Abstract

Innovation for social progress (ISP)—that which addresses society’s greatest challenges, like climate change and education—is characterized by a unique double-externality challenge: imperfect appropriability that leads to knowledge spillovers, and production or consumption externalities that generate “incorrect” prices. We develop a theoretical model showing how these two market failures are interdependent, which changes the predictions of how they affect firms’ incentives to innovate in ISP technologies. The effects of each, as well as policies aiming to address them, can be either enhanced or attenuated by the other. This is not just due to an interaction effect – their direct effects are also adjusted. We then estimate the effects of carbon pricing and technology-neutral R&D tax credits on firms’ R&D, patents, and productivity in the UK’s energy, transportation, and manufacturing sectors using a heterogeneous difference-in-discontinuities approach. Our preliminary results indicate that technology-neutral tax credits dampen the directional effect of carbon pricing on environmentally-friendly innovation. These findings suggest that accounting for market failure interdependence in policy design is important if the goal is to steer the direction of innovation towards ISP technologies.