Non-tradeable pollution permits as green R&D incentives

Profit-seeking firms can be induced to internalise the environmental damages caused by production via several policy instruments, a widely used one being emission permits. In a very influential paper, Laffont and Tirole (J Public Econ 62:127-140, 1996) point out that the allocation of pollution rights to firms may hinder their willingness to undertake uncertain R&D projects for environmental friendly technologies. We revisit this issue in a duopoly model, showing that a lottery allocating a given volume of emission rights exclusively to the winner might indeed be used by the regulator to spur the introduction of green technologies at least by the loser and, if properly designed, by the entire industry, in an admissible range of the model parameters. We also show that there exist parameter constellations wherein firms' incentives are aligned with social ones.