03.04.2025Smarter Policy for effective Green Innovation

To tackle global warming, economies need to transition from polluting products to low-emission alternatives, which requires fostering innovation in process, product, and environmental solutions. In a recent paper, Armin Schmutzler, Professor of Economics in our department examines the indirect effects of innovation, exploring how market share reallocation can influence greenhouse gas emissions – either positively or negatively. Building on this, Schmutzler explores how public policy can play a role in steering innovation toward more environmentally beneficial outcomes.

The well-known case of the automotive industry

The automotive industry has accounted for 25% of global CO₂ emissions and has therefore seen tremendous efforts to replace traditional internal combustion engine vehicles (“brown firms”) with electric alternatives (“green firms”). This shift from polluting products to low-emission substitutes has required major innovation, much of it driven by public policy. This situation has therefore provided the author an interesting base to tackle a new question: How suitable are different instruments for inducing innovations that foster the transition from brown to green products?

When green products negatively impact market share… and the environment

In his paper, Schmutzler begins by examining the main drivers of innovation among “green” and “brown” firms and the impact of environmentally friendly solutions on consumer behavior. The paper finds that innovations by the “green” firms—especially process and non-targeted product innovations—typically reduce total emissions by shifting market share away from the brown firm. However, targeted product innovations aimed specifically at green consumers can have the opposite effect as the “green” firms may raise its prices, shifting away buyers (losing market share), and ultimately increase total emissions. The author finds that environmental innovations by the “brown” firms only lead to emission reductions if the efficiency gains from lower specific emissions outweigh the negative effects of a growing market share. 

Well-designed policies for a better outcome on the environment

Governments have used various tools to foster green innovation, such as infrastructure investment and consumer incentives. But which policies most effectively encourage the right kinds of innovation? The author observes that when price instruments like carbon taxes are in place, there's generally less need to subsidize process innovations by green firms, as market forces already incentivize cleaner practices. In the absence of such pricing mechanisms, however, direct public support becomes essential—both for process and environmental innovations—to drive meaningful emission reductions. Even when carbon pricing exists, subsidizing environmental innovations remains important, as it can amplify both direct and spillover environmental benefits. The paper also points out that firms often hesitate to innovate in markets dominated by competitors, fearing intensified competition and insufficient returns.
Ultimately, this paper underscores the complexity of promoting green innovation and establish a direct link to the reality and the complexity of the market, from the supply side but also from the demand side, where in the end, consumers choices are binding. Public policies must therefore consider firms’ innovation strategies, market dynamics, and consumer preferences to ensure green technologies take hold and achieve real environmental impact.