Evaluating the Relative Effectiveness of Economic Incentives and Direct Regulation for Environmental Protection: Impacts on the Diffusion of Technology

The views expressed in this paper are those of the authors, and publication does not imply their endorsement by CSIA or Harvard University. This paper may be reproduced for personal and classroom use. Any other reproduction is not permitted without written permission of the Center for Science and International Affairs. EXECUTIVE SUMMARY The effect of public policies on technological change may, in the long run, be among the most important determinants of success in environmental protection. In this paper, we develop a new framework for analyzing the diffusion of environmentally desirable technology. This framework can be used to compare quantitatively the effectiveness of direct regulation and economic-incentive approaches to environmental protection in fostering adoption of energy-conserving technologies, a particularly important issue in the context of greenhouse-gas emissions and the threat of global climate change. We develop a dynamic model of the adoption decision faced by an individual who must determine whether and at what time to invest in an existing energy-saving technology. First-order, necessary conditions emerge which are aggregated into a model which can be econometrically estimated with aggregate data, by taking account of unobserved heterogeneity among households. Econometric estimation results can be used in factual and counterfactual simulations to investigate the implications of alternative policy mechanisms. In this working paper, we simply develop an initial formulation of the underlying theoretical model of technological adoption, and we demonstrate how it can yield an econometrically estimatable model of the diffusion process. Our purpose here is to solicit feedback regarding the general framework and specific theoretical specification which we propose. Subsequently, we intend to carry out econometric estimation of a refined model's parameters with data on the use of various energy-conserving building practices, and thereby to examine a set of hypothesis regarding the relative effectiveness of economic incentives and direct regulation for environmental protection in terms of their impacts on the diffusion of technology.