Rik Rozendaal (Leiden University): "Market power, innovation, and the green transition "

Abstract:

This paper studies the relationship between climate policy, market power and innovation. Using linked data on patent applications and firms' balance sheets, I find empirical evidence that (i) the direction of innovation is path dependent, and (ii) firms with a higher degree of market power are, on average, more invested in dirty technologies than their direct competitors. These findings suggest that climate policy affects market leaders and laggards differently. I then develop a model of directed technical change and the environment with strategic interaction between competing firms. Firms compete for market power by innovating in clean or dirty technologies. A carbon tax can decrease the effective technological distance between two competitors, and thus affects both the intensity and the direction of innovation. In the model, the increase of a carbon tax can sharply increase clean innovation while also increasing dirty innovation by some firms. Calibration results show that the transition to a green economy may temporarily decrease aggregate market power, as measured by the average markup, by strengthening competition in markets, and lead to an overall increase in innovation.