Innovation for Social Progress

In this paper, we aim to fill this gap. We posit that the two market failures are interdependent rather than additive, which has implications for the ways in which policy can steer the direction of innovation towards low-carbon solutions. We develop a difference-in-discontinuity-in-effects research design to examine the impact of carbon pricing and technology-neutral R&D tax credits on innovative activity in the United Kingdom’s manufacturing sector. We find that carbon prices and R&D tax credits are substitutes in their effects on manufacturing firms’ R&D expenditures and total factor productivity (TFP) for those in emissions-intensive and less emissions-intensive industries. Due to carbon pricing, firms in emissions-intensive industries see increased R&D expenditures and TFP by 2.2% and 2.3%, respectively but these effects are reduced to -1% and 0 when the R&D tax credit rate is 33% higher. This is illustrative of how technology-neutral R&D tax credits can attenuate the impact of carbon pricing. In less emissions-intensive industries R&D expenditures fall by 8.9% in response to carbon prices. We believe the decrease in R&D expenditures is the result of process- and/or organizational innovations. It may also be driven by an increase in relative competitiveness. However, the higher R&D tax credit dampens the effect of carbon pricing. The direct effect of carbon pricing on TFP is the same for directly and indirectly regulated firms (+2.3%) and this is yet again attenuated by the more generous R&D tax credits, so much that the total effect of carbon pricing on TFP is statistically zero. To summarize, the two instruments are substitutes in all cases.