Decarbonizing Industrial Sectors: Innovation, Market Structure, and Public Policies – DISIMS

In order to limit global warming below two degrees Celsius, as stated in the Paris Agreement, it is imperative that large and developed economies, such as Germany and France, become carbon neutral by 2050.
Achieving the necessary emission reductions will require fundamentally new production processes and technological changes. But research, development, and deployment of new technologies are often hindered by knowledge and learning spillovers, along with other market failures, leading to an underinvestment in these critical new technologies.
In addition, German and French firms compete with producers from jurisdictions where carbon emissions are less stringently regulated, creating comparative advantages for those producers. In this context, international trade not only renders European climate policy less effective—leading to so-called 'carbon leakage', where producers in less regulated economies gain competitiveness, and increase emissions—but also raises fears of deindustrialization.
While extensive literature discusses these two challenges in isolation within frameworks of perfect or monopolistic competition, remarkably little research exists at the intersection of industrial organization and environmental economics that illuminates the combination of these issues, which are crucial for a successful transformation. The interplay of imperfect competition, incomplete regulations, and knowledge spillovers complicates policy prescriptions and evaluations, potentially leading to different policy recommendations. As general second-best theory suggests, given the multiple market failures and distortions in the industrial sector, policies aimed at correcting an individual market failure might not necessarily improve welfare if additional distortions affect the equilibrium.
The first aim of the proposed theoretical research is to use insights from industrial organization to understand how environmental regulation and market structures influence firms’ incentive to innovate. Many industries contributing significantly to climate change are characterized by imperfect competition—due to high fixed costs for entry (e.g., steel, cement)— and applying models of industrial organization is crucial for an accurate analysis. However, this approach is largely absent in the literature on environmental economics. We aim to provide significant insights about the intra-industrial effects of climate and environmental policies, with a particular focus on innovation.
Second, we complement our firm level analysis with an economy-wide perspective that enables to assess aggregate welfare impacts by understanding its consequences on inter-industrial effects, international trade, as well as via other general equilibrium interactions on factor prices and subsequently demand. In contrast to the existing literature, the purpose of the proposed research is to develop, estimate and simulate structural models with both partial and general equilibrium effects of climate policies.