Environmental policies in the presence of more than one externality and of strategic firms

Abstract

We first study the optimality of a committed policy mix of tax and subsidy to control pollution when firms are involved in abatement technology R&D that is subject to knowledge spillovers. Then a comparison of tax and subsidy is provided when the policy mix is not available and the regulator can use only one single policy. Two different behavioral assumptions for the firms are examined: when firms are myopic, and when they are strategic, i.e. react to the ex-ante committed policies strategically. The results suggest that using a policy mix the committed regulator can attain optimality if firms are myopic, however, a strategic reaction from the firms may compromise the efficiency of the policy mix. We also show that when the policy mix is not available to the regulator and they have to commit to only one single policy, then tax policy may have some advantages over subsidy. Moreover, our results suggest that unlike the policy mix, the single policy is more effective in the case of strategic firms rather than myopic ones.

Keywords:

• Emission taxes; committed policy; policy mix; abatement technology; R
• &D; knowledge spillovers; end-of-pipe techniques

JEL classification:

• H
• 23
• H
• 21
• Q
• 53
• Q
• 55
• Q58

Disclosure statement

No potential conflict of interest was provided by the author(s).

Notes

1 In his original work, Pigou refers to these situations as incidental uncharged disservices and incidental uncharged services.

2 For a comment on these group of techniques see the Appendix A.

3 This case is referred to as ex ante regulation or commitment in some of the literature; see, e.g. Requate [2005]. It is also possible to assume that the regulator moves second by adopting the level of her policy instrument after the firms have made their choices, which is known as ex post or uncommitted regulation. But we set aside the latter assumption and focus only on the case of a committed regulator. Also note that, in a survey of the literature, Requate [2005] concludes that ex post regulation is always time consistent. This may make the latter assumption of less interest to investigate (Requate 2005).

4 An alternative assumption is considering an imperfectly competitive, e.g. an oligopoly, set-up for the product market. However, we leave this assumption and just work with the perfectly competitive assumption in order to be able to merely focus on the impact of strategic reaction of firms to the policies.

5 Note that $e_i(0,0)$ is the emissions per unit of burning R without any R&D investment in new technologies. When a firm invests in new technologies, i.e. A_i > 0, then the actual pollution discharged into the environment per unit of energy resource decreases.

6 As per the assumption made for the firms, the price of the product is normalized to one.

7 Here, we can use this comparison directly without solving the social planner’s problem for optimal policies due to the assumption that the regulator is committed to the announced regulations and will not act as a Stackelberg leader.

8 This is the result of considering homogeneous pollution and an identical impact by emissions on the environment, regardless of the source. One example is CO2, where the marginal damage imposed by pollution does not depend on the location of its emission and reception.

9 Note that we assume that firms are selling their product in a perfectly competitive international market; however, if the number of domestic firms is limited they can act strategically toward domestic regulations and this assumption is not in contradiction with firms being part of a perfectly competitive international market.

10 If there is no policy in effect, then the firm’s choice of investment in new abatement technologies will be nil. That’s why when it comes to the first-order condition for the investment on the right-hand side, there are only policy impacts.

11 See Appendix B for more details.