Abstract
We analyze the implications of the interaction of market failures associated with pollution and the environment, and market failures associated with the development and diffusion of new technology. These combined market failures imply a strong prima facie case for public policy intervention to foster environmentally beneficial technology. Both theory and empirical evidence suggest that the rate and direction of technological advance is influenced by incentives from the market and from regulation. Environmental policy based on incentive-based approaches is more likely to foster cost-effective technology innovation and diffusion than policy based on command and control approaches. In addition, society's investments in the development and diffusion of new environmentally beneficial technologies is very likely to be less than socially desirable in the presence of weak or nonexistent environmental policies that would otherwise foster such technology. Positive knowledge, adoption spillovers, and information problems further weaken innovation incentives. While environmental technology policy is fraught with difficulties, a long-term view suggests a strategy of experimenting with different policy approaches and systematically evaluating their success.