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Environmental Protection for Sale: Strategic Green Industrial Policy and Climate Finance


Industrial policy has long been criticized as subject to protectionist interests; accordingly, subsidies to domestic producers face disciplines under World Trade Organization agreements, without exceptions for environmental purposes. Now green industrial policy is gaining popularity as governments search for low-carbon solutions that also provide jobs at home. The strategic trade literature has largely ignored the issue of market failures related to green goods. I consider the market for a new environmental good (like low-carbon technology) whose downstream consumption provides external benefits (like reduced emissions). Governments may have some preference for supporting domestic production, such as by interest-group lobbying, introducing a political distortion in their objective function. I examine the national incentives and global rationales for offering production (upstream) and deployment (downstream) subsidies in producer countries, allowing that some of the downstream market may lie in nonregulating third-party countries. Restraints on upstream subsidies erode global welfare when environmental externalities are large enough relative to political distortions. Climate finance is an effective alternative if political distortions are large and governments do not undervalue carbon costs. Numerical simulations of the case of renewable energy indicate that a modest social cost of carbon can imply benefits from allowing upstream subsidies.

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  1. Own calculations based on data from World Bank (2015).

  2. Examples: European Union—Certain Measures on the Importation and Marketing of Biodiesel and Measures Supporting the Biodiesel Industry (Complainant: Argentina, 2013); India—Certain Measures Relating to Solar Cells and Solar Modules (Complainant: United States, 2013); European Union and Certain Member States—Certain Measures Affecting the Renewable Energy Generation Sector (Complainant: China, 2012); Canada— Measures Relating to the Feed-in Tariff Program (Complainant: European Union, 2011); Canada—Certain Measures Affecting the Renewable Energy Generation Sector (Complainant: Japan, 2010); China—Measures Concerning Wind Power Equipment (Complainant: United States, 2010).

  3. Fischer et al. (2014, 2016a) consider strategic subsidy policies with environmental consequences in somewhat different frameworks among Cournot duopolies (with no third market). Other well-known studies in the environmental economics literature have considered strategic policy responses to trade and market structure (e.g., Barrett 1994; Conrad 1993), and a recent study by but they have ignored the important distinction between upstream providers of abatement technologies and downstream sectors deploying them (Greaker and Rosendahl 2008).

  4. An exception is Margolis et al. (2005), who look at invasive species issues.

  5. As further evidence of the broad link between GIP and employment objectives, during the Great Recession, the European Union devoted 59% of its stimulus to green projects, while individual member states and the United States each allocated on average about 11% of their stimulus packages, and China spent 38% on green projects; globally, 9% of green stimulus was spent on renewable energy specifically (Robins et al. 2009).

  6. Alberici et al. (2014) find that “in 2012, the total value of public interventions in energy (excluding transport) in the EU-28 is €2012 122 billion,” with €2012 41 billion for renewable energy (pp. i–ii). For 2012, the annual allocation of allowances was 2170 million; at an average annual price of roughly €7, the value of the annual cap was just over €2012 15 billion. Sources: and (also cited in Fischer 2016).

  7. Climate finance is distinct from the technology transfer envisioned in the Kyoto Protocol. Glachant et al. (2016) explore strategic incentives to transfer less polluting technologies to trade partners when the downstream industries adopting them compete (albeit imperfectly) through international trade.

  8. Since a green good represents a relatively small sector in the economy, we decline to model general equilibrium effects. Brander and Spencer (1985) show that with an additive utility function including a perfectly competitive numeraire good, the results carry through in a general equilibrium model with terms of trade. We also avoid dynamic effects; policies that stimulate upstream innovation, like R&D subsidies, generally have the same cost-reducing effect as upstream subsidies, over the longer term. We discuss some important caveats related to unmodeled scale economies and learning spillovers in the conclusion.

  9. One could vary other demand parameters by country, as we do in the numerical simulations, but the strategic issues related to heterogeneous downstream demand are captured sufficiently by the parameter m.

  10. Fischer (2016) explores the interactions with imperfect competition and finds the welfare costs from that market failure to be small relative to the costs of the downstream externality. Still, it is worth mentioning that those upstream market failures pull in the opposite direction from the political distortion in this paper; imperfect competition and scale externalities lead to underproduction, while the political distortion leads to overproduction.

  11. An alternative structure would be heterogeneous firms with imperfect substitutability (as in Melitz 2003). However, representative supply curves are in better keeping with our numerical parameterization, which relies on linear demand functions and the assumption of identical products. The important aspect is simply that we have positive producer surplus, which makes strategic countries want to engage in industrial policy, in order to influence the terms of trade.

  12. Common models of industry lobbying assume concentrated industries with individual firms perceiving benefits from their own lobbying. This paper implicitly considers that several kinds of groups (and not just firms) may organize to lobby for their special interests. This choice seems realistic for representing the landscape of clean energy interests, which include not only equipment manufacturers but also installers, researchers, financers, environmental consumer groups, construction services, and utilities. (Solar Energy Industries Association is a good example of a blended interest group, with the stated mission “to promote, protect and expand solar energy across America”). The focus on upstream scale over profits is then also more compatible with the assumption of competitive firms.

  13. The main difference is that with profits overweighting, the two subsidies would be increasing in a nonlinear fashion, rather than in a linear fashion as presented here. Thus, some second-order effects would be introduced.

  14. This result stands in contrast to that with Cournot-competing producers with constant marginal costs, where a positive upstream subsidy is strategically optimal (Fischer 2016). In that case, the upstream subsidy helps expand market share and profits, without raising production costs. Here, capturing more market share incurs a deadweight loss from higher total production costs.

  15. To contrast, in the case of Cournot competition and no third market, the Nash equilibrium finds the average of the upstream subsidies equal to the planner’s upstream subsidy, even with asymmetric regions (Fischer 2016).

  16. This result is of course also the case with Cournot competition as the number of firms gets arbitrarily large (Fischer 2016).

  17. This result also has the same flavor of that with Cournot competition as the number of firms gets arbitrarily large. In that case, the upstream subsidy converges to zero and the downstream subsidy to \(v_{i}\) (Fischer 2016).

  18. The primary assumption is that the fossil supply curve is upward sloping and cost increases are fully passed through. This assumption is less realistic for China, where prices are regulated and adjusted infrequently.

  19. Though the membership is somewhat different, the IEO projections for OECD Europe are similar in scale to those of the European Union in Hübler et al. (2015). This choice is made based on available data and for consistency with the global scale of generation in 2020.

  20. Although updated IEOs are available, they include recent, more ambitious climate policy pledges that are difficult to remove from the baseline to consider a reference scenario without additional policies.

  21. These models were designed for looking at endogenous technical change across two stages; to create a static model, we use the first stage only.

  22. The model can allow carbon prices \(\tau _i \) that vary across regions, but these scenarios are not explored in this paper.


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Correspondence to Carolyn Fischer.

Additional information

Fischer would like to acknowledge the European Community’s Marie Skłodowska-Curie International Incoming Fellowship, “STRATECHPOL—Strategic Clean Technology Policies for Climate Change,” financed under the EC Grant Agreement PIIF-GA-2013-623783, and the hospitality of the Fondazione Eni Enrico Mattei (FEEM). The numerical simulations are made possible by prior work funded by US Environmental Protection Agency Grant # 83413401 and the Swedish Foundation for Strategic Environmental Research (MISTRA) INDIGO program.


Appendix: Analytical Results

To avoid tedious algebraic manipulations, the optimal and Nash solutions are solved in Mathematica using the linear functional forms, and the results are reported here. To provide core intuition without unnecessary complications, the reported results generally assume symmetric producer countries. The notebook file with proofs is available from the author upon request.

No Downstream Externality

Proof of Proposition  1(b)

We can simplify the expressions for the welfare derivations with our functional forms and solve for the Nash equilibrium. The effect of the third-party market is best seen with the assumption of symmetry across the producing countries: that is, \(m_1 =m_2 =(1-m_3 )/2.\)

When \(\omega >0\), the symmetric Nash solution is

$$\begin{aligned} \eta _i^{\mathrm {Nash}} (0,\omega )= & {} m_3 \frac{hb(a-c+w)}{Z}>0 \\ \gamma _i^{\mathrm {Nash}} (0,\omega )= & {} -\eta _i^{\mathrm {Nash}} +\omega \end{aligned}$$

where \(Z=(b+h)^{2}+m_3 h(2(b+h)-hm_3 )\)

Furthermore, \(\gamma ^{\mathrm {Nash}} >0\) if

$$\begin{aligned} \omega >m_3 \frac{hb(a-c)}{Z}. \end{aligned}$$

Thus, the larger the third-party market share, the higher is this threshold for wanting a positive upstream subsidy.

When \(v_i =0\), and \(\omega =0,\) the symmetric Nash solution yields

$$\begin{aligned} \eta _i^{\mathrm {Nash}} (0,0)= & {} m_3 \frac{hb(a-c)}{Z}>0 \\ \gamma _i^{\mathrm {Nash}} (0,0)= & {} -\eta _i^{\mathrm {Nash}} <0 \end{aligned}$$

Thus, we see the tax/subsidy shift is strictly increasing in \(m_3 \). It is also increasing in h, at least initially. Furthermore, when \(m_3 =0\) and \(\omega =0,\) symmetric countries have no subsidies in equilibrium.

1.1 Discussion of Asymmetric Firms

For this case of \(m_3 =0\) and \(\omega =0,\) with no third-party region, the asymmetric Nash solution yields

$$\begin{aligned} \gamma _1^{\mathrm {Nash}}= & {} -\eta _1^{\mathrm {Nash}} =\frac{(a-c)bh\Delta _m }{2(b+h)(b+h+h\Delta _m )}=\eta _2^{\mathrm {Nash}} =-\gamma _2^{\mathrm {Nash}} \\ Y^{\mathrm {Nash}}-Y^{*}= & {} -\frac{(a-c)bh\Delta _m ^{2}}{2(b+h)(b+h+h\Delta _m )^{2}}<0 \end{aligned}$$

where \(\Delta _m =m_1 -m_2 \) is the extent to which region 1 has a larger market share.

Downstream Externality

For the proof of optimal strategies without and with an externality, we derive the analytical solutions in Mathematica and report simplified results here.

Proof of Proposition 3

Although the value of an individual subsidy is a complicated expression, without relying on the symmetry assumptions, with our functional forms, \(\eta _i^{\mathrm {Nash}} +\gamma _i^{\mathrm {Nash}} =u_i v_i +\omega \).

For example of the individual subsidies, when \(v_i =v,i=\{1,2\},\)and \(\mu _i =\mu ,\,\forall i,\) the symmetric Nash solution yields

$$\begin{aligned} \eta _i^{\mathrm {Nash}} (v)= & {} \eta _i^{\mathrm {Nash}} (0)+\frac{vub(b+h(1+m_3 ))}{Z}>0 \\ \gamma _i^{\mathrm {Nash}} (v)= & {} \gamma _i^{\mathrm {Nash}} (0)+vu-\frac{vub(b+h(1+m_3 ))}{Z}<0 \end{aligned}$$

Proof of Proposition 4

This result essentially requires \(\mu _3 >0\) and \(m_3 >0.\) We show the result for the case of symmetric producer countries that value the externality at the global value (that is, \(v_2 =v_1 =v_G \) and \(m_1 =m_2 =(1-m_3 )/2)\), and when the marginal external benefit is the same across countries \((\mu _i =\mu \,\forall i)\), so the location of deployment does not matter. The difference in global deployment is a function of the difference between the Nash and globally optimal upstream subsidies, as well as the political distortion:

$$\begin{aligned} Y^{\mathrm {Nash}}-Y^{*}=\frac{m_3 (\gamma ^{Nash}-\gamma ^{*})}{b+h}+\frac{(1-m_3 )}{b+h}\omega \end{aligned}$$

If \(\omega =0,\) then \(\gamma ^{\textit{Nash}}<\gamma ^{*}\) and \(Y^{\textit{Nash}}<Y^{*}\). If the political distortion is large enough, deployment may be even higher with the Nash equilibrium among strategic countries. However, if \(\mu _3 >\mu \), there is the additional problem that strategic countries deploy too little abroad, reducing the external benefits achieved under the Nash equilibrium.

Contributions to Climate Finance

Proof of Proposition 5

If the planner cannot use upstream subsidies, the optimal contributions, split equally, are

$$\begin{aligned} f_i ^{*}=\frac{\mu _3 v_G }{2} \end{aligned}$$

and the optimal downstream subsidies in producing countries remain the same.

Proof of Proposition 6

In the unconstrained (subscript u) symmetric Nash equilibrium with \(v = 0\),

$$\begin{aligned} \eta _u^{\textit{Nash}}= & {} -m_3 \frac{bh(a-c+\omega )}{Z_2 }<0 \\ \gamma _u^{\textit{Nash}}= & {} \omega -\eta _u^{\textit{Nash}} >0 \\ f_u^{\textit{Nash}}= & {} -\frac{b(b+h)(a-c+\omega )}{Z_2 }<0 \\ \end{aligned}$$

where \(Z_2 =\left( {3(b+h)-hm_3 } \right) \left( {b+h-hm_3 } \right) >0\).

Proof of Proposition 7

In the restricted (subscript r) symmetric Nash equilibrium with \(\mu _i =\mu ,\,\forall i\),

$$\begin{aligned} \eta _r^{\textit{Nash}}= & {} \frac{-m_3 bh(a-c)+\left( {3(b+h)-2hm_3 } \right) (\omega +2\mu )}{Z_2 } \\ f_r^{\textit{Nash}}= & {} \frac{-b(2b+h)(a-c)+b\left( {b+2h-hm_3 } \right) (\omega +2\mu )}{Z_2 } \\= & {} \eta _r^{\textit{Nash}} -\frac{b(a-c+\omega +2\mu )}{3(b+h)-hm_3 } \\ \end{aligned}$$

If \(\mu _3 \ne \mu ,\quad f_r^{\textit{Nash}} >\eta _r^{\textit{Nash}} \) if

$$\begin{aligned} \mu _3 >\mu +\frac{b(a-c+\omega +2v\mu )}{v(b+h+hm_3 )} \end{aligned}$$

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Fischer, C. Environmental Protection for Sale: Strategic Green Industrial Policy and Climate Finance. Environ Resource Econ 66, 553–575 (2017).

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