Screening green innovation through carbon pricing

Abstract

Effective climate change mitigation requires green innovation, but not all projects have equal social value. We examine the role of innovation heterogeneity in a model where the policy maker cannot observe innovation quality and directly subsidize the socially most valuable green innovations. We find that carbon pricing works as an innovation screening device; this creates a premium on the optimal carbon price, raising it above the Pigouvian level. We identify conditions for perfect screening and generalize results to screening policies under alternative intellectual property regimes and complementary policies. A calibration reveals that screening can justify a carbon price that is up to three times the Pigouvian price.