Energy Efficiency and Directed Technical Change: Implications for Climate Change Mitigation

In this paper, I construct a putty-clay model of directed technical change and use it to analyze the effect of environmental policy on energy use in the United States. The model matches key data patterns that cannot be explained by the standard Cobb-Douglas approach used in climate change economics. In particular, the model captures both the short- and long-run elasticity of substitution between energy and non-energy inputs, as well as trends in final-use energy efficiency. My primary analysis examines the impact of new energy taxes. The putty-clay model suggests that tax-inclusive energy prices need to be 273% higher than laissez-faire levels in 2055 in order to achieve policy goals consistent with international agreements. By contrast, the Cobb-Douglas approach suggests that prices need only be 136% higher. To meet the same goals, the putty-clay model implies that final good consumption must fall by 6.5% relative to a world without intervention, which is more than three times the prediction from the standard model. In a second analysis, I find that policy interventions cannot achieve long-run reductions in energy use without increasing prices, implying that energy efficiency mandates and R&D subsidies have limited potential as tools for climate change mitigation. Finally, I use the model to analyze the long-run sustainability of economic growth in a world with non-renewable resources. Using two definitions of sustainability, the new putty-clay model delivers results that are more optimistic than the existing literature.