Innovation-Led Transitions in Energy Supply

I generalize a benchmark model of directed technical change to allow innovations and factors of production (here energy resources) to be substitutes or complements. I show that a dominant sector is forever locked-in under substitutability but researchers' market incentives can drive a transition away from a dominant sector under complementarity. In a calibrated numerical implementation to climate change policy, transitions from coal to gas and then to renewable energy occur in laissez-faire. Optimal policy uses a subsidy for clean R&D to hasten the transition to renewable energy and an increasing emission tax to control residual fossil fuel use. A standalone clean research subsidy is more valuable than a standalone emission tax unless climate change is especially costly or policy cannot be enacted soon. A standalone mandate to use renewable energy can also increase welfare by igniting an energy transition, but only if it is sufficiently large