Technological Diversity, R&D, and Environmental Regulation

Inducing technological change is an important objective of environmen-tal regulation. Frequently, there are several technological options that could, if developed, extenuate a given environmental problem. We consider the question how reliably policy-induced technological progress leads to the pursuit of the best technological options. We use a setting with a produc-tion and an R&D sector, with horizontal and vertical technological progress, technology-specific cost uncertainty, and time-limited patent protection. We show that only the current least-cost technology will be used and developed, if firms in the production sector are regulated with an emission tax or an emission standard. In contrast, a regulation based on permit trading can in-duce technological diversity in the production sector and thereby facilitate the development of several technologies in the R&D sector. Thus taxes and standards may lead to a technological lock-in into the current least-cost tech-nology, whereas tradable permits can avoid this problem, albeit at the cost of slower technological progress