Environmental Policy and Technical Change: A Survey

In this survey we review the literature that studies the relationship between environmental policy and technical change. We divide the literature in two broad areas of research. First, we look at the studies that evaluate the impact of environmental regulation on technological change after the implementation of environmental policy ( ex-post ). Second, we introduce the studies that assess the impact of environmental regulation on innovation dynamics before the implementation of environmental policy ( ex-ante ). While the first group is dominated by econometric work, in the second group we find the fast growing literature based on Integrated Assessment Models (IAMs) created to study the policies to limit global warming. Both ex-post and ex-ante studies corroborate the hypothesis that environmental policy plays an important role in inducing innovation and in increasing the adoption as well as the diffusion of new technologies. Policy experiments carried out using Integrated Assessment Models highlight that the size and the direction of the inducement effect depend on at least three elements. First, relative prices play an important role, but also scale and market size effects are relevant in shaping incentives to innovate. Second, the inducement effect can vary across different R&D programs and with the degree of policy stringency. Third, nearly all studies stress the role of substitution in terms of flexibility, either within the energy sector, between energy and other inputs such as labour or capital, or between final sectors with different energy intensities. A relevant lesson that should be communicated to policy makers is the importance of combining efficiently policies to address the environmental and the knowledge externalities. Areas in which there is room for more research are mentioned throughout the survey. They include the need of exploiting better cross-country dimension of recent panel data sets, launching a new comprehensive assessment of the determinants of eco-friendly innovation in developing countries, assessing the interactions between "clean" and "dirty" R&D, testing whether firms are operating at the frontier of efficiency or not.