Why is there still investment in polluting capital?

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Abstract

Despite governments’ commitments to limit global warming to 1.5 degree Celcius, there is still investment in carbon-intensive capital. This paper uses a growth model featuring irreversible investment, capacity utilisation, clean and polluting capital to study this apparent paradox. It shows that current investment in polluting capital and CO$_2$ emissions are coherent with expectations of a future carbon tax, if investors also expect a bailout of polluting capital. This result implies that governments’ credibility can play an important role in reducing the cost of implementing an optimal carbon tax by committing not to bail out. However, there exists a temptation for a short-sighted government to boost output and consumption in the short run by announcing a future bailout.

Citation

@techreport{MS24,
author = {Raphaël Huleux},
year = {2024},
title ={Why is there still investment in polluting capital? Stranded Assets and Policy Uncertainty}}