Voluntary Approaches and the Organisation of Environmental R&D

The present paper uses a setting where firms commit to environmental R&D expenditure that reduces their emission levels before the regulator sets the emission tax. It examines two scenarios with respect to the organisation of environmental R&D: (i) independent R&D and (ii) an industry-wide environmental R&D Cartel (ERC). In the first scenario (1) firms choose their emission-reducing R&D non-cooperatively, (2) the regulator sets the emission tax and (3) firms compete in the market by choosing quantities. In the second scenario both the second and third stages remain the same, however, in the first stage firms form an industry-wide ERC that cooperatively undertakes environmental R&D. Thus, in both R&D scenarios, the regulator follows a time-consistent policy; this corresponds to the case where the regulator is unable to commit credibly to the emission tax. It is shown that for relatively small damages, environmental innovation is higher in the case of an ERC compared to independent R&D, while for relatively large damages the opposite is true. The same ranking applies to the comparison of social welfare. However, firms always have an incentive to be part of an industry-wide ERC as this increases their profitability