Work Package 4 – How to incentivise “clean” innovations

By ,

Participants: Bruegel, Imperial

The revised EU Emissions Trading System (EU ETS) has been assessed ex-ante as an engine for innovation.

According to the corresponding Impact Assessment [SEC(2010)1369], the EU ETS auction system for allocating allowances worth 30-40bn EUR strengthens incentives for innovation. However, in order to perform an ex-post evaluation of emission trading policy’s effectiveness in promoting innovation, new methods and tools must be developed. Quantitative evidence and supporting databases are needed to inform future EU ETS policies.

The EU ETS is one of the largest and most important components of the EU 2020 strategy and a key environmental policy. The Porter hypothesis suggests that tighter environmental regulations – such as the EU ETS – may lead to more innovation and thus improve competitiveness. The EU ETS may be especially relevant with respect to green innovation, as market forces alone are unlikely to provide sufficient incentives for green innovation due to the inability of private actors to internalize negative pollution externalities. In theory, a price on carbon – imposed through a tax or a cap and trade scheme (such as the EU ETS) – should correct for the externality and provide innovators with the right incentives. In practice, it is not clear if such environmental policy is effective: (1) There might be other market failures present (e.g. innovation spillovers, capital constraints), which may be worse for clean technologies than others (2) Technology lock-in may occur due to increasing returns and network effects (Accemoglu et al.) (3) Climate policy for the foreseeable future will be fairly unilateral. As a consequence, there is danger that polluting activities just move away from regulated areas, are not replaced by clean activities, and clean innovation does not occur. If, however, it can be empirically shown that unilateral policies manage to induce innovation, this can provide a powerful justification for such policies. Increased innovation in green technologies may lead to spillovers that can help to reduce emissions even in countries that have no, or less stringent climate, change policies (e.g. by making green technologies cheaper than dirty alternatives). Increases in innovation could affect the social dimension as innovation may also lead to increases in employment. Additionally, the EU ETS creates incentives to move toward green or renewable energy generation, which may lead to job creation as it has been proposed that green energy generation technologies are more labour intensive than the dirty energy jobs they replace (Wei et al. 2010).

The EU ETS provides an important test case for the ability of a market-based and unilateral scheme to induce an innovation response and/or job creation. To assess ex post whether environmental policies are costly or beneficial to competitiveness and innovation in practice, empirical tools and studies are needed. Company performance data, green patent data, and EU ETS data may be used to measure innovation efforts, carbon reduction and competitiveness over time. These data may also be used to assess the employment impacts of the EU ETS policy on covered companies. The EU ETS is operational in 30 countries and impacts the power, oil, iron and steel, glass, cement, bricks, lime, pulp, paper, board, ceramics, and lime sectors. Therefore, the employment and innovation impact of this policy would be observable across an array of sectors.

The objective is to assess the effect of emissions trading, and, in particular, the allocation of emission rights, on the innovation activities, performance, emissions, and employment levels of EU ETS firms. In order to do this, we will leverage work from an earlier Bruegel paper on EU ETS’ effect on company performance, and on a database of green patents compiled by LSE. Using the patent classification system we will also separately identify innovation likely to help reducing emissions (Clean Innovation; e.g. patents on wind turbine design).

What will be needed is the refining of these data and the linking of patent data to ETS participation and company performance data. This will result in a new policy evaluation tool, which could be utilized in the future to monitor the success of different Emission Trading System policy changes. The innovation effects measured by this new tool may also be used as a proxy for difficult-to-observe additional innovations which may potentially occur via spillovers, process improvements, or supplier linkages.