CIAO DATE: 04/2010
August 2009
Department of Economics and Business, Colorado College
In an effort to explore the potential for financing environmental innovation, this paper examines different forms of financing and attempts to evaluate their effectiveness. The study considers both public and private forms of funding as well as providing policy suggestions for the support of appropriate financing for eco-innovation. Key Findings: • The literature on the financing of innovation is very limited, and a virtually non-existent literature on the funding of eco-innovation in particular. • R&D spending in the energy sector is relatively quite small, when compared to other industries and sectors. In addition, since fossil fuels receive close to one-quarter of the federal funding it is perhaps not surprising that there is a dearth of research on funding for eco-innovation. • Innovation is inherently risky and uncertain. Moreover, if we are unsure about the rate of innovation, then we have difficulty predicting the pattern of global climate change, which makes it difficult to substantiate the reasons for further research funding. • Public funding occupies a significant and important position in innovation financing. One essential role of government is the funding of basic research, especially technologies that are not in and of themselves commercially viable, but may serve as a springboard for subsequent innovation. Further, of one hundred lines of inquiry only one might merit commercialization by venture capital funding. • Environmental innovation is complicated by both environmental externalities as well as the public good nature of the technology. R&D subsidies address the public good characteristic, but fail to account for the environmental externality, so do not address adoption challenges. Subsidies, either R&D or production subsidies, are an easy target for interest groups, creating a political challenge. As a result, subsidies frequently take less transparent forms such as price controls that reduce prices below full cost. • It is clear that energy and agriculture are two of the most heavily subsidized economic sectors, and both impact directly on the ability of eco-innovation to draw resources and to draw consumers. Global energy subsidies are close to $300 billion per year and the majority of these serve to lower consumer prices in non-OECD nations. Alternatively, in OECD countries, most subsidies go to production in the form of direct payments or as R&D support. Roughly eleven percent of that total supports the distribution of low-carbon energy. • While taxing carbon-intensive fuels may be a more economically efficient mechanism, it is probably politically unfeasible. Moreover, economists cannot even cleanly recommend the elimination of subsidies for fossil fuels due to the complexity of the system. For example, encouraging the use of oil products such as kerosene can curb deforestation. • Most innovation is still funded by private sources, whether internal to the firm itself (e.g. via retained earnings) or through third-party funding sources (e.g. bank loans, venture capital). Moreover, corporate interest in eco-innovation is largely market-driven, so policymakers would do well to ensure that the incentives and abilities to early profits are appropriate and preserved. • It is important to note that there is some evidence that appropriate funding may differ based on the stage of the innovation’s life cycle. Current case studies appear to favor technology push factors early in the product cycle, versus market opportunities later in the cycle. • Finally, empirical studies frequently identify the lack of access to credit as a significant barrier to adoption and technological diffusion. For environmental innovators, the challenge is not only attracting sufficient funding, but ensuring that the associated incentives are appropriate to the lifecycle stage. This paper concludes that the challenge to policymakers is one of balance: encouraging financing and removing obstacles to the process while still allowing the wisdom of the market to function and the powers of the invisible hand to best guide investments. While the importance of eco-innovation is increasingly evident, the mechanisms for funding these technologies remain largely unexplored. A rich set of questions remain to be answered, questions that will help reveal the most efficient and effective means of financing environmental innovation.
Resource link: Financing Environmental Improvements: A Literature Review of the Constraints on Financing Environmental Innovation [PDF] - 299K