Greener or cheaper goods: Economies of scope in R&D investments

This paper examines firms' incentives to simultaneously invest in cost-reducing and in green R&D (abatement) under the presence of regulation. We show that, without regulation, firms only invest in cost-reducing R&D when economies of scope are absent, but invest in both types of R&D otherwise. With regulation, investments exhibit strategic complementarities, with and without economies of scope, leading to more investments in cost-reducing R&D, thus requiring more stringent emission fees. Assuming that firms invest in only one form of R&D, a traditional approach in the literature, gives rise to an undertaxation problem. This inefficiency is attenuated if R&D investments exhibit economies of scope, but emphasized if pollution is severe, and the market is concentrated; which is further increased when investment decisions are sequential.