“It’s all in the Mix!” – Internalizing Externalities with R&D Subsidies and Environmental Liability
This is one of the “ tales of two market fai lures”: we consider a setting where firms generate environmental externalities and may invest into environmentally friendly technical change generating R&D spillovers. We analyse the joint use of environmental liability law and R&D subsidies to internalize the double externality. Two alternative liability rules are considered, strict liability and negligence. In a complete information scenario, the social optimum in terms of pollution abatement and technical progress may be induced by combining either liability rule with an appropriate R&D subsidy . However, if the policy maker has incomplete information with respect to the firm’s productivity of R&D investments and if he non- discriminatorily sets a uniform liability rule and a uniform subsidy, if at all only the so-called double negligence rule that uses an abatement and a technology standard may induce the social optimum. The double negligence rule dominates strict liability with respect to the goal of minimizing social costs under a mild condition also in those cases in which none of the liability rules is able to induce firstbest behavior of firms. Somewhat counterintuitively the non- discriminatory double negligence rule may even dominate a (simple as well as a double) negligence rule with type-specific norms and compliance-contingent type-specific subsidies.
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