Technology and the Economics of Climate Change Policy

Climate change policy analysis is fraught with uncertainty and controversy, but at least one thing is perfectly clear: technological innovation is the key to addressing climate change. Moving the economy to a greenhouse – friendly future will necessitate a profound economic transition – a transition that simply cannot come to pass without technological progress.

In this report, an impressive team of economists led by Jae Edmonds and Joe Roop explains how economic models of climate change take technological innovation into account. The authors demystify a highly technical subject that is essential to sound policy formulation, raising five central insights:

  • All future projections of technological change are a matter of assumption. Much is known about how technological change has occurred in the past and what will drive it in the future. However, all projections require assumptions about the future role of technological change in the way the economy grows, in the way energy is used, and in the options available as alternatives to fossil fuels.
  • Technological progress reduces the cost of climate change mitigation. This result is robust across a broad range of model types and assumptions.
  • Significant technological progress occurs over long time horizons. This fact should be taken into account in establishing lead times for climate policies.
  • Policies and prices can “induce” technological change. Thus both policy-makers and businesses play a major role in fostering technological change.
  • Modeling “induced” technological change (that is, change stimulated by climate policies or price changes) is important because it more closely reflects reality. However, modeling this phenomenon is in its infancy.

This report on technological change addresses one of the factors identified by the Pew Center as having the largest influence on economic modeling results. An earlier Center report, “An Introduction to the Economics of Climate Change Policy,” by John Weyant describes the five factors, which include: how baseline greenhouse gas projections are measured, what climate policies are considered, how the substitution of goods and services by producers and consumers is represented, and whether and how GHG reduction benefits are addressed. Two other Pew Center reports explore in detail the role of climate policies, with an emphasis on international emissions trading, and the role of substitution in determining the outcome of economic modeling.

The Center and the authors appreciate the valuable insights of several reviewers of early drafts of this paper, including Nebojsa Nakicenovic, Ian Parry, and Alan Sanstad. Special thanks are due to Ev Ehrlich for serving as a consultant for the Center’s economics series and to Judi Greenwald for her editorial assistance.