Can environmental policy encourage investment in research and development?

Policies that support cleaner production technologies can lower climate change risks and environmental problems without hurting the economy in the long run. However, there is limited evidence on how these policies motivate companies to invest in clean technologies. This Misum Academic Insight examines how taxes on emissions can affect technology spending in highly polluting companies.

This Misum Academic Insight is based on the research article “Can Environmental Policy Encourage Technical Change? Emissions Taxes and R&D Investment in Polluting Firms” published in The Review of Financial Studies. The paper was ‘highly recommended’ by the Financial Times in their Academic research award: tipping point for action.

Policies promoting cleaner production technologies have sparked research on their impact on developing cleaner products, but less attention has been given to how they incentivize polluting firms to invest in transformative technologies. The study examines the influence of emission taxes on technology spending in highly polluting firms, focusing on sulfur oxide (SOx) emissions and research and development (R&D) investment.

The findings show that higher SOx taxes significantly increase firm-level R&D spending in sectors with dirtier production technologies. However, pollution taxes were not found to not drive more patenting, indicating that firms focus their R&D investments on acquiring and utilizing external knowledge. The R&D response to pollution taxes is concentrated in sectors where acquiring external knowledge is more feasible.

The research contributes to the empirical literature on how innovative activity responds to environmental policies and regulations. New evidence on the micro-level linkages through which market-based environmental policies can influence technical change are provided. The study shows that tax policy can also encourage the technology investments which allow firms to broadly overhaul the way they produce, in order to reduce pollution at the source. In practical terms, the findings indicate that when faced with higher emissions taxes, firms with polluting production technologies tend to prioritize investment in their ability to adopt and utilize new technologies.

Read the Misum Academic Insight here.

Authors

Christian Thomann, Research Affiliate in the Sustainable Finance Initiative and Associate Professor at KTH

Gustav Martinsson, Research Affiliate in the Sustainable Finance Initiative and Associate Professor at Stockholm University

James Brown, Professor at Ivy College of Business, Iowa State University