Energy Self-sufficiency through Renewables with Endogenous Investment in R&D: The Role of Central Authority

Abstract

The energy crisis, the increase in oil prices that follows any war, inevitably leads both firms and governments to review their investment strategies in energy sources, in order to achieve self-sufficiency through renewables. This paper analyzes the strong interplay between investment in R&D and firms’ behavior in reducing oil usage in competitive markets, where firms have to pay for the energy saving technology offered by a monopolistic innovator. By assuming that innovation follows a Poisson process, whose arrival rate depends on the number of resources invested in R&D, we show that market instruments are not able to mimic central authority, which provides a higher level of social welfare, than market instruments. This is induced by the endogeneity of the R&D process. The result is similar to Denicolo (1999) and Parry (2003), although under different assumptions. However, higher taxation indeed induces more investment in R&D, as in the cited research studies.