Innovation for social progress (ISP) – innovation that addresses society’s greatest challenges, like climate change, education, and healthcare – is characterized by a unique double-externality challenge. Imperfect appropriability, which generates knowledge spillovers and applies to innovation of all types, but also production and consumption externalities, which lead to prices not fully reflecting the costs and benefits to society. In this paper, we posit that these two market failures are interdependent and show how this changes the expected effects of each on ISP relative to when they are considered in silos. We then test the theoretical predictions by estimating the effects of knowledge spillovers and carbon pricing – capturing the two market failures and their interactions – on green and dirty innovation in the United Kingdom’s energy, transportation, and manufacturing sectors. Using instrumental variable and difference-in-discontinuities approaches, we find that, while carbon pricing generally increases green innovation, knowledge spillovers attenuate this effect. Technology-neutral R&D tax credits aiming to address the appropriability challenge do as well. Our findings highlight the importance of considering market failure interdependence when designing policy that aims to steer the direction of innovation.
Ansprechpartnerin: Cristina Rujan