Policy commentary

Inducing Innovation for Climate Change Mitigation

Feb 11, 2008 | Richard G. Newell

Welcome to the RFF Weekly Policy Commentary, which is meant to provide an easy way to learn about important policy issues related to environmental, natural resource, energy, urban, and public health problems.

Stabilizing global climate change at acceptable levels over the next century will require the development and wide diffusion of transformative technologies to dramatically lower the greenhouse gas emissions that result from economic activity. What is the best long-term strategy for promoting such technological change? This is the critically important issue discussed in this week's commentary by Richard Newell, one of the foremost experts on energy and environmental technology policy.
Next week, commentator Hellen Gelband will discuss the growing prevalence of MRSA.
Fossil fuels provide for over 80 percent of U.S. and global energy use, but unfortunately, also contribute the majority of greenhouse gas (GHG) emissions. Achieving the very significant reductions in GHGs that are now widely regarded as necessary would require innovation and large-scale adoption of GHG-reducing technologies throughout the global energy system. Alongside policies aimed directly at mandatory GHG emissions reductions—such as a cap-and-trade system or a carbon tax—much discussion has surrounded policies targeted at technology R&D activities and technology-specific mandates and incentives. The resulting debate is therefore not so much over the importance of new technology per se, but rather over which policies and institutions will be the most effective and efficient for achieving the technological changes and associated emissions reductions necessary for stabilizing GHG concentrations.

When considered alongside policies that impose mandatory GHG-reduction requirements, additional technology policies may not seem necessary or desirable. After all, the point of market-based approaches is to establish a price on GHG emissions. Just as people will consume less of something that carries a price than they will of something that is given away for free, attaching a financial value to GHG reductions should induce households and firms to buy technologies with lower GHG emissions the next time they are in the market (for example, a more efficient car or appliance). This market-demand pull should in turn encourage manufacturers to invest in R&D efforts to bring new lower-GHG technologies to market, just as they do for other products and processes. That is why many experts and most economists—including this one—think that establishing a market-based price for GHG emissions is the single most important policy for encouraging the innovation and adoption of GHG-reducing technologies.

But is a GHG price the only useful policy, or should we have other bows in our quiver? There are, in fact, several motivations for including additional R&D policies as complements to a pricing policy in a comprehensive strategy to address climate change. The economics literature on R&D points to the difficulty firms face in capturing all the benefits from their investments in innovation, which tend to “spill over” to other technology producers and users. This market reality can lead to underinvestment in innovative efforts—even given intellectual property protection—potentially warranting policies that directly target R&D. The problem of private-sector underinvestment in technology innovation may be exacerbated in the climate context, where the energy assets involved are often very long-lived and where the incentives for bringing forward new technology rest heavily on domestic and international policies rather than on natural market forces. Put another way, the development of climate-friendly technologies has little market value absent a sustained, credible government commitment to reducing GHG emissions.

If more stringent emissions constraints will eventually be needed, society will benefit from near-term R&D to lower the cost of achieving those reductions in the future. An emissions price that is relatively low in the near term may be inadequate to induce such innovative efforts absent very credible expectations that the policy will indeed be tightened in the future. If the politically feasible near-term emissions price (or the expected long-term emissions price) is lower than what would be best for society, market inducements for R&D on GHG-reducing technologies will also be insufficient. These motivations provide compelling rationales for public policies targeted at the R&D phases of the technology innovation process, including efforts that lower the cost and expand our options for low-GHG renewable energy, energy efficiency, nuclear power, and carbon capture and storage.

What specific policies might be useful in this regard? The R&D tax credit against corporate income has been the historical means
for encouraging greater private sector R&D—in general, not just for energy or climate. Making the R&D tax credit permanent would help to further strengthen private-sector incentives that would be induced by a price on GHG emissions—currently the credit expires and then is extended every few years. Targeting the tax credit specifically at GHG-reducing technologies would be difficult, however. Another worthwhile option is to use innovation-inducement prizes to encourage GHG-reducing innovation, by offering financial or other rewards for achieving specific technology objectives that have been specified in advance.

While increased private sector R&D is an essential part of the solution, private R&D tends to be focused on applied research and especially development. Publicly funded contracts and grants for clean energy R&D—which focuses on strategic basic research and pre-commercial applied research—are therefore important additional parts of the overall strategy. By virtue of its critical role in the higher education system, public R&D funding will continue to be important in training researchers and engineers with the skills necessary to work in both the public and private sectors to produce GHG-reducing technology innovations. This linkage has led to a recent increase in political support for expanded spending—particularly on physical sciences and engineering.

Overall, public funding for research tends to receive widespread support based on the significant positive spillovers typically associated with the generation of new knowledge. Many experts have advocated at least doubling relevant energy R&D over the next several years in order to help accelerate climate technology innovation. Translating this support into real increases in funding is more of a challenge— a challenge that could potentially be met through funds arising from a carbon tax or from a cap-and-trade system with allowance auctions.

Agreement over the appropriate role of public policy in technology development tends to weaken, however, when it comes to directed technology support for widespread technology deployment. Most economists and many other experts think that a broad-based, technology-neutral emissions price stands the best chance of guiding deployment among the wide variety of technological options at the lowest possible cost. To date, however, almost all technology-focused funding in proposed climate legislation is targeted at deployment rather than R&D.

In sum, climate technology policies are best viewed as a complement to rather than a substitute for an emissions pricing policy. But they are an important part of the climate policy portfolio, particularly if we hope to lower the cost and expand the options for significant future GHG reductions in both the United States and abroad.


Views expressed are those of the author. RFF does not take institutional positions on legislative or policy questions.

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Further Readings:

Newell, R.G. 2007. Climate Technology Research, Development, and Demonstration: Funding Sources, Institutions, and Instruments. Issue Brief 9 in Assessing U.S. Climate Policy Options. Washington, DC. Resources for the Future.

Jaffe, A.B., R.G. Newell, and R.N. Stavins. 2005. A tale of two market failures: Technology and environmental policy. Ecological Economics 54:164–174.

Jaffe, A.B., R.G. Newell, and R.N. Stavins. 2002. Environmental policy and technological change. Environmental and Resource Economics 22:41–69.