Induced technological change and the attractiveness of CO2 abatement policies

The significance of induced technological change (ITC) for the attractiveness of CO2 abatement policies is investigated. Analytical and numerical general equilibrium models in which technological change results from profit-maximizing investments in R&D are used. It is shown that carbon abatement policies have very different impacts on R&D across industries, and do not necessarily raise the economy-wide rate of technological progress. Focusing only on the sectors with positive R&D impacts can lead to substantial under-assessment of the GDP costs of CO2 abatement policies. The presence of ITC implies lower costs of achieving a given abatement target, but it implies higher gross costs (costs before netting out environment-related benefits) of a given carbon tax. Gross costs depend importantly on the efficiency of R&D markets prior to the introduction of CO2 policies.