The Environment and Directed Technical Change

TLDR: In this article, the authors characterize dynamic tax policies that achieve sustainable growth or maximize intertemporal welfare, as a function of the degree of substitutability between clean and dirty inputs, environmental and resource stocks, and cross-country technological spillovers.

Abstract: This paper introduces endogenous and directed technical change in a growth model with environmental constraints and limited resources. A unique final good is produced by combining inputs from two sectors. One of these sectors uses "dirty" machines and thus creates environmental degradation. Research can be directed to improving the technology of machines in either sector. We characterize dynamic tax policies that achieve sustainable growth or maximize intertemporal welfare, as a function of the degree of substitutability between clean and dirty inputs, environmental and resource stocks, and cross-country technological spillovers. We show that: (i) in the case where the inputs are sufficiently substitutable, sustainable long-run growth can be achieved with temporary taxation of dirty innovation and production; (ii) optimal policy involves both "carbon taxes" and research subsidies, so that excessive use of carbon taxes is avoided; (iii) delay in intervention is costly: the sooner and the stronger is the policy response, the shorter is the slow growth transition phase; (iv) the use of an exhaustible resource in dirty input production helps the switch to clean innovation under laissez-faire when the two inputs are substitutes. Under reasonable parameter values (corresponding to those used in existing models with exogenous technology) and with sufficient substitutability between inputs, it is optimal to redirect technical change towards clean technologies immediately and optimal environmental regulation need not reduce long-run growth. We also show that in a two-country extension, even though optimal environmental policy involves global policy coordination, when the two inputs are sufficiently substitutable environmental regulation only in the North may be sufficient to avoid a global disaster.

Figures

Table 1: Optimal policy for different values of ε and ρ

Figure 2: Optimal environmental policy for different values of ε and ρ = 0.01

Table 3: Welfare costs of relying solely on carbon tax as a function of the elasticity of substitution and the discount rate

Figure 6: 2 countries case: simulation of a policy that avoids a disaster under autarky but not under free trade

Figure 1: The impact of the environmental stock in our calibration and in Nordhaus’s DICE model.

Table 2: Welfare costs of delayed intervention as a function of the elasticity of substitution and the discount rate