The Environment and Directed Technical Change: Acemoglu et al.

Acemoglu, Aghion, Bursztyn, and Hemous put out an interesting NBER Working Paper last October. The abstract is below. They carry out a simulation which shows that a carbon tax alone is significantly inferior in terms of loss of consumption to a combination of a carbon tax and clean technology development subsidy. Results depend on the elasticity of substitution between dirty and clean inputs and the discount rate. If the elasticity of substitution is 10 then temperature never rises by more than 1.76C irrespective of the discount rate and a carbon tax only policy costs 0.92 to 1.55% of consumption relative to the optimal policy depending on the discount rate. But lower elasticities of substitution (5 or 3) make a carbon tax worse (2-4% consumption loss) and result in catastrophic climate change (7-8C) under higher discount rates (1 to 1.5% rate of time preference, latter is Nordhaus' choice).

It is likely that the interfuel elasticity of substitution is greater than unity. But, based on my research I think it is very unlikely to be as high as 5 or 10.

Based on this research more attention should be paid to combining innovation policy with a carbon tax. This is a position that is, I believe, advocated by Roger Pielke among others. But it also shows that there can be a huge difference between using discount rates as high as 0.015% rather than the 0.001% favored by Nicholas Stern in assessing climate policy.

There is a lot more besides this in the paper including the effects of delay and non-renewable resources and the problem of global policy coordination,

Abstract
This paper introduces endogenous and directed technical change in a growth model with environmental constraints and limited resources. A unique final good is produced by combining inputs from two sectors. One of these sectors uses "dirty" machines and thus creates environmental degradation. Research can be directed to improving the technology of machines in either sector. We characterize dynamic tax policies that achieve sustainable growth or maximize intertemporal welfare, as a function of the degree of substitutability between clean and dirty inputs, environmental and resource stocks, and cross-country technological spillovers. We show that: (i) in the case where the inputs are sufficiently substitutable, sustainable long-run growth can be achieved with temporary taxation of dirty innovation and production; (ii) optimal policy involves both "carbon taxes" and research subsidies, so that excessive use of carbon taxes is avoided; (iii) delay in intervention is costly: the sooner and the stronger is the policy response, the shorter is the slow growth transition phase; (iv) the use of an exhaustible resource in dirty input production helps the switch to clean innovation under laissez-faire when the two inputs are substitutes. Under reasonable parameter values (corresponding to those used in existing models with exogenous technology) and with sufficient substitutability between inputs, it is optimal to redirect technical change towards clean technologies immediately and optimal environmental regulation need not reduce long-run growth. We also show that in a two-country extension, even though optimal environmental policy involves global policy coordination, when the two inputs are sufficiently substitutable environmental regulation only in the North may be sufficient to avoid a global disaster.