The interplay between carbon regulations and green technology innovation: a comparative analysis

This paper investigates the impact of government carbon regulations on firms' incentives in green technology innovation, considering the knowledge spillover and innovation synergy effect. We develop a stylised model that represents a competitive market consisting of oligopoly firms producing substitute products and generating carbon emissions. We compare the effectiveness of two commonly used regulatory policies: carbon tax and cap-and-trade policy. Our findings indicate that, under moderate regulation intensities, tax policy is generally preferable, while cap-and-trade policy generates stronger incentives when regulations are stringent. However, in cases where competition intensity is low, tax policy can outperform in stringent regulation ranges. Additionally, we clarify that free allocation, while compensating firms for carbon costs, hampers innovation by restricting market share changes in a heterogeneous market. Our study contributes to the debate on carbon regulation policy by providing insights into firms' innovation incentives for green technology innovation and shedding light on the trade-off mechanisms involved in carbon policy design.