Understanding the dynamics of clean technology: implications for policy and industry

Using an optimal control approach, I examine the effectiveness of various strategies for firms to investing in clean technology when faced with an emissions tax in a duopolistic market. Explicitly allowing for the cumulative nature of R&D, I show that emissions per unit of output are lowest when the firms cooperate in R&D, as compared to the scenarios when they compete in R&D or merge into a single entity. It is shown that R&D cooperation leads to the highest level of social welfare among the three alternative scenarios, and that a profit maximizing firm will never choose the most environmentally conscience investment strategy. In contrast to the traditional static analysis, which ignores the temporal effects associated with R&D, my dynamic analysis has implications for emission tax policy and environmental innovation to improve overall welfare.