FEEM working papers "Note di lavoro" series
2004 .156

Environmental Innovation, War of Attrition and Investment Grants


Authors: Michele Moretto, Cesare Dosi
Series: Climate Change and Sustainable Development
Editor: Carlo Carraro
Type: Journal
Keywords: Environmental innovation,Investment irreversibility,Network externalities,Investment grants,Second-price auction
JEL n.: Q28,O38
JEL: Forthcoming in International Game Theory Review
Pages: Vol 10

Abstract

The paper analyses the timing of spontaneous environmental innovation when second-mover advantages, arising from the expectation of declining investment costs, increase the option value of waiting created by investment irreversibility and uncertainty about private payoffs. We then focus on the design of public subsidies aimed at bridging the gap between the spontaneous time of technological change and the socially desirable one. Under network externalities and incomplete information about firms' switching costs, auctioning investment grants appears to be a cost-effective way of accelerating pollution abatement, in that it allows targeting grants instead of subsidizing the entire industry indiscriminately.

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