Voluntary Agreements and the Incentives for Innovation

Various parties have expressed serious concerns regarding the effect of environmental taxes on innovation. The argument is that innovation and investment in emission-abatement technology frequently require capital for investment. Pollution taxes siphon working capital from firms, and new investment becomes more difficult and/or more costly if it is necessary to borrow the capital from banks. In recent years, voluntary agreements have gained increased popularity and have become a central instrument in several countries' environmental policies, the Netherlands perhaps being the most notable example. A core rationale behind voluntary agreements is that they permit collective targets to be set for the entire sector, allowing for a different pace of realization of energy-efficiency improvements among the various individual companies within a sector. This provides the flexibility for firms to set their own goals in a cost-effective manner and to use their own resources to innovate and effect changes in the manner which suits them best. It has been claimed that voluntary agreements provide an improved climate for innovation. How voluntary agreements rate with regard to innovation incentives relative to environmental taxes depends on several factors, in particular the specific design of the agreement and whether the agreements are renegotiated after the market penetration of new technology. The author claims that, whatever advantages voluntary agreements have over the traditional regulatory approach, which makes mandatory particular forms of behavior or specific technological approaches, it is difficult to see that agreements would provide better incentives for innovation. Incentives for innovation may be particularly poor if the regulator requests renegotiation of the agreement with the arrival of new technology that substantially changes marginal conditions. It is proposed that if the authorities for various reasons nevertheless choose to use voluntary agreements as instruments, the agreements should be designed to be incentive-based.