The effect of carbon price on low carbon innovation

Abstract Whilst many governments have implemented carbon pricing to provide firms with a greater financial incentive to develop low carbon technologies, the effect of the carbon price on the level of low carbon innovation remains unclear. In this study we develop an empirically grounded model of firms’ carbon price expectations and innovation processes. We use this model to show that a 1 USD increase in the expected future carbon price is associated with a 1.4% increase in the level of patenting in low carbon technologies, based on data for countries participating in the EU emissions trading system. We also find that firms gradually update their expectations of the future carbon price in response to recent price changes. Our findings indicate that higher carbon prices provide an effective incentive for low carbon innovation.