages in R&D and,in case of R&D success,sells an advanced abatement technology to the downstream firms. We study three different timings of environmental policy,ex post taxation (or issuing permits),ex interim commitment to a tax rate (a quota of permits) after observing R&D success but before adoption,and finally ex ante commitment before and independent of R&D success. We show that ex interim commitment always dominates ex post environmental policy. Moreover,ex interim second best taxation dominates ex interim second best optimal permit policy. There is no unique ranking,however,between ex ante and ex interim commitment. Finally we sketch ways to generalize the model to upstream duopoly.