CAN ENVIRONMENTAL POLICIES PROMOTE THE DEVELOPMENT OF CLEANER TECHNOLOGIES?
Environmental policy has been an essential tool for addressing environmental problems worldwide. One of the critical issues policymakers face when designing environmental policies is their potential impact on technological change. The question is, can environmental policies promote the development of cleaner technologies? Calel and Dechezlepretre [1] explore the relationship between environmental policy and directed technological change in the context of the European Union Emissions Trading System (EU ETS). At present, the EU ETS is the largest cap-and-trade program in the world. However, there are many countries that either already implemented or are discussing a cap-and-trade program. In 2011 global carbon markets were worth over $175 billion. According to the World Bank’s State and Trends of Carbon Pricing Report [2] the share of global greenhouse gas (GHG) emissions that is covered by carbon pricing systems has increased from 5% in 2011 to 23% in 2022.
The European Carbon Market
The EU ETS is a cap-and-trade system designed to reduce GHG emissions in the European Union (EU). It was launched in 2005, and it covers approximately 40% of all GHG emissions in the EU. The system works by setting a cap on the total amount of GHG emissions that can be produced by participating firms. Each firm receives an allocation of permits that allows them to emit a certain amount of GHG. If a firm exceeds its allocation, it must purchase additional permits from other firms. The price of these permits is determined by market forces, and it provides a financial incentive for firms to reduce their GHG emissions. The average price between 2005 and 2009 was around ten euros, and estimates suggest that the system reduced emissions by three to six percent compared to a business-as-usual scenario between 2005 and 2007. In 2022 the price surpassed one hundred euros and has stabilized on a high level ever since, meaning that the cost of polluting reached a new record high [2]. The goal of the EU ETS is not only to provide incentives to reduce GHG emissions but also to incentivize low-carbon innovation, as new technologies can reduce the long-term costs of reducing emissions.
Data and Research Design
Calel and Dechezlepretre used a dataset that covers over thirty million firms in the EU to investigate the impact of EU ETS on the direction of technological change. They identified over 5’500 companies accounting for over 80% of the EU ETS-wide emissions in their dataset. Additionally, the dataset contains information on the amount of GHG emissions, the number of patents, and the amount of investment in research and development (R&D) for each firm. The authors can identify and compare unregulated and would-be regulated firms before and after the launch of EU ETS. They used a matched difference-in-difference method to compare the behavior of firms that were subject to the EU ETS with those that were not. This method could be applied, as the EU ETS was designed to cover only large installations. Hence, there are firms that possess very similar characteristics, with the only difference being that one has an installation that is just large enough to be covered by the EU ETS while the other firm’s largest installation lacks the necessary size. The researchers are only able to find a suitable match for 3’428 out of the over 5’500 companies registered with the EU ETS. The other firms did not have a twin in the control group to be matched with. As a result, the researchers are forced to decrease the size of their sample. The researchers proxy low-carbon innovation by leveraging the low-carbon patenting classification of the European Patent Office (EPO). Since 1978 over 2.5 million patents have been filed with the EPO, but only 2% have been classified as low-carbon inventions.
Results
The authors found that the EU ETS had a significant impact on the direction of technological change. Firms subject to the EU ETS increased their investment in R&D and patented more clean technologies than firms that were not subject to the policy. This suggests that the EU ETS had a positive effect on directed technological change towards cleaner technologies. This positive effect is also clearly visible in the figure below. Before the launch of the EU ETS cap-and-trade program in 2005 the two groups followed a similar path, but ever since the launch the companies that are part of the program file more low-carbon patents.
Statistically speaking, the researchers estimate that if the results are extrapolated to the whole sample of firms that are subject to EU ETS, then the EU ETS treatment leads to a statistically significant increase of 9.1% in patenting activity or in absolute numbers to 183 additional patents. These 183 patents account for a 0.8% increase in the total amount of low-carbon patents filed at the EPO compared to the counterfactual. Additionally, the researchers control whether the EU ETS led to a crowding out of other innovation, proxied by a reduction of other patenting activity. However, they find that, if anything, the EU ETS led to a slight increase in other patenting activity, i.e., to a 0.8% increase or 541 additional patents. These results mean that the EU ETS did not crowd out other patenting activity, and it disproportionately impacted low-carbon patenting. Hence, the findings are promising for policymakers who are interested in promoting a cleaner and more sustainable economy, as it seems that a Carbon Market has a significant positive impact on R&D investment and low carbon patenting. Therefore, serving as an instrument that promotes directed technological change towards cleaner technologies.
Limitations
Calel and Dechezlepretre note that their study has some limitations. For example, their analysis only covers the European Carbon Market, and the findings may not apply to other environmental policies or other regions. In other words, it is unclear if their study is externally valid. Additionally, they note that they can only explain 2% of the post-2005 low-carbon patenting surge in Europe with the EU ETS.
Areas for Further Investigation
First, it would be an interesting investigation to look for the other factors that contributed to the surge in low-carbon patenting. This could enable policymakers to make more informed decisions. Second, the price of carbon permits has considerably increased in the past couple of years. Thus, it would be interesting to study how the impact of the EU ETS on innovation changed due to the significantly higher permit prices.
Conclusion
In summary, the paper by Calel and Dechezlepretre provides evidence that environmental policies can promote directed technological change towards cleaner technologies. The authors found that the EU ETS had a significant impact on the direction of technological change, increasing investment in R&D and patenting more clean technologies. This study provides valuable insights for policymakers who are interested in promoting a cleaner and more sustainable economy, and it suggests that the policymakers can learn from the EU ETS. Nonetheless, the paper also shows that the effects on the pace of technological change on the aggregate level are negligible, as only a few firms are affected by the cap-and-trade program.
Sources:
[1] Calel, Raphael and Dechezlepretre, Antoine (2016) Environmental policy and directed technological change: evidence from the European carbon market. Review of Economics and Statistics, 98 (1). pp. 173-191. ISSN 0034-6535
[2] World Bank. 2022. State and Trends of Carbon Pricing 2022. State and Trends of Carbon Pricing;. © Washington, DC: World Bank.