The COP26 United Nations Climate Change Conference that concluded in mid-November resulted in the commitment of billions of dollars to climate finance, to advance environmental sustainability and phase out the use of coal. The COP26 Energy Transition Council stated the aim of doubling the rate of investment in clean power by 2030.
The urgency of these issues was underlined by John Kerry, the US’s climate envoy, who called COP26 “the last best hope” to avoid the worst consequences of climate change.
However, there has been a longstanding debate on how policy affects the creation and diffusion of innovations. How exactly should public money be spent?
We sought to examine this question, looking specifically at how to best stimulate renewable energy innovation and diffusion, using data from 15 European countries.
Suppose a country, Germany, for example, had $200 million euros to invest in promoting the adoption of renewable energy systems, such as photovoltaics. Such a budget could be spent in different ways. One option is that the government could provide fiscal incentives to companies investing in innovation — i.e., in the research and development of more efficient solutions that would eventually be brought to market and possibly adopted. But this “technology-push” option might bear fruit only a few years down the line, once the new technology had been developed and commercialized.
Germany could also use its money to subsidize households willing to install photovoltaic systems already available on the market, and guarantee an advantageous price for the sale of excess electricity back to the grid — called feed-in tariffs (something that Germany did, in fact, implement). This “demand-pull” mechanism obviously favors existing technology, already on the market, and it does not necessarily incentivize the development of radical innovation that would become available only after a few years.
Or, as a third option, governments could decide to stimulate the economy overall — by, for example, lowering taxes — based on the hypothesis that a richer country is more likely to adopt renewable energy solutions, especially if they are more expensive than fossil fuel technologies. (A parallel of this hypothesis on an individual level is that consumers are unlikely to buy an expensive electric vehicle unless they have a certain amount of disposable income.)
Diverse policy measures most effective
To understand which option would be most effective, we looked at data on renewable energy from 15 European countries across a 13-year period. We examined the extent to which R&D investment, public policy and gross domestic product per capita had an effect on renewable energy innovation (measured by the number of patents filed in the field) and diffusion (the ratio of renewable energy electricity to total electricity).
Our conclusions largely confirmed our hypotheses: The use of fiscal incentives for firms to invest in R&D stimulates radical innovation, while more downstream interventions, such as feed-in tariffs, encourage the use of available technologies.
Countries should implement a multifaceted approach to renewable energy policy and investment, to finance both short-term and long-term growth of the market.
Indeed, Germany’s actual feed-in tariff program, one of the first in Europe, produced permanent structural changes in the energy industry. The initial stimulus helped the renewable energy industry become cost-competitive to an extent that, when Germany recently dropped its feed-in tariff levels, the renewable energy market as a whole remained unaffected.
Interestingly, we found that a high GDP per capita does not significantly affect innovation, but it does have a positive effect on the adoption of commercially available systems.
We therefore advocate that countries implement a multifaceted approach to renewable energy policy and investment: creating niche markets through demand-based policies, but also supporting R&D, to finance both short-term and long-term growth of the market. Policymakers should also not overlook the importance of affluence and GDP growth.
Extendibility of results
Our research should be interpreted with some caution because the correlation between policies and renewable energy diffusion can be overinflated, as we indicated in a separate research article on the limitations of panel data.
Companies leaders should also take note that a shortsighted focus on available technologies could backfire, to the advantage of those companies that have a long-term innovation strategy.
We should also emphasize that our study was limited to 15 European countries. However, because of the significant differences among these countries, it is likely that our results could be extended to other contexts with a reasonable level of accuracy.