Adopt or innovate: understanding technological responses to cap-and-trade

Environmental regulations have consistently been found to spur innovation in ‘clean’
technologies, with one significant exception. Past cap-and-trade programs have encouraged
adoption of existing pollution control technologies, but had little effect on
innovation. Several explanations have been offered, including secondary market failures
and a lack of polluter sophistication. In this paper I argue that it likely has more to
do with the state of the technologies. Using a newly constructed panel of British companies,
I show that the European carbon market—the world’s largest cap-and-trade
program—has, contrary to past experience, encouraged innovation rather than adoption.
I discuss how these contrasting findings can be reconciled, and the implications
for planned reforms.