Induced Technological Change and Climate Policy

Over the upcoming decades, large-scale reductions in emissions of carbon dioxide (CO2) and other greenhouse gases (GHGs) will be required to reduce the risks of global climate change.  In order to achieve this transformation, the development and diffusion of new technologies to reduce GHG emissions will be critical.  As the world’s largest and most inventive economy, the United States must play a decisive role in the discovery, innovation, and marketing of these new technologies, and climate policies can be influential drivers in this process.

Technological change occurs for a variety of reasons as firms compete in existing and new markets.  However, climate policies can spur additional or “induced” technological change (ITC).  This can be achieved through technology “push” policies that boost the invention and innovation processes (such as funding for R&D), and through direct emissions control policies that “pull” new technologies into the market (such as a GHG cap-and-trade program).

In this report, Lawrence Goulder of Stanford University explores the role of induced technological change (ITC), and examines the implications of ITC for the effective design of climate policy.  These implications fall into four main categories: (1) how much ITC can lower the costs of climate policies, (2) what this means for the timing of policies, (3) the value of announcing policies well in advance of enactment, and (4) the most appropriate use of various policy instruments to boost technological change.  Until recently, economic models of climate change could not address these issues.  However, state-of-the-art modeling now treats ITC as an integral or “endogenous” component in calculations, thus providing new insights into this critical topic.

This report finds that all economic models that include ITC produce lower overall cost estimates for GHG reductions, especially when the climate policy is announced in advance.  Goulder also concludes that in order to reduce GHG emissions most cost-effectively, both technology-push and emissions reduction policies are required.  In addition, although studies show different implications of ITC on the overall timing of climate policy, all find that some abatement must begin now in order to jump-start the critical process of technological change.

The Pew Center and the author are grateful to Ian Parry, Richard Newell, Ev Ehrlich, Alan Manne, and Koshy Mathai for helpful comments on previous drafts of this report, and to Mark Jacobsen for his research assistance.  Previous Pew Center reports have addressed the role of technology in economics modeling (Edmonds et al.) and lessons for climate change from other U.S. programs in technology and innovation (Alic et al.). Insights from this report, together with companion papers in the Pew Center’s Economics series, are being utilized in the development of a state-of-the-art assessment of the costs to the United States of climate change mitigation.