Environmental Policy Choice under Uncertainty

Market-based instruments are believed to create more efficient incentives for firms to adopt new technologies than command-and-control policies. We compare the effects of a direct technology regulation and of an adoption subsidy under asymmetric information about the costs of technological advances in pollution control. We show that the policy maker may want to commit to her policy. The reason is that uncertainty about adoption costs induces the policy maker to set subsidy levels that increase over time; firms, expecting higher subsidies in the future, postpone investment. Direct regulation offers a commitment possibility that allows to prevent firms from postponing investment.