Investment, Green Transformation and Growth

The aim of this paper is to develop a two-sector model to explore green economic transformation. The clean energy sector includes a novel technology subject to learning by doing and knowledge spillovers across firms. The dirty sector generates pollution, global warming and other environmental damage from energy used for production. Comparing investment and growth under decentralized, or private, decision-making with socially optimal investment and growth helps to identify the policies required to promote a green transition of the economy. In the decentralized economy, infinitely lived households maximize (indirect) utility and individual firms in the two sectors maximize profits, so that both externalities are ignored. In contrast, a social planner accounts for the externalities. The result is that investment and thus growth of the clean energy sector under decentralized decision-making are too low, whereas growth of the dirty energy sector is too high, compared to the socially optimal growth rates of these sectors. The implications are that policies that boost green R&D and innovation and impose carbon pricing are necessary. These results are in line with policy strategies that advocate economy-wide support for green innovation, carbon pricing and infrastructure investments for clean energy adoption.