Macro Innovation Dynamics and the Golden Age New Insights into Schumpeterian Dynamics, Inequality and Economic Growth
Macro Innovation Dynamics and the Golden Age
Paul J. J. Welfens
Macro Innovation Dynamics and the Golden Age New Insights into Schumpeterian Dynamics, Inequality and
Paul J. J. Welfens Jean Monnet Chair for European Economic Integration and Chair for Macroeconomics President of European Institute for International Economic Relations (EIIW) at the University of Wuppertal Wuppertal, Germany Non-resident Senior Research Fellow AICGS/Johns Hopkins University Washington, DC USA Research Fellow IZA Bonn, Germany
ISBN 978-3-319-50366-0 ISBN 978-3-319-50367-7 DOI 10.1007/978-3-319-50367-7
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Innovations were responsible for driving the Industrial Revolution in the eighteenth and nineteenth centuries. The twentieth century has witnessed the combination of multinational companies’ foreign direct investment dynamics and product as well as process innovations; and the early twenty-first century is shaped largely by digital innovation dynamics. While innovations have been analyzed by many economists—beginning, in particular, with Schumpeter—there is surprisingly limited research carried out on the role of innovations in Macroeconomics (as a textbook, Aghion/Howitt’s Endogenous Growth Theory summarizes many approaches). With my book, “Innovations in Macroeconomics”, I have tried to contribute to closing some of the knowledge gaps and emphasis has been given to the role of foreign direct investment (FDI), innovations and trade. The role of FDI is growing in the context of economic globalization and it requires the making of a distinction between GDP and gross national product—typically neglected in open economy macroeconomics so far. This point has already been emphasized in Innovations in Macroeconomics. Consumption in an economy with trade and FDI is proportionate to GNP, not to GDP; and imports are also proportionate to domestic GNP. The export volume is proportionate to foreign GNP—not to GDP. For many countries there is a considerable difference between GNP and GDP. In this complementary book, I present my papers for the Brisbane conference of the Schumpeter Society, the paper for the Jena conference of the Schumpeter Society as well as my paper on innovation and growth for a Sino-German project—here funding from the German National Science Foundation is gratefully acknowledged—plus a new approach to the golden age in the presence of a research sector. Moreover, the last chapter—my paper for the Montreal conference of the International Joseph A. Schumpeter Society—suggests an innovative approach that uses a knowledge production function that can be plugged directly into a macroeconomic production function and hence enables a straightforward way for new endogenous growth approaches from both a theoretical and empirical perspective. The main ideas in this book are to include innovations into the Mundell-Fleming model and to take a broad, fresh look at the golden age in neoclassical growth theory. In a broader view that includes environmental aspects, the question of a golden rule that maximizes per capita consumption is even more important than the classical contributions in this field: An economy that has a capital intensity v
exceeding that which is required by the golden rule is not achieving the maximum per capita consumption on the one hand, on the other hand, in the case of a closed economy, one may emphasize that the amount of physical capital produced and employed—this is associated with the use of resources and energy (leading to higher CO2 emissions)—is too high: the environmental quality is thus worse than a situation in which the golden rule was observed would imply. The golden age, characterized by maximum per capita consumption in the steady state, has, in the original contribution of Edmund Phelps (1961), been dubbed “a fable for growthmen” and indeed the golden rule has not been considered as a serious element of economic policy—it was rather discussed as a very theoretical point of neoclassical growth analysis; with the adoption of endogenous growth theory the golden rule seemed to become a remote corner of analysis. The contribution of Phelps had emphasized, in its application to a setup with a Cobb-Douglas production function, that the golden rule requires that the savings rate is equal to the income share of capital and the output elasticity of capital. This interpretation is not fully consistent to the extent that it is understood to imply that all profits must be invested if per capita consumption is to be maximized; rather a certain combination of the savings rate of capital owners and of workers is also compatible with the golden age. An alternative condition for the golden rule is to require that the growth rate of output should be equal to the real interest rate and one may argue that profit maximization and competition will bring about this equality. Hence the only task of government then is to implement competition and to encourage profit maximization. There are, however, three difficult problems for competition policy: (1) Competition policy in small open economies is not easy to implement effectively in a world economy with multinational companies playing an increasing role; while in the tradables sector free trade policy effectively is competition policy, the problem in the non-tradables sector is much more difficult—often the presence of just one multinational company already covers the entire domestic market so that there is little room for actual or potential competition (the non-tradables sector could represent between 20% and 40% of output in OECD countries and Newly Industrialized Countries; and even more in developing countries). (2) Profit maximization is not always the natural behavior of relevant economic actors; the government sector itself and government-owned firms should be considered as a potential problem or to put it differently: here, looking at the sectoral implication of the golden rule would be particularly useful, but no minister of finance and no council of economic advisers has so far seriously emphasized the golden rule as a policy element. This point will be rather neglected in the subsequent analysis: There is (3) the question of negative external effects from production. How can negative external environmental effects—related to production—be integrated in a simple growth model? Finally, there is the problem that the more innovative the economy is, the less likely one should expect full competition to characterize the economy: Whenever there are product innovations or patents—the latter giving an effective monopoly over several years to the innovator—one may face the problem that production factors are not simply rewarded in line with marginal productivity: Market power could play a crucial role in factor markets, possibly less so in small open economies than in big economies.
Moreover, deviations from the golden age are not in practice an irrelevant problem of reality and economic policy, respectively. It should be rather obvious that in rather poor countries a lack of growth-enhancing economic policy will bring about starvation, so that pushing governments to consider the implications of the golden rule should be a natural element of modern development policy and UN or World Bank projects for stimulating economic development in the South of the world economy. This book has been completed in 2015 and 2016 in Beijing and Washington DC, respectively. In China another project financed by the German National Foundation has commenced. Again, we are grateful to Mu Rongping and Reinhard Meckl who have initiated the projects that have a broad focus on innovation dynamics, including green innovation dynamics (the first book edited by Rongping/Meckl was Innovation for Green Growth; Beijing: Science Press: 2014). In Washington DC I presented at both the Congressional Research Service and at the IMF (on June 27 and 28, 2016, respectively) a theoretical and empirical paper on the knowledge production function—a joint paper with Andre Jungmittag in which we have conducted an empirical analysis covering 20 EU countries between 2002 and 2014 and also suggested ways of plugging the empirical results into a macroeconomic production function. This paper, which looks at the creation of new knowledge, is not included here, however, part of the theoretical basis is shown in the last chapter of this book (those interested can find the EIIW paper No. 212 on the website of the European Institute for International Economic Relations: www.eiiw.eu). I am grateful for the research support of Jens Perret and Tony Irawan (EIIW and the Schumpeter School of Business and Economics, respectively). I am also grateful for the editorial support of David Hanrahan, Samir Kadiric and Evgeniya Yushkova (EIIW). As regards our China research projects, I would also like to thank Mu Rongping (Chinese Academy of Sciences), Rainer Walz (Fraunhofer Institut ISI, Karlsruhe), Klaus Rennings (ZEW) and Reinhard Meckl (Universita¨t Bayreuth) for discussions on the subject matter, as well Raimund Bleischwitz (University College, London) and, in the field of innovation and growth, colleagues at the International Joseph A. Schumpeter Society—the bi-annual meeting in Denmark was particularly stimulating (unfortunately I was unable to attend the Brisbane meeting but Tony Irawan has presented my paper). Special thanks go to Andre Jungmittag from the Frankfurt Applied University; discussions about trade, innovation and economic stability with IMF colleagues are also acknowledged, as is the hospitality of AICGS/The Johns Hopkins University, Washington, DC, over many years. The responsibility lies, however, with the author only. Wuppertal, Washington and Beijing Summer 2016
Paul J. J. Welfens 保罗. 威尔芬斯
Reference Phelps ES (1961) The golden rule of capital accumulation. Am Econ Rev 51:638–643
About the Book
This book is organized in five chapters: Following a short introduction, Chap. 1 suggests some new ideas on innovation, growth and income inequality. The innovative approach presented introduces a modified neoclassical growth model which includes a new bias of technological progress in a quasi-endogenous growth model in which part of labor is used in the research & development sector. The combination of a macroeconomic production function and a new progress function, plus the assumption that the output elasticity of capital is positively influenced by the size of the R&D sector, sheds new light on innovation and growth as well as on income inequality: Thus there is a new approach for explaining Piketty’s historical findings of a medium term rise of the capital income share in industrialized countries—both in the earlier and later part of the nineteenth century and in 1990–2010 (this contribution has been published originally in the Journal International Economics and Economic Policy). A rising share of capital income can be explained within this approach by the increase in the output elasticity of capital, which has been developed in a new way, namely in the context of R&D. In the approach presented herein, the golden rule issues are also highlighted and it is shown that choosing the right size of the R&D sector will bring about maximum sustainable per capita consumption. While the basic new model is presented for the case of a closed economy, one could easily accommodate both trade and foreign direct investment and thereby get a better understanding of complex international investment, trade and FDI dynamics—including with respect to the envisaged Transatlantic Trade and Investment Partnership between the US and the EU. The second chapter is my revised contribution from the first Sino-German project. The analysis links R&D, foreign direct investment, output and CO2 emissions in a simple growth model. Based on the modified neoclassical growth model, key issues can be raised with respect to sustainable growth and several conclusions can be drawn with respect to economic welfare and optimum consumption per capita, respectively. It may be argued that in several industrialized countries—and China—investment-GDP ratios in certain periods are above the level that is consistent with optimum per capita consumption; the capital intensity exceeds the ratio of capital to workers (in efficiency units) that is consistent with a maximum long-run per capita consumption. CO2 emission levels could be reduced in an efficient manner on the basis of a broad approach that emphasizes ix
About the Book
Schumpeterian dynamics: Taxing emissions and giving subsidies for innovations could be useful elements of innovation-enhancing policy. Promoting green innovations—including the sustainability design of products-, renewable energy and realizing adequate genuine savings could be key policy elements for a consistent strategy to achieve sustainable growth. Moreover, green ratings for companies listed on the stock market could be crucial options for combining sustained growth, modernization and innovation. Part of the analysis is based on the EIIW-vita global sustainability indicator. A further analytical contribution is presented in Chap. 3. Economic growth is, in reality, not a smooth process and it is not clear why economic growth is rather unstable across OECD countries and the global economy. Economic growth is certainly influenced by many factors, including innovation dynamics and technology, respectively. Technological progress can have domestic sources and is, then, largely related to the innovation system, but in open economies the subsidiaries of foreign MNCs can also play a role in the host country. Moreover, there could be international technology spillovers, part of which are related to international trade and FDI dynamics. Foreign direct investment has rarely been included in the analysis of economic growth, despite the fact that economic globalization has clearly reinforced the role of multinational companies in world investment. From a macroeconomic perspective, the presence of MNCs’ subsidiaries should not only bring effects on capital accumulation and technology transfer; rather it is important to consider that a distinction has to be made between GDP and GNP. This distinction, which concerns the specification of the savings function as well as other functions, has been much neglected in the literature; it is relevant both in medium term macro models and in long run growth models. In the standard neoclassical growth model with exogenous technological progress a rise of the progress rate leads to a fall of the level of the growth path and a higher permanent growth rate of output. This suggests that a technology shock should bring about a quasi-growth cycle and such a phenomenon—with a temporary fall of output—is, however, not observed in newly industrialized countries. The empirical patterns of growth and innovation dynamics do not show such a paradoxical temporary fall of income and income per capita, respectively. The paradoxical result of the standard growth model is avoided in a model in which the output elasticity of capital depends on the progress rate; certain parameter restrictions apply which are highlighted in the analysis; furthermore, we get additional insights into the issue of the golden rule and maximization of per capita consumption, respectively. Moreover, it is interesting to consider the role of foreign direct investment for the growth model of an open economy and technological progress, respectively. In this semi-endogenous set-up, the focus is mainly on asymmetrical foreign investment, namely inward FDI inflows. Foreign direct investment inflows have a direct impact on the steady state solution, namely both on the level of the growth path and the permanent growth rate—the latter to the extent that we consider a technological progress function in which both the foreign progress rate and the share of the capital stock owned by foreign investors are considered. The relative impact of domestic
About the Book
progress and internationally induced progress is discussed. Finally, the issue of a consistent investment function which takes into account both the short term and the long run consistency is considered and the impact of changes in the progress rate are pointed out—along with broader policy conclusions of the analysis presented. At the bottom line it is shown that a positive impact of the progress rate on the output elasticity of the capital stock can bring a smooth transition to both a higher level of the growth path and a higher permanent growth rate. The perspectives on the role of FDI inflows in a two-country model with symmetrical flows have to be explored in further analysis. Key policy conclusions concern the question of to what extent government should try to achieve a golden state while adequately taking into account the role of foreign direct investment inflows. Within a broader group of countries it would also be useful to consider options for cooperation in growth policies—certainly to the extent that there are symmetrical or asymmetric international technology spillover effects. Chapter 4 presents a new multiplier analysis for a Schumpeterian MundellFleming model. Traditional open economy macro models have focused on the mix of fiscal and monetary policy while completely neglecting innovation policy. The new model presented is the first macro model that explicitly considers product innovations in an open economy model. Product innovations are considered in the consumption function, the investment function, the export function, the import function as well as the money demand function; plus the net capital inflow function. The policy multipliers are derived for fiscal policy, monetary policy and innovation policy. In an extended version of the model, the role of foreign direct investment is considered, in an approach for a small open economy. Domestic and foreign product innovations are considered and their impact on policy multipliers is analyzed. Finally, the role of supply-oriented, innovation-enhancing fiscal policy is discussed. Moreover, the empirical evidence for product innovation dynamics is considered. Chapter 5 can be summarized as follows: The macroeconomic production function is a traditional key element of modern macroeconomics, as is the more recent knowledge production function which explains knowledge/patents by certain input factors such as research, foreign direct investment or international technology spillovers. This study is a major contribution to innovation, trade, FDI and growth analysis, namely in the form of a combination of an empirically relevant knowledge production function for open economies—with both trade and inward FDI as well as outward foreign direct investment plus research input—with a macro production function. Plugging the open economy knowledge production function into a standard macroeconomic production function yields important new insights for many fields: The estimation of the production potential in an open economy, growth decomposition analysis in the context of economic globalization and the demand for labor as well as long run international output interdependency of big countries; and this includes a view at the asymmetric case of a simple two country world in which one country is at full employment while the other is facing underutilized capacities. Finally, there are crucial implications for the analysis of broad regional integration schemes such as TTIP or TPP and a more realistic and comprehensive empirical analysis.
About the Book
At the bottom line, there are many good arguments for integrating Schumpeterian aspects into open economy macroeconomics. The technology factor in International Economics—with people concerned about the environment—is increasingly important (here Lucas Bretschger’s research at ETH Zürich has made crucial contributions over many years). The modified neoclassical growth models are rather simple in the basic setting, however, this type of modeling is still very useful for considering key issues and topics.
Capital income share as a % of GDP . . . . . . .. . . . . . .. . . . . .. . . . . . .. . . . Gini coefficient . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Imported R&D services from abroad which is used as intermediate input (as a % of GDP/total value added) . . . . . . . . . . . Total R&D services which is used as intermediate input (as a % of GDP/total value added) . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . Total domestic R&D services which is used as intermediate input (as a % of GDP/total value added) . . . . . . . . .. . . . . . . . . . . .. . . . . . Total intramural R&D expenditure (GERD) (as a % of GDP) . . . . Total factor productivity (2010 ¼ 100) . . . . . . . . . . . . . . . . . . . . . . . . . . . .
55 56 57 58 59 60 61
Multiplier for Schumpeterian MundellÀFleming model . . . . . . . . . 105 Multiplier for innovation dynamics and FDI inflows in a Schumpeterian MundellÀFleming model . . . . . . . . . . . . . . . . . . . . . . . . . . 106 α* multiplier . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 106 Knowledge production function: patent applications at the European Patent Office explained by researchers (full time equivalent), per capita GDP (PPP, constant dollars), inward FDI–GDP ratio: panel data analysis for 20 EU countries, 2002–2012; all variables in logs . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . . 128
Green Innovations and CO2 in a Growth Perspective: A Neoclassical Model
Economic growth is a key field of modern Economics and indeed since the Industrial Revolution sustained economic growth of per capita income has been observed in the world economy. In the USA, the twentieth century stands for a longrun per capita growth rate of about 2%, the 1990s even 3% per year was achieved. Japan and several Asian Newly Industrialized Countries have recorded 5–8% over more than a decade in the 1960s, 1970s, and 1980s, China even achieved 8–10% in the first decade of the twenty-first century, but there is, of course, not much doubt that the growth rate of China will reduce to 2–3% over time, as its per capita income is converging towards that of the US or leading EU countries. Economic growth is welcomed by both ordinary citizens and politicians; however, the rise of per capita income typically also means that there is an increasing use of natural resources and fossil energy sources—the exploitation of natural, nonrenewable resources is effectively reducing the effective (adjusted) savings rate as is emphasized by the World Bank, which adds education expenditures to the traditional definition of savings and thus gets rather different savings rates than the traditional view on gross savings suggests. Moreover, the use of fossil fuels implies that the growth of output in the world economy goes along with CO2 and other emissions (particulate matter) that imply risks for physical assets and human life in the long run. The question as to how CO2 emissions, as a negative externality of production, could be included in a growth model is considered subsequently; in this context, one may also point to the new sustainability book with the EIIW-vita global sustainability indicator (Welfens et al. 2015). The basic neoclassical closed economy growth model, with a savings rate (s), a growth rate of population (n), and a growth rate of knowledge (a), results in the steady state solution for the ratio of real GDP (Y ) to labor in efficiency units y # : ¼ (Y/(AL) ¼ (s(1 À τ)/(a + n))β/(1 À β), where β is the output elasticity of capital K, and the production function is Y ¼ Kβ(AL)1 À β (A is the stock of knowledge, L is labor, τ is the income tax rate, # indicates the steady state; 0 < β < 1). Note that the only fiscal variable that can be considered here is the income tax rate; the growth rate of Y in the steady state is a + n. Under certain conditions, the neoclassical model is # Springer International Publishing AG 2017 P. J. J. Welfens, Macro Innovation Dynamics and the Golden Age, DOI 10.1007/978-3-319-50367-7_1
Green Innovations and CO2 in a Growth Perspective: A Neoclassical Model
equivalent to the modern growth model as presented in Aghion and Howitt (1998): The modeling is more complex, the ingredients are Utility-maximizing households (infinite time horizon), and the utility function is U(C) ¼ (C(1 À ε) – 1)/(1 À ε); the intertemporal elasticity of substitution η ¼ 1/ε. The relevant Euler equation is here given by –ε(dC/dt)/C ¼ ρ – r, (where r is the real interest rate; note (1/(1 + ρ) is the 0 discount factor; ρ > 0. This gives the fundamental equation for the growth rate g ¼ (ρ – r)η. According to the above equation, in the decade after the Transatlantic Banking Crisis, the growth rate should have increased strongly since the real interest rate has fallen massively in the USA, Europe, and Asia. This is not what we see however. The frictions observed in the new post-Lehman Brothers reality are particular, and the new world with almost zero real interest rates implies many distortions. This book is really about the normal world and complementary aspects of economic growth (e.g., environmental aspects in the subsequent analysis)—and one may hope that the OECD countries will have returned to a normal economy setting by the end of 2025 (BREXIT is, however, another destabilizing impulse for the EU and the OECD, respectively). A modified neoclassical growth model is still quite useful. Additionally, the implications of some modern endogenous growth models are not fully convincing; e.g., in the context of a simple Romer model— with λ denoting a productivity parameter in the research sector where product varieties are produced that feed into output (output parameter α00 > 0)—one gets 0 00 00 for the growth rate g0 in steady state: g ¼ (α λL – ρ)/(α + ε); it is a bit strange that the size of the economy (L) affects g0 , although in a digital world the number of people L could play a positive role for economic growth—namely in the context of digital network effects. The digital economy itself raises, however, certain critical issues which have been largely neglected (see, however, my book Interneteconomics.net). Again, the neoclassical growth model is useful for many key issues and topics, including certain environmental aspects of growth. People have a natural interest in achieving high living standards, which thus generates analytical interest in the topic of economic growth. At the beginning of the twenty-first century, the dynamics of global warming have added one important element, namely to consider the role of CO2 emissions and other greenhouse gas emissions, respectively. Innovation dynamics—including green innovations—can be considered in various ways in growth models (e.g., Bretschger 1999, 2008, 2011); some economists have argued that green innovations and the diffusion of environmentally friendly new products could contribute to climate change mitigation in an efficient manner and create new opportunities for economic growth (e.g., Aghion et al. 2009; Popp et al. 2009). Environmental issues and growth dynamics can also be considered in the broader context of trade (e.g., WTO 1999) and foreign direct investment (Welfens 2011; Erdem 2010, 2015). In a broader perspective, issues may also be raised related to capital markets and investment incentives— subsequently, part of the analytical focus will be on the role of green ratings: Companies are rated on the basis of the sustainability of production processes and products sold.
Green Innovations and CO2 in a Growth Perspective: A Neoclassical Model
Green innovations are not easy to launch since innovation risks and costs are often high, while established, less environmentally friendly technologies and products dominate many markets. However, once green innovations have successfully been launched, there are good prospects that competition in markets will lead to rapid diffusion of more environmentally friendly products (Acemoglu et al. 2009; Aghion et al. 2009). If companies with a green innovation project are afraid that they cannot fully capture the Schumpeterian innovation rents, because policymakers will effectively push for accelerated diffusion, there is risk of underinvestment in green innovations (Jaffe et al. 2005; Newell 2009). The role of innovations for sustainable growth—sustainable consumption and production— has been emphasized by many authors (e.g., Iges 2010; Erdem 2010). The role of information and communication technology, including concepts of green IT, has also been emphasized (e.g., Welfens 2010b). With some degree of uncertainty, green innovations (Walz 2010) can be measured and also countries can be identified on the basis of their innovation dynamics. International patent applications are highly correlated with per capita income, except for most OPEC countries. It is well known that resource rich countries face Dutch Disease problems, which is to say that the high share of value added in the capital-intensive resource extraction sector only gives weak impulses for the modernization of the industry—and only with a relatively high share of modern manufacturing industries and a modern innovation system will a country generate significant contributions to green innovations. The market power of OPEC countries has ambiguous effects on CO2 emissions and global innovation dynamics, respectively: • As regards impulses for reducing CO2 emissions it might be argued that OPEC countries’ market power indirectly stimulates CO2-emission-saving technologies in OECD countries and some Newly Industrialized Countries. • While the above argument may be valid to some extent, it should not be overlooked that the industrial modernization of OPEC countries in a world economy with lower prices of nonrenewable energy sources is likely to have advanced faster than it currently is and this would mean that global innovation dynamics might be stronger without OPEC market power; whether a general increase in innovation dynamics also implies more green innovation dynamics has to be clarified on the basis of empirical analysis. The broad international consensus to limit greenhouse gas emissions in the medium term and to cut emissions in the very long run has contributed to a broad policy debate in OECD countries on how energy efficiency and resource productivity could be raised. The broad need to implement eco-efficiency principles in production implies certain adjustment requirements and the need to adopt new initiatives for green innovation dynamics. The OECD (2009, p. 28), with respect to the EU and the USA notes: “Such tasks are not trivial for manufacturing companies and places great demands on their organizational management capability. The development of environmental management systems (EMSs) has tied many of the
Green Innovations and CO2 in a Growth Perspective: A Neoclassical Model
environmental monitoring and management principles together, providing a framework to move towards eco-efficient production. [. . .] An EMS is meant to provide companies with a comprehensive and systematic management system for continuous improvement of its environmental performance. Once implemented, the system relies on a structure that is typically characterized by four cyclical, action-oriented steps: i) plan; ii) implement; iii) monitor and check; and iv) review and improve [. . .]”; and with respect to the European Union, the OECD analysis states (p. 38): “In the last few years, many companies and consulting firms have started using eco-innovation or similar terms to present positive contributions by business to sustainable development through innovation and improvements in production processes and products/services. A few governments and the European Union (EU) are now promoting the concept as a way to meet sustainable development targets that keep the industry and the economy competitive. In the EU, eco-innovation has been considered to support the wider objectives of its Lisbon Strategy for competitiveness and economic growth. In 2004, the Environmental Technology Action Plan (ETAP) was introduced to promote the development and implementation of eco-innovation. The ETAP defines eco-innovation as ‘the production, assimilation or exploitation of a novelty in products, production processes, services or in management and business methods, which aims, throughout its life cycle, to prevent or substantially reduce environmental risk, pollution and other negative impacts of resource use (including energy)’. The action plan provides a general road map for promoting environmental technologies and business competitiveness by focusing on bridging the gap between research and markets, improving market conditions for environmental technologies, and acting globally. Eco-innovation now forms part of the EU’s Competitiveness and Innovation Framework Program 2007-13, which offered EUR 28 million in funding in 2008 to stimulate the uptake of environmental products, processes and services especially among SMEs. In the United States, environmental technologies are also seen as a promising means of improving environmental conditions without impeding economic growth, and are being promoted through various public private partnership programs and tax credits. [. . .] In 2002, the Environmental Protection Agency laid out a strategy for achieving better environmental results through innovation. [. . .] Based on this strategy, it set up the National Center for Environmental Innovation and is promoting the research, development and demonstration of technologies. [. . .] In Japan, the government’s Industrial Science Technology Policy Committee introduced the term ‘ecoinnovation’ in 2007 as an overarching concept which provides direction and a vision for the societal and technological changes needed to achieve sustainable development.” A study by the European Commission (Conte et al. 2010) has presented a modelbased approach of cost-efficiency of alternative EU climate policy options through which innovation dynamics could be encouraged to contribute to an environmentally sustainable growth path. The innovative model, which is based on the Commission’s QUEST Dynamic Stochastic General Equilibrium Model, assesses different policy options in order to identify the best policy mix of environmental and innovation market instruments in terms of their cost-effectiveness. The key
Green Innovations and CO2 in a Growth Perspective: A Neoclassical Model
finding of the authors is that an adequate policy mix should strongly stimulate research and development in the short-term and phase it out by spreading the innovation support to all sectors in the economy in the medium run. Moreover, the authors emphasize the role of the supply chain (Conte et al. 2010, p. 1): “The essential contribution of our approach is to consider that green innovation occurs along the supply chain and is not necessarily bounded within a single sector. The introduction of an exhaustive sectoral input-output matrix allows us to capture the development and use of environmentally friendly products substituting dirty products across different sectors of the economy. Such a “green” multi-sectoral version of the model allows us to evaluate the marginal economic effects of sectorwide measures compared to economy-wide policy intervention in the environmental and innovation markets. In applied terms, this model is calibrated on our newly constructed dataset that includes green R&D and CO2 emissions for five sectors with a distinctive potential for nesting green activities.” Sustainable growth is a key challenge for Europe, Asia, and other regions of the globe in the twenty-first century. The concept of double sustainability will be emphasized here; sustainability in the traditional sense of environmental economics means that future generations should have the opportunity to enjoy at least the same level of well-being as current generations (a notion of sustainability developed in the Brundtland Report that largely shows the perspective of industrialized countries and does not emphasize the obvious desire and need of developing countries to catch up with OECD countries). The second notion of sustainability emphasized here is related to financial markets—sustainability means that banks, investment funds, and insurance companies, as well as other investors, have a long-run perspective. This second notion suggests emphasizing a stronger role for the green rating of companies listed on the stock market, and such a rating should be a signal for investors interested in thoughtful long-run decision-making. Sustainable development has a natural connotation with growth analysis, namely in the sense that the growth modeling typically looks into the conditions of long-run growth and a stable steady state solution. Besides the long-run growth analysis, medium-term adjustment and growth dynamics can also be looked into. (Barbier 2009) has argued that governments’ spending programs aiming to overcome the Transatlantic Banking Crisis should be more focused on the promotion of environmentally friendly growth, so that the global economy could be stimulated and new employment would be created, at the same time, carbon dependency could be reduced, the degradation of the ecosystem could be reduced, and the problem of water scarcity could be tackled more effectively. Moreover, the Millennium Development Goal of overcoming extreme poverty by 2015 could be achieved. The approach of Barbier is comprehensive but leaves many questions open, including whether or not the chosen analytical basis is consistent. Many policymakers prefer to rely on DSGE models that stand for a complex approach while neglecting key elements of globalization, which in turn are relevant for greenhouse gas emissions; e.g., the role of foreign direct investment (FDI) is ignored, although FDI is quite important for international technology transfer and green growth in many countries. In a rather simple neoclassical growth
Green Innovations and CO2 in a Growth Perspective: A Neoclassical Model
framework, many key analytical challenges of green innovation and green growth can easily be incorporated. While a DSGE model is certainly useful for certain analytical perspectives, the following analysis will largely be confined to a simple modified neoclassical growth model. The analysis presented first looks at the basics of green innovation dynamics (Sect. 1.1). In Sect. 1.2, aspects of modified neoclassical growth modeling—including the role of the golden rule—are discussed. Section 1.3 presents some policy conclusions. At the bottom line, analytical progress is developed subsequently and some rough calculations on the impact of CO2 emissions on true gross domestic product are also presented; for many OECD countries the corrected gross domestic product figures—taking into account the quasi-negative value-added of CO2 emissions— are rather small relative to official figures from the System of National Accounts. However, there are also industrialized countries in which imputed negative valueadded from CO2 emissions are rather big: China, a country where CO2 emissions have so far not been internalized through policy intervention, is an interesting case where the negative value-added from CO2 emission is in the range of 2–3% of official gross domestic product (the range is a function of the opportunity costs of CO2 emission reduction). The analysis presented argues that green innovation dynamics could play a crucial role in sustainability and long-run growth. Information and communication technology is a sector that is highly innovative and could particularly contribute to green growth—despite some rebound effects in the field of green ICT. One of the most important green potentials that could be exploited by ICT is a much more efficient use of machinery and equipment: By introducing virtual markets and creating virtual machines, individual demand curves at any point of time can be aggregated rather effectively, namely in a way that raises the capacity utilization of real machinery and equipment: The demand collected via computer systems and assigned to virtual machines can be assigned in a second step to real machines and this two-stage system will allow to operate the existing capital stock in many sectors in a much more efficient way than prior to the expansion of ICT. This special aspect will subsequently be neglected. However, many other key aspects of green innovation and green growth will be discussed. It will be argued that rather simple growth models allow to gain important new insights in the field of green growth analysis.
A Rational Approach to Promotion of Green Innovation
Taxation and Subsidies as a Means to Internalize External Effects
A government in a market economy has several tasks: creating institutions necessary for transactions in markets, stabilization of the economy, and internalizing negative as well as positive external effects. Promoting innovations is a standard
A Rational Approach to Promotion of Green Innovation
task of government, however, before paying subsidies for research and development; the economy should be opened up for trade and competition in goods and factor markets introduced; China has been among the countries that have made enormous progress in this field since 1990, and membership of the WTO in 2001 has been an important signal. The EU’s eastern enlargement also stands for a remarkable experience in the field of trade liberalization, privatization, and competition. With the ongoing discussion about greenhouse warming and other environmental problems—including nuclear risks—there is a special need to emphasize green innovation dynamics. Innovation dynamics will be high if there are five key elements present: • Strong competition • Sufficient emphasis on human capital formation and the expansion of digital networks which are important for both fast diffusion of technologies and for creating internet-based innovation networks (with more emphasis on technology-intensive production, there will be a growing demand for human capital so that there is some trade-off between rising government expenditures on education and rising promotion of innovation) • Efficient innovation system • International technology flows—typically partly related to trade and foreign direct investment inflows • Adequate incentives: such incentives should tax emissions and provide R&D subsidies As regards innovations, there are often positive external effects from innovations in a certain sector (or from certain innovative firms in this sector) so that subsidies for innovators and research & development are justified. In the market for R&D services, the social benefits are higher than the private benefits (DD1 is above DD0; DD1 indicates private benefits from R&D; q is the quantity) so that the optimum allocation of resources—the optimum quantity of R&D (q1)—is only obtained if the marginal costs curve in the innovation sector (k0i) is shifted downwards in a way that we get an output that internalizes the positive external effect. In the left-hand panel b, we consider an industry j with emissions, that is, a sector j with negative external 0 effects is shown so that the social marginal benefits (DD 1) are below the private 0 social benefits (DD 0); Q stands for the quantity of the good with emissions. By imposing an adequate Pigou taxon producers, the supply curve—the marginal cost curve—can be shifted upwards k0j1 ¼ k0j0 ð1 þ t0 Þ where t0 is the Pigou tax rate (see
Fig. 1.1): Thus, the optimal output Q1 is obtained and not the output Q0, which would result in an economy without government intervention. The Pigou tax—or tradable emission permits—helps to correct a partial market failure, which would normally characterize the market for goods with emissions. If there were no sector with Pigou tax, the income tax would have to be raised in order to finance the subsidies for innovative firms.
Green Innovations and CO2 in a Growth Perspective: A Neoclassical Model a) R&D Sector
b) Sector with Emission
k‘j0 k‘i0 (1-subsidy rate) E‘1
p‘2 p1 E0
Fig. 1.1 Subsidizing the innovation sector and imposing a Pigou tax on the sector with emissions
As regards the economy in the real world, in a framework of Schumpeterian innovation dynamics and emissions, it may be emphasized that there are two types of market failures at the same time that can, however, be solved through a combined policy: Subsidies are given to innovative firms in order to internalize the positive external effects from innovation; these subsidies can be financed partly or fully from revenues arising from a Pigou tax on emissions (or from government selling tradable CO2 emission permits to firms). For the sake of simplicity, focus will be placed on a Pigou tax where the tax rate is τ0 , so that the government budget 00 00 0 0 constraint reads: G + τ η Y ¼ τY + τ η Y. G denotes real government consumption, τ00 is the subsidy rate for the share η00 of production activities that are subsidized; τ is the income tax rate, η0 is the share of output, which is subject to the Pigou tax (seigniorage from “producing money” is ignored here). This problem of an adequate tax and subsidization system is considered here in a principal way. Paradoxically, the emissions are welcome to some extent because this allows government to finance subsidies for innovations and research & development, respectively—without any deadweight loss; in the absence of emissions and an emission tax, respectively, the subsidization of innovations would require to raise the income tax rate, which in turn would reduce the level of the long-run growth path in a growth model; and under certain assumptions could even reduce the long-run growth rate of output, namely if the income tax rate would negatively affect the technological progress rate. It may also be noted—taking due account of well-known results from endogenous growth models in the context of the Lucas–Uzawa approach (see Appendix A.4 for a simple model without tax considerations)—that a progressive income tax rate
A Rational Approach to Promotion of Green Innovation
system might to some extent undermine the incentive to invest in human capital and could thereby reduce the long-run growth rate. A few formal aspects of the link between R&D subsidies and emission taxation should also be highlighted. Let us rewrite the government budget constraint as follows: h 00 i 00 00 τ ¼ γ À τ0 η0 ðτ0 Þ À τ η τ
Here, γ : ¼ G/Y; it has been taken into account that η ¼ η (τ )—with ∂η /∂τ 00 00 00 00 00 < 0—and that η ¼ η (τ )—with ∂η /∂τ > 0. This implies that the income tax 0 0 0 00 00 00 rate can be reduced if τ η (τ ) > τ η (τ ), and a lower income tax rate will raise the level of the growth path. An interesting case is an economy without any income tax; 00 0 0 0 0 therefore, the government budget constraint will read (with η ¼ (1 À η ) ): γ ¼ τ η (τ ) À 00 0 00 τ [1 À η ](τ ). Taking the total differential, we can write: 00
dγ ¼ η0 dτ0 þ τ0 η0 τ0 dτ0 þ τ dη0 À ητ00 dτ
À Á 00 00 00 Since dη0 ¼ η0τ0 dτ0 , we finally get dγ ¼ η0 þ τ0 η0 τ0 þ τ η0 τ0 dτ0 À ητ00 dτ and can thus derive a condition under which the ratio of government consumption to GDP is unchanged: It must hold that: 00
h 00 i 00 η0 þ τ0 η0 τ0 þ τ η0 τ0 =ητ00 dτ0
There is a problem here, since if γ 0 is optimal (however defined), it would be pure coincidence if a necessary change in one of the tax rates—the subsidy rate is a negative tax rate—would leave γ unchanged. In any case, sustainable development, broadly defined, not only requires that environmental constraints are taken into account, but that the government budget constraint and the balance of payments constraints are considered as well. As regards externalities, it is quite important to make a distinction between consumption and investment goods. It has been assumed that negative externalities from emissions are from both sectors and that there is no difference between the two types of goods. Unfortunately, the OECD/IEA does not offer adequate data on sector differences in CO2 emissions—some of the relevant data for the BRICS are given in Appendix A.3. Different sectoral externalities can broadly be analyzed within a two-sector approach. If there are only positive externalities in the capital goods sector—and if these are internalized through a subsidy—and if all negative externalities (emissions) are in the consumption goods sector, key issues can be analyzed within a one sector model: The positive externality shows up in the equation for profit maximization, namely that the real interest rate should be equal to the net marginal 00 product of capital, which is βkβ À 1 – δ + τ (assuming that per capita output y ¼ kβ, 00 where k is the capital intensity K/L; K is capital and L is labor). Moreover, τ ¼ γ + τ will have to be taken into account, which is relevant for the savings function—since