Optimal CO2 Abatement in the Presence of Induced Technological Change

This paper explores the significance of policy-induced technological change for the design of carbon-abatement policies. We derive analytical expressions characterizing optimal CO2 abatement and carbon tax profiles under different specifications for the channels through which technological progress occurs. We consider both R&D-based and learning-by-doing-based knowledge accumulation, and we examine each specification under both a cost-effectiveness and a benefit–cost policy criterion. We show analytically in a cost-effectiveness setting that the presence of induced technological change (ITC) always implies a lower time profile of optimal carbon taxes. The same is true in a benefit–cost setting as long as damages are convex in the atmospheric CO2 concentration. The impact of ITC on the optimal abatement path varies. When knowledge is gained through R&D investments, the presence of ITC justifies shifting some abatement from the present to the future. However, when knowledge is accumulated via learning-by-doing the impact on the timing of abatement is analytically ambiguous. Illustrative numerical simulations indicate that the impact of ITC upon overall costs and optimal carbon taxes can be quite large in a cost-effectiveness setting but typically is much smaller under a benefit–cost policy criterion. The impact of ITC on the timing of abatement is very slight, but the effect (applicable in the benefit–cost case) on cumulative abatement over time can be large, especially when knowledge is generated through learning-by doing.