While the impact of increasing concentrations of greenhouse-gases in the atmosphere on the climate system cannot be accurately predicted, there is a non-trivial risk that beyond some ex-ante unknown tipping points – in terms of greenhouse-gas concentration and/or global temperature – irreversible and highly expensive events might unfold. This calls for quick action to reduce the probability that such tipping points will be passed2. Consequently, annual greenhouse gas emissions will have to be reduced dramatically before 2050. In order to stabilize CO2 concentrations at about 450 ppm3 by 2050, global emissions would have to decline by about 40-70% by 2050.
Such aggressive decarbonisation on a global scale will require an international agreement because otherwise fossil fuels not used in some countries will simply be used in other countries4. And we cannot wait until low-carbon technologies become cheaper than expiring fossil fuels because, in particular, the last percentage points of cost advantage that fossil fuels have will be difficult to overtake without a price on carbon5. But an agreement is only feasible and stable if the climatebenefit for each country exceeds the cost. The cost of decarbonisation essentially depend on the cost of low-carbon technologies. Consequently, reducing the cost of these technologies in Europe not only allows for cheaper domestic decarbonisation and for a competitive edge to be gained in selling these technologies overseas, but most importantly it would strongly facilitate an international agreement.
Without public intervention, European companies will under-invest in low-carbon innovation for three reasons: (i) in all sectors, innovators cannot reap the full benefits of their innovation because good ideas might be used to enhance productivity beyond the product made by the original inventor (e.g. by inspiring new innovation or being merely copied by competitors). No company will invest in a project for which the expected return is below the upfront investment, even if the societal benefits exceed the initial investment cost. (ii) The European carbon price is likely to be below the social cost of carbon and there is no sufficient long-term visibility of the carbon price-signal. As companies will
only invest in technologies that mitigate CO2 emissions at a cost below the carbon price, investments in technologies with higher abatement cost (e.g. carbon capture and storage) are not brought forward, even though they might be needed to mitigate climate change. (iii) Low-carbon technologies are most competitive in markets where greenhouse-gas emissions are regulated.
Hence, even though emissions outside the EU are as bad for the planet as emissions within the EU, companies invest at less than socially-optimal levels in developing low-carbon technologies, because they do not receive extra remuneration for the ability of their technology to reduce emissions in markets that do not regulate emissions.
The policy question hence is: how can the EU overcome in the most efficient way these market failures that hold back low-carbon innovation. We first provide some evidence that companies that do ‘green innovation’ appear not to be different from other innovators. Then we discuss what public policies are used to support low-carbon innovation and where we see room for improvement.