Market failures associated with environmental pollution interact with market failures associated with the innovation and diffusion of new technologies. These combined market failures provide a strong rationale for a portfolio of public policies that foster emissions reduction as well as the development and adoption of environmentally beneficial technology. Both theory and empirical evidence suggest that the rate and direction of technological advance is influenced by market and regulatory incentives, and can be cost-effectively harnessed through the use of economic-incentive based policy. In the presence of weak or nonexistent environmental policies, investments in the development and diffusion of new environmentally beneficial technologies are very likely to be less than would be socially desirable. Positive knowledge and adoption spillovers and information problems can further weaken innovation incentives. While environmental technology policy is fraught with difficulties, a long-term view suggests a strategy of experimenting with policy approaches and systematically evaluating their success.

Environmental policy discussions increasingly focus on issues related to technological change. This is partly because the environmental consequences of social activity are frequently affected by the rate and direction of technological change, and partly because environmental policy interventions can themselves create constraints and incentives that have significant effects on the path of technological progress. This chapter summarizes current thinking on technological change in the broader economics literature, surveys the growing economic literature on the interaction between technology and the environment, and explores the normative implications of these analyses. We begin with a brief overview of the economics of technological change, and then examine theory and empirical evidence on invention, innovation, and diffusion and the related literature on the effects of environmental policy on the creation of new, environmentally friendly technology. We conclude with suggestions for further research on technological change and the environment.

The relationship between technological changeand environmental policy has receivedincreasing attention from scholars and policymakers alike over the past ten years. This ispartly because the environmental impacts ofsocial activity are significantly affected bytechnological change, and partly becauseenvironmental policy interventions themselvescreate new constraints and incentives thataffect the process of technologicaldevelopments. Our central purpose in thisarticle is to provide environmental economistswith a useful guide to research ontechnological change and the analytical toolsthat can be used to explore further theinteraction between technology and theenvironment. In Part 1 of the article, weprovide an overview of analytical frameworksfor investigating the economics oftechnological change, highlighting key issuesfor the researcher. In Part 2, we turn ourattention to theoretical analysis of theeffects of environmental policy ontechnological change, and in Part 3, we focuson issues related to the empirical analysis oftechnology innovation and diffusion. Finally,we conclude in Part 4 with some additionalsuggestions for research.

We develop a methodology for testing Hicks's induced innovation hypothesis by estimating a product-characteristics model of energy-using consumer durables, augmenting the hypothesis to allow for the influence of government regulations. For the products we explored, the evidence suggests that (i) the rate of overall innovation was independent of energy prices and regulations; (ii) the direction of innovation was responsive to energy price changes for some products but not for others; (iii) energy price changes induced changes in the subset of technically feasible models that were offered for sale; (iv) this responsiveness increased substantially during the period after energy-efficiency product labeling was required; and (v) nonetheless, a sizable portion of efficiency improvements were autonomous.

We develop a framework for thinking about the 'paradox' of very gradual diffusion of apparently cost-effective energy-conservation technologies. Our analysis provides some keys to understanding why this technology-diffusion process i.s gradual, and focuses attention on the factors that cause this to be the case, including those associated with potential market failures - information problems, principal/agent slippage, and unobserved costs - and those explanations that do not represent market failures - private information costs, high discount rates, and heterogeneity among potential adopters. Additionally, our analysis indicates how alternative policy instruments - both economic incentives and direct regulations can hasten the diffusion of energy-conserving technologies.

As renewed attention has been given by policy makers to energy conservation issues, it has frequently been asserted that an energy-efficiency gap exists between actual and optimal energy use. The critical questions is how to define the optimal level of energy efficiency. This paper seeks to disentangle some confusing strands of argument that are frequently brought to bear on this question, by identifying the major conceptual issues that determine the set of feasible answers. We identify five separate and distinct notions of optimality: the economists' economic potential, the technologists' economic potential, hypothetical potential, the narrow social optimum and the true social optimum. Each of these has associated with it a corresponding definition of the energy-efficiency gap. Our analysis demonstrates that necessary preconditions for identifying the right measure of the energy-efficiency gap include understanding and disentangling market failure and non-market failure explanations for the gradual diffusion of energy-efficient technologies.

Concern about carbon dioxide as a greenhouse gas has focused renewed attention on energy conservation because fossil fuel combustion is a major source of CO₂ emissions. Since it is generally acknowledged that energy use could be significantly reduced through broader adoption of existing technologies, policy makers need to know how effective various policy instruments might be in accelerating the diffusion of these technologies. We examine the factors that determine the rate of diffusion, focusing on (i) potential market failures: information problems, principal-agent slippage, and unobserved costs, and (ii) explanations that do not represent market failures: private information costs, high discount rates, and heterogeneity among potential adopters. Through a series of simulations we explore how alternative policy instruments—both economic incentives and more conventional, direct regulations—could hasten the diffusion of energy-conserving technologies.

By affecting relative economic returns, public infrastructure investments can induce major changes in private land use. We find that 30 percent of forested wetland depletion in the Mississippi Valley has resulted from private decisions induced by federal flood-control projects, despite explicit federal policy to preserve wetlands. Our model aggregates individual land-use decisions using a parametric distribution of unobserved land quality; dynamic simulations are used to quantify the impacts on wetlands of federal projects and other factors.