Directed technical change and economic growth effects of environmental policy

A Schumpeterian growth model is developed to investigate how environmental policy affects economic growth, when environmental policy also affects the direction of technical change. The model is designed to match several stylized facts to ensure its empirical relevance. It is shown analytically that a tightening of the environmental policy directs research efforts toward pollution abatement technologies and away from production technologies. Hence, economic growth is reduced unambiguously. However, the effect is highly non-linear. At first, a tighter environmental policy has a small impact on economic growth. Yet, the growth effects become substantial if the environmental policy is tightened sufficiently. Nonetheless, the economic growth rate is barely affected by a realistic tightening of the environmental policy. These model predictions are consistent with empirical observations for the OECD. • Developing a Schumpeterian growth model featuring production and pollution abatement technologies. • A stricter environmental policy unambiguously reduces economic growth. • Highly non-linear economic growth effects of environmental policy tightenings. • Economic growth barely affected by realistic environmental policy changes. • Model predictions consistent with empirical observations for the OECD.