The Role of Technology Policy in Addressing Climate Change

By Adam Jaffe, Director, Motu Economic and Public Policy Research

This article is a condensed version of “Technology Policy and Climate Change,” Climate Change Economics, 3(4) 2012. This version has also appeared in the December 2013 Motu Research Update. If you are interested in staying up to date with Motu's research please sign up to our newsletter.

Like most economists, I believe that the primary policy response to the climate change challenge must be to raise the price associated with the emission of greenhouse gases (GHGs), in order to create the appropriate economic incentives to align economic activities—production, consumption, and investment of all kinds—with the social objective.  Despite the current political controversies surrounding such policies, and the low prices currently imposed on GHGs in several jurisdictions that have implemented emissions trading systems, I believe we will eventually see significant effective prices on GHG emissions in many countries.  In this article, I argue that the implementation of such policies is necessary but not sufficient as a global response to the climate challenge.  Emissions policy should be complemented by “technology policy,” i.e. a set of actions designed to foster the creation, improvement and diffusion of new low-GHG technologies.

Measuring greehous gas emissions and absorbtion in a wheat field in Tatura. CSIRO Atmospheric Research http://scienceimage.csiro.au/image/534/measuring-gas-emissions-and-absorption-from-wheat/.

The problem is big.  As a thought exercise, consider trying to achieve a 50% reduction in the ratio of world GHG emissions to world GDP (which most models suggest would not avert significant adverse climate impacts) by 2050.  Since the “oil crisis” of the early 1970s, the ratio of world oil consumption to world GDP has been reduced by about 40%, as the price of oil has increased by more than a factor of six.  Economic theory tells us that the demand for fossil fuels as a group has to be less elastic than the demand for petroleum specifically.  This suggests strongly that it would require an enormous increase in the effective price of fossil fuels to reduce the GHG/GDP ratio as needed worldwide.  Even assuming the current policy impasses over climate change are eased, effective price increases of the needed magnitude seem very doubtful.

It’s not clear what the needed transformation will look like, but history suggests that it won’t happen without government support.  Given the magnitude of reduction in GHG intensity that is needed, it will only come about through a profound transformation in the social-economic-technological system by which we heat and cool buildings, transport people and goods, and grow and make things.  It is not clear that there is a historical analogy for change of this magnitude, but I submit that digital computation and communication have been improved over the last four decades in a way that is qualitatively comparable to the change we need in our carbon system.^[1]  And I think the analogy is instructive.  We do not calculate or communicate today with improved versions of the devices that were available for these purposes in 1970.  We use a system whose backbone infrastructure and individual components did not exist, and in important aspects were not even imagined, in 1970.  If we are going to meet the climate challenge, we are going to have to effectuate a comparably broad and deep reconstruction of our energy, transport, agricultural and industrial systems.

The information technology and digital communications transformation was fostered in significant ways by public policy around the world.  Particularly in the U.S., the government invested in both research and in acquisition of early-stage technology projects related to defense, space, and communications that accelerated technology development significantly.  Other, less extensive technological transformations such as nuclear power, commercial aviation and health care have analogous histories of government research and technology purchase in support of technological development (Henderson and Newell, 2011).  Thus, while there may be doubt as to whether any historical precedent for the needed transformation can be found, there is most certainly no historical precedent that did not involve significant explicit government support.

Theory says two market failures require two policy instruments.  From the perspective of the theory of welfare economics, the justification for carbon policy is that there is a negative externality associated with GHG emissions.  But there are wholly distinct positive externalities associated with technological innovation and diffusion.  Carbon policy does not and cannot internalize these, leaving a separate policy gap to be addressed (Popp, et al, 2010).

These externalities flow generally from the fact that knowledge is a public good (Griliches, 1992), leading to the problem of “imperfect appropriability” of the returns to new technology.  This appropriability problem is inherent both in research and development, and in the diffusion of new products, because the production and use of new products itself generates knowledge about the production process and the best product designs.  This means that in the absence of policy intervention both the research process and the market deployment of new technologies will be suboptimal (Popp, et al, 2010).

Evaluation is essential.  Theory tells us that government action to spur technology development and deployment is socially desirable, but theory tells us relatively little about which specific policy instruments are most cost-effective.  Various governments have engaged, to varying degrees, in regulations, government procurement preferences, targeted development funding, etc.  Careful empirical evaluation of such programs—which requires attention to the incremental impact of the policy over what would have occurred in the absence of the policy—would tell us which instruments work best under what circumstances (Jaffe, 2002).  We are going to be engaging in climate policy for decades.  An investment in such evaluation during the first decade could have a large impact on the effectiveness of policy in the following decades.

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[1] Other GHGs such as methane are important, but this does not affect the conclusion that huge reductions in the carbon intensity of human activity will be necessary.

References
Griliches, Zvi, 1992. “The search for R&D spillovers,” The Scandinavian Journal of Economics

Henderson, Rebecca and Richard Newell, eds., 2011.  Accelerating Energy Innovation: Insights from Multiple Sectors, University of Chicago Press

International Energy Agency (2012), RD&D Statistics, www.iea.org/stats/rd.asp

Jaffe, Adam B., 2002.  “Building Programme Evaluation into the Design of Public Research-Support Programmes,” Oxford Review of Economic Policy

Popp, David, Richard Newell and Adam Jaffe, 2010.  “Energy, the environment, and technological change,” in B. Hall and N. Rosenberg, Eds., Handbook of the Economics of Innovation, North Holland