Design, Trading, and Innovation
David M. Driesen
Proponents of economic incentives frequently state that emissions trading promotes technological innovation.1 This chapter examines the claim that this trading of compliance obligations fosters innovation. Although I use the term emissions trading throughout for the sake of concreteness, the claims made here apply fully to other kinds of environmental benefit trading
This chapter makes two theoretical claims and two empirical claims. The first theoretical claim is that emissions trading does a poorer job, in theory, of encouraging expensive innovation than traditional regulation. I will also argue that expensive innovation has special value that justifies the expense in some important cases. The second theoretical claim is that emissions trading may perform worse than traditional regulation in encouraging inexpensive innovation as well, at least in theory.2
My first empirical claim is that both emissions trading and traditional regulation have sometimes encouraged innovation and sometimes failed to do so. My second claim is that we do not have convincing empirical evidence that trading fosters innovation better than a comparably designed traditional regulation.
A casual review of the literature might lead one to assume that emissions trading's advantages in encouraging innovation are well established both in theory and empirically.3 The theory many academics mention most often, I will argue, focuses too much attention on the incentives trading creates for sellers of credits and pays too little attention to the incentives created for buyers. It also relies on a skewed picture of traditional regulation created by academic lawyers. In light of these problems with the basis for the trading encouraging innovation argument, it is not surprising