Human history has been defined by innovation and technological progress. Economists have for decades recognized that technological progress is critical for increasing general material wealth and the quality of human life. More recently, economists began focusing on the specific role that technological progress plays in the environmental context. In this chapter we synthesize the large conceptual literature related to innovation, technology adoption, and the environment.

The general topic of technology nests several related but distinct sub-areas of environmental economics, and so in this chapter we will look at multiple decision margins from a variety of actors. For example, when subject to environmental regulation, polluting firms can directly invest in R&D (research and development) efforts to reduce their abatement costs. In section 11.1 we study this type of behavior when investment has purely private benefits, and ask if additional efforts by the regulator are necessary to assure an efficient amount of investment in abatement cost reduction. In section 11.2 we generalize the model to allow for investment spillovers, whereby R&D effort by an individual firm creates knowledge that serves to reduce the abatement costs of all firms in the industry. We will show that, while purely private benefits from investment do not result in additional market imperfections, the spillover case produces a second market failure, based on the public good nature of R&D effort. Thus two policy instruments are needed to reach an efficient outcome.

In other contexts, polluting firms do not internally innovate, but instead must decide whether to bear the fixed cost of installing an available (abatement) cost-reducing new technology. We study this context in section 11.3, where we compare private and socially optimal adoption outcomes and discuss the performance of our suite of policy instruments in regulating emissions, and encouraging firms to deploy the new technology. The incentives for technology adoption that the various policy instruments provide have been loosely referred to in the literature as their “dynamic efficiency” properties. We discuss rankings of policies relative to a common environmental starting point, as well as their comparative usefulness for decentralizing the fully efficient outcome.