Sustainable growth with renewable and fossil fuels energy sources

How to control climate change and to spur clean energy are among the most important challenges facing the world today. So far, a large strand of literature on climate change states that we need several economic policy instruments to correct for existing types of market failures, for instance, an environmental tax on the carbon emissions and a research subsidy for research and development (R&D) in the renewable energy sector. We think that the failure of the existing policies on climate change is the fact that implementation of renewable energy is spurred by flow of monetary subsidies to renewables’ price. Such a short-run policy leads investment in renewables to be suboptimal since investors do not trust climate change policies. We believe that a more fruitful approach to tackle climate change should take into account that investors in renewable energy react positively to a stock of commitment and reputation of the policy makers on the long run. To this end, the novelty of this paper is constituted by modeling a stock of public capital which captures intensity of government long term commitment to support new technology developments. We consider a Schumpeterian model of endogenous growth to take into account that production emit pollutants. The final good is produced employing labor and energy services from renewable energy and fossil fuels that are imperfect substitutes. The quantity of energy from fossil fuels is a function of investment and the amount of resources extracted. In our framework, the price of the non-renewable energy follows the generalized version of the Hotelling rule. Concerning the renewable energy, we construct two variants since we take into account two different channels for government intervention. In the first variant, the quantity of renewable energy depends on  investment and the stock of knowledge. In the second variant, a stock of public capital enters the production function as an input, with investment and the existing specific knowledge. We work on the effective value of an innovation paid to the inventor as an incentive for doing research in renewable energy in order to lower production costs and make it competitive in the energy market. There is the perspective of a non-linear jump, that is, there is a critical R&D threshold beyond which renewable energy gains in importance with respect to the fossil fuels input.  We first present the decentralized economy and study the behavior of agents in each sector: the final good sector, the energy services, the consumers and the government. We characterize both the decentralized equilibrium and the first-best optimum solutions. Next, we show how the optimum can be implemented by an appropriate flow of public capital, comparing the relative effectiveness of current monetary subsidies and government reputation and commitments, in order to enable policy strategies.