Adopt or Innovate: Understanding Technological Responses to Cap-and-Trade

One important motivation for creating cap-and-trade programs for carbon emissions is the expectation that they will stimulate much-needed low-carbon innovation. I construct a new panel of British firms to investigate this hypothesis, finding that the European carbon market has encouraged greater low-carbon patenting and R&D spending among regulated firms without necessarily driving short-term reductions in carbon intensity of output. This stands in contrast to past cap-and-trade programs, which have primarily spurred adoption of existing pollution control technologies, with little effect on innovation. I discuss how to reconcile these contrasting findings and implications for the future of carbon markets. (JEL D22, O32, O34, Q52, Q54, Q58)