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Environmental policy effects: an R&D-based economic growth model with endogenous labour supply

ABSTRACT We investigate the effect of environmental policy on economic growth by using an R&D-based growth model with endogenous labour supply and conducting a numerical analysis. The model brings together two channels for substituting polluting capital inputs: A static channel and a dynamic channel. A decrease in pollution permit levels indicates a direct effect on reducing growth rate and an indirect effect on rising growth rate via the two channels. Under the assumed functional forms of abatement and production technologies, the indirect effect dominates the direct effect at equilibrium. Thus, the policy can raise growth rate and improve welfare.