Adoption paid by non-adopters: an innovative techno-economic policy to spread clean technologies

Full paper

Valentino Piana
Climate change mitigation and adaptation measures will require the fastest possible adoption rate of clean technologies to substitute the most polluting ones. Based on insights of diffusion theory and robust empirical evidence, an innovative tax scheme is proposed, in a wider framework of diffusion as a process involving social, technological and economic aspects. 1. Objectives of the scheme By repetitively levying a small tax on non-adopters to finance adopters, a responsive mechanism of stimulation is put in place to foster an efficient level of [] diffusion of greenhouse gas emissions-reducing technologies (Duval, 2008) at no cost for the policymaker and with an electoral majority of consensus in the population at large. Adopters enjoy a boost of profits, whereas many people are left out of the scheme (e.g. because they are poor) while receiving the environmental benefits. Administrative and monitoring costs are kept low by trivial methods. With slightly higher monitoring costs, the same mechanism can target performance thresholds (e.g. levels of CO2 emissions) instead of specific technologies. 2. Background The scheme is a supplement to emission reduction targets and allocation rights, as requested by a growing number of stakeholders (Ecosecurities, 2007), to frame the political discourse on mitigation and adaptation measures as opportunities for technological diffusion & profit instead as a burden on taxpayers and industry in trouble. To quickly begin an effective reduction in emissions from the bottom up is as important as a global agreement on long-term targets: the two goals mutually reinforce each other, by breaking scepticism and fears. By deepening the Technology-Centred Approach (Barrett, 2003), our proposal emphasises the large diffusion of existing clean technologies at their early commercialisation stage, so it can have an immediate impact on emissions and the profitability of innovators. 3. Diffusion as techno-social-economic process The diffusion of an innovation in a population of potential users has been studied for decades. The standard theory of diffusion of technological and behaviour innovations (e.g. Rogers, 1962, revised in 2003) has been enlarged by new strands of models and insights (e.g. Nelson and Winter, 1982; van Dijk and Nomaler, 2000) but it is still confirmed that diffusion follows more or less an S-shaped curve of successive adoptions by: 1. a very small group of pioneers (who have a special preference for the technology often beyond direct economic benefit, e.g. they have a green culture); a small group of early adopters (who scrutinise the pioneers and are rewarded by the social consideration of being opinion maker); a group of early majority (who are attracted by economic benefits carrot); the late majority (who should be motivated by the negative effects of non-adopting stick); the laggards (who adopt only if there is a compelling mandate by law, because they have a stubbornness out of cultural reasons, e.g. antienvironmentalist attitude).

2. 3. 4. 5.

Other patterns can be due to intensive advertising before launch of the innovation on the market (with an early peak of sales), erratic paths around a low average due to products having both strong minuses and pluses, constant low sales because of forced repurchasing by the same categories of users, diffusion failure (with fast aborted trajectories). Cyclical fashions might exhibit irregular sinusoidal dynamics. However, the large majority of successful innovation in normal conditions appeals to different user categories as described. We think that policies targeted to fast and wide diffusion of innovation should take into account the heterogeneity of potential buyers. In particular: 1. 2. 3. 4. 5. pioneers should be free, with a liberalisation of laws, regulations and social conventions; early adopters should be praised in moral and social terms across mass media and communication networks; the early majority should receive positive material incentives; the late majority should suffer from negative material disincentives if they do not adopt; the laggards should face a mandate by law to adopt before a certain temporal deadline.

In so doing, the policymaker would impact the different motivational triggering factors of the population of consumers or firms, taking advantage of asymmetries like between positive and negative incentives, as underlined by prospect theory (Kahneman and Tverski, 1979; Brekke and JohanssonStenman, 2008).

Economics Web Institute (2009)

4. Climate change mitigation requires diffusion of innovations and behaviours

the

* the first time: a payment to the entire population of adopters, but * the further times: a payment just to whom adopted meanwhile, i.e. between two application dates. Each adopter can get the revenue just once. The revenue of a lump-sum tax of a fraction f of the cost C of adopting a new clean technology, levied on non-adopters, is distributed to recent adopters. The entire burden of adopting is brought by non-adopters. Not only they pay the tax but also they do not share the tax revenue and they do not have the advantages of using the innovation (e.g. alternative fuel cars and distribution stations, gas-free refrigeration platforms, eco-buildings, etc.). If the tax is levied at the beginning of the diffusion curve, when only a very small number of pioneers has adopted, then the tax revenue will be extremely high, even if the fraction f is small, because almost everybody is a non-adopter. The adopters will receive more than C, making a large profit, which will have a strong media coverage, prompting for imitation. In the next round, non-adopters again have to pay f. In order to avoid paying, some (not all) will adopt; their strategy clearly pays off: they receive a larger sum than C because non-adopters are still a large majority. If the tax is levied frequently enough, the recipients will be less numerous than the payers, with a ratio of f needed to cover the adoption cost. As far as the diffusion process proceeds and nonadopters become a minority ("late comers"), there might be a change: the tax revenue could be distributed as a loan to those who promise to adopt in this new period. If they adopt, the loan is forgiven, if not they have to pay it back. Since a minority of them will promise to adopt, they will be prized with a loan fairly near to the entire C (although possibly not covering it in whole). In another vein, as the number of non-adaptors goes down, one might increase the percentage of tax. This will raise a larger revenue even at this stage and will encourage everyone to "get on board" early If non-adopters are a very small minority, they can be left in peace with the tax scrapped (if it is tolerable that somebody does not adopt), or the loan structure can be in place indefinetely. In this simplest form, the tax does not generate revenue for the state, it's a mere redistribution within an industry or a population; some receives what other pays. 6. A real-world application: distribution stations of alternative fuel To reduce CO2 emissions and save energy, new "fuels" have been proposed for cars (e.g. GPL, electricity, hydrogen, compressed air,...) with distribution infrastructure being a major obstacle to their diffusion. The consumer does not want to buy a car that has no

A large reduction in CO2 and other greenhouse gases is linked to the modification of technological coefficients of the installed stock of capital (buildings, cars, plants, land,) as well as of the behaviours of consumers and firms (house temperature, km travelled, working hours, deforestation activities, ). Its not enough that R&D labs propose breakthrough innovations: they should be timely and widely adopted. Carbon taxes and prices (e.g. generated by a cap-and-trade international system) will broadly influence the purchase and use of new technologies but on certain key markets there might be entire classes or specific technologies whose diffusion should be explicitly targeted, involving a complex strategy of communication, as widely explained in Moser and Dilling (2007). 5. The proposed scheme: the simplest case Early majority potential buyers are particularly sensitive to positive incentives, whereas late majority should feel the cost of not adopting. Since together they account for the largest part of the population, a wide adoption requires their mobilisation. Pioneers should be taken as positive example and wide media coverage should be generated at early stage of diffusion. The perspective of a final deadline for adoption is effective also on laggards, especially it is very credible, with no past experience of deadlines missed and postponed. In this vein, we propose PRODINT (PRO-Diffusion-ofINnovation Tax). Let's concentrate on a situation in which innovation is embodied in a durable good, thus adoption means just to purchase it by paying a given price P. Let's further assume that the use of the good does not generate any additional flow of money neither positive nor negative (see chapter 6.3. for the removal of this hypothesis). Adoption thus has a sunk cost (P) but no fixed or variable cost. Although in general the cost C of adopting the good comprehends not only P but also monetary and nonmonetary components due to the difficulty of using the new good, any cultural resistances to adopt, and possibly the cost of overwhelming the very unawareness of its existance, in this simplest case the adoption cost might be reduced to P. The tax on non-adopters will be a lump-sum whose value is a fraction f of C. The tax revenue be distributed in equal shares to recent adopters, defined as the agents that at a certain date can demonstrate of having adopted the innovation after a previous date. Were the tax levied just once, it would be a mere payment from non-adopters to users. However we assume that it is levied several times, thus turning out to be:

Economics Web Institute (2009)

stations nationwide, while no distribution chain wants to set up stations if the number of consumers is too low. This vicious cycle can be broken by PRODINT, levied on existing gasoline stations. A small tax is levied on each station that does not distribute the alternative fuel, irrespective of the ownership of the station (large chains, independent owners,...). The total tax revenue is given to the very few pioneers that add the new fuel to their existing supply lines (e.g. some environmentally-minded independent owners). They receive a huge amount of money, since non-adopters are thousands and outnumber the adopters. The news spread, the profits lure new adopters (e.g. environmentally-sensitive owners that were afraid of the cost of adoption). Again the small tax is levied and they receive a very good amount of money, attracting a third wave of adopters (owners attracted by money only, without a particular environmental sensitivity). This should be enough for chains to take in serious consideration stopping financing adoptions of their competitors. One or two can establish plans for adding alternative fuel to their offer in a number of stations over time. These plans are credible commitments, so car purchaser begin to have good reasons to buy cars with the new fuel (e.g. hybrid cars). Since alternative fuel can be cheaper or be made cheaper by a legislation that internalize the costs of pollution and CO2 emission to the different fuels, early car adopters will enjoy a cost advantage with respect to the conventional car users. The wider number of alternative fuel cars increases the profits of stations offering alternative fuel. Since they remain a minority, each one covers a much wider area (consumption basin) which allows a relatively quick increase of sales. Normal market mechanism will start working, spreading the new fuel in further stations and consumers near to those stations beginning to switch to the new fuel. The PRODINT mechanism will stay until a satisfactory diffusion of the new distribution infrastructure is achieved. It costed nothing to the policy-maker, who can boast the reduction of CO2 emissions and the trasport costs. Producers of alternative fuel cars will make healthy profits, attracting further producers thus guaranteeing a wider choice of car models. As the reader will have noticed, we are taking into account not only strictly monetary factors, but also the mentality, the level of information and behavioural inertia of the various actors involved. 7. Some key monitoring costs details: administrative and

receive to their bank accounts the share of tax revenue. No bureaucracy has to be added. Monitoring costs can be brought down to very low levels through widespread power of control. For instance, any citizen could be entitled to signal nonadoption and this message is compared with official declaration of the adopter/nonadopter; in case of discrepancy (or a number of signalled discrepancies) a mission to verify is sent; if indeed there is a violation, then a high fine is issued; the citizen(s) having signalled receive(s) a part of the fine. Many other systems of monitoring and administration can be deviced, while keeping simplicity and low costs being their features. 8. The main advantages of PRODINT In synthesis, the main advantages of this tax system are the following: 1. totally relying on spontaneous decision, leaving people free to adopt or not; 2. no tax burden for the population as a whole; 3. during the process a large amount of people is better off with the scheme than without; of course, non-adopters would have preferred the absence of the scheme but they become a minority over time; if the wide diffusion triggers the diffusion of a complementary technology (as with the case of cars after the stations) even the "forced" adopters are happy of having done this; 4. the tax levied can be really small in absolute terms. Additionally, the reaction of the sellers of the good is much better than in presence of a state incentive: they do not change their prices because they do not know how much the adopters might receive from the tax. On the contrary, lump-sum or percentage state-paid incentives to customers are often transferred to extraprofits of the sellers who increase price of that sum, by keeping almost at the same net price the purchaser. In the sector producing the innovation, this scheme generates a diffusion dynamics that matches reasonable production timetable, with increasing production over time and a relatively long tail, whereas deadlines - which mandate everybody adopting - generate a skyrocketing production before deadlines and zero afterwards, with the necessity of having a large production capacity which ends up to be useless. Capital is piled up, labour is selected in a rush, has no time to learn the job and then is fired because employment goes to zero. In turn, the smoother dynamics fostered by PRODINT allows incremental improvements of the innovation itself, as for solar panels getting more efficient over time, because the profits from early production can be channelled to R&D, as you can experiment in this interactive model.

Administrative costs of PRODINT are minimal. By leveraging existing technology, one can imagine a bank account where people pay the tax, while signalling by email that they adopted the good so as to

Economics Web Institute (2009)

Note that in the supplier sector, many firms compete and the consumer has the time to compare the many differentiated versions offered, whereas with deadlines the suppliers are sure to sell and do not care about additional features. 9. Some more advanced cases 9.1. Variable cost of adoption If the cost C of adopting is not constant but has an observable distribution in the population, then the size of payments to recent adopters might be somewhat adjusted to it. This in particular is relevant when adoption relates to a vertically differentiated good and the policymaker would like to influence not only the mere fact of adoption but also its "quality", by giving more to the boldest adopters of "better" technologies. 9.2. Unknown and extremely variable cost of adoption A more extreme case is when not only the cost of adoption is different for each agent in the population, but also it cannot be observed from outside (it is a private information of the agent). In this case, the policymaker can request the agent to write down its estimate of adoption cost (leaving room for opportunistic behaviour) and establish the amount of tax in relation to its distribution. In particular, given a target fraction of the population that one wants to motivate to adopt, one can sum up the declared adoption cost of that fraction, beginning from the lowest estimates. In this way one obtains the lowest total amount to be given to that fraction so as it to adopt. This amount is divided by the number of non adopters and fixed as their tax. The tax revenue is distributed as a loan to those who promise to adopt in this new period. If they adopt indeed, the loan is cancelled, if not they have to pay it back. One would expect firms to overshoot, by declaring higher costs than real ones. But those who ask the largest sums will usually end up rather paying than receiving. Those who receive will probably get high profits from the tax, confirming that it is better not to overshoot. In this uncertain scenario one thing is sure: adoption is granted in the requested quantity. Individual profits and losses represent "collateral damage" for meeting the target. 9.3. Adoption of a technology with a stream of costs and revenues over time Many technologies involve not only a cost C for purchase but also additional costs over time in terms of maintenance, fuel, etc. In particular, a recurrent situation is where a more expensive technology in terms of C has lower variable costs over time (e.g. an efficient engine that requires less fuel but is more expensive at the time of purchase, a solar panel, etc.). In this case, the adoption is linked to a low discount rate and a long acceptable payback period: the investor compare the present value of the technology

by discounting the savings in the future with the higher cost of investment now. More in general, the technology can involve also revenues flows, with discounting once again being the common way to take decisions of adoption. This means that the prevailing interest rate on the market is a key determinant in choosing to adopt, with too high interest rates discouraging innovation diffusion. PRODINT modifies only the cost of purchase, not the stream of costs and revenues afterwards, so it increases the roof for interest rate below which adoption takes place, it reduces the years for payback, so it drastically help adoption for a number of investors. In more technical terms, PRODINT increases both the Net Present Value (NPV) and the Internal Rate of Return (IRR) of the investment, so that a wider number of investors find the decision profitable. 9.4. Meeting performance threshold instead of specific technology diffusion In certain cases, the policymaker does not know the exact technology that would be necessary to reach its goals (e.g. "lowering greenhouse gases emissions" or "increasing the competitiveness of the industry"). In other cases, technologies are known but there are several of them in competition to each other (e.g. broadband Internet connection delivered by satellite, cable, Wi-Fi, Wi-MAX, x-DSL, etc.) and the policymaker does not want to favour one against the other, possibly because of consensus constraints. To the extent that performance is measurable, the tax can be levied on the group of agents that does not meet a minimum threshold and the tax revenue given to those exceed a sufficiency threshold. The two thresholds can converge in one or be separated by a neutral zone, where no payment is made in either direction. If performance, e.g. energy efficiency, is presently distributed according to a bell curve, the situation can be depicted in the following way:

People and firms using technology whose energy efficiency is below EE1 will pay the tax, whose revenue is transferred to those whose energy efficiency is higher than EE2. Because of the fact that the blue taxed are more numerous than the red receivers, the

Economics Web Institute (2009)

tax can be small and tolerable, while the incentive will be strong. Since the improvement in the environment resulting from higher average efficiency (the main benefit of the entire strategy) is given to all, the neutral zone can align itself with the recipients and form a political majority. The thresholds can be established to change over time, e.g. an increase of 2% per year, so to create a clear, stable, and pro-diffusion environment for all the agents. 9.5. Distributive justice: four remarks In normal conditions, pioneers and early adopters tend to have higher income, higher education, and better social connections than late comers. Thus, PRODINT might be criticised as a redistribution from the poor to the rich. There are three remarks to contrast this danger, as some would consider it: 1. distributive justice, if felt necessary, can be achieved by other means, e.g. a progressive income taxation with large negative taxes paid back to the poor; 2. by acknowledging the existence of PRODINT, a poor could take a loan and adopt the innovation, getting the share in tax revenue; in this way PRODINT opens the opportunity to adopt even to people that would have not afford it; 3. the goal of PRODINT is fast adoption, thus an implicit assumption is that the agent can (afford to) adopt and it's just because of cultural inertia that he does not; accodingly, the universe of taxed agents might be circumscribed to those that can afford the innovation (e.g. SUV + Hybrid electric vehicles could be the universe, with owners of SUV being taxed and owners of HEVs receiving the revenue, fostering people to sell their SUV and buy HEVs instead - the rest of the population enjoying this development from a safely neutral fiscal point of view). A more radical objection to PRODINT from a "green" point of view is that PRODINT is an incentive to buy something, not to live better with less. There is some truth in this: the implicit assumption is that people have a need and some technology is necessary to satisfy it, with PRODINT channelling adoption to the most environmental friendly one. However, if one can single out which is the "environmental correct" behaviour, then PRODINT could be directed to support those people that follow it, not necessarily own & use some technology. For instance, if tele-work and car-sharing are seen as a better solution than owning a car at all (SUV, Hybrid,... alike), than PRODINT could be levied on all car owners wth the revenues distributed to teleworker and car-sharing users. More in general, PRODINT is very flexible and can be used adequatedly in many situations, as suggested by

Hamond J., Merriman H., and Wolff G. (1999), once the goal of a wider diffusion of a certain technology or a certain behaviour has been judged useful [2].

10. Political constraints, democratic majorities, and lobby attitudes PRODINT is designed as fiscally-neutral, so that it can be adopted by governments of any political orientation. If by contrast the government would like to counter-cyclically inject money in the system during a recession, the subsidy might be higher than tax revenue or large exemptions might be conceded. Conversely, if a large fiscal deficit is considered as a problem, PRODINT can be parametrised so as to produce a positive inflow to the budget. The government can decide by its own will, or be subject to democratic majorities (when voters make PRODINT a crucial issue of the electoral campaign) or to lobbies (who compare what businesses gains or lose from a policy and use this differential to influence the parliamentary debate, e.g. by financing electoral campaigns of corresponding politicians). PRODINT can be supported by a democratic majority:

PRO
AGAINST

A minority pays the tax, a small minority gets the subsidy, but the people excluded from the scheme would support it because they have a net gain (the environmental benefit) at no cost. In lobbying terms, PRODINT increases the profits of the producer of clean technology, so it can prospectively fund a pro-environmental business lobby. Even if that is not formally established, trade organisations having among their members both winners and losers from this tax will probably reduce or annihilate their lobbying activities against it, to avoid the risk of an exit from the (voluntary) trade association of the clean producers. 11. Theoretical justifications The broad framework of PRODINT is evolutionary economics, that has deeply analysed technology innovation and its diffusion (Nelson and Winter, 1982). Economic and non-economic factors have been found to be relevant, in particular not only the amount of information available but also the capability of

Economics Web Institute (2009)

interpreting it, with ex-ante preferences (e.g. to environmental protection). In psychological terms, prospect theory by Kahneman and Tverski (1979) would underline the importance of providing highly visible reference points for decision; the dichotomization of adoption and non-adoption, with its harshly different treatments and phase-afterphase results (pay vs. receive, denounced by citizen vs. praised,...) are all meant to give decision-makers an extreme incentive to act. PRODINT implements the principle of "polluter pays" in a new, albeit fully legitimate, way. The non-adopter is the polluter and what is paid is not a fine for the damage but the adoption by non-polluters for a real improvement. 12. A quantitative exploration of the effects of the scheme: methodology and results The policy has been tested in an Agent-Based Model of an artificial economy with two competing technologies, product differentiation, heterogeneous consumers, R&D, advertising, and finance, based on Piana (2003). Starting conditions: 68% of consumers use the incumbent technology characterised by high emissions, 4% use the challenger technology (low emissions) and 28% do not own any good. Production costs of clean technology are twice as high as the dirty one, with sale prices based on a mark-up over costs. Dynamics: two firms, each developing one technology, invest in advertising and R&D to improve performance and production costs, with equal technological opportunities for both. Firms set the price while consumers choose to buy a new product or continue to use their current one. Consumers are heterogeneous, as they differ in income, green orientation, attitude to non-energy performance (e.g. aesthetical design), rules of choice, intensity of good use, subjective rate of discount for future stream of costs and revenues, expectations about the value of the PRODINT subsidy. PRODINT is structured as a tax levied each period at the same small level (2% of the difference in initial prices between the two goods) on owners of "dirty technology" emitting more than a certain threshold. PRODINT revenue is redistributed in equal share to all recent adopters of "clean" technologies. The two technologies evolve over time because of R&D, funded by current and past profits, capital and loans. Averages of 10 simulations (of 30 periods each) show that - with PRODINT - GHG emissions peak earlier, fall steeper and deeper.
1.080 1.060 1.040 1.020 1.000 980 960 940 920 900 880 860
1 2 3 4 5 6 7 8 9 10 11 12 13 14 15 16 17 18 19 20 21 22 23 24 25 26 27 28 29 30

This is because clean technologies reach a faster and wider diffusion than without PRODINT. Diffusion over time with PRODINT
1000 900 800 700 600 500 400 300 200 100 0
1 2 3 4 5 6 7 8 9 10 11 12 13 14

Periods

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

Diffusion of Clean technology

Diffusion of Dirty technology

Non owners

Diffusion over time without PRODINT

Periods

15

16

17

18

19

20

21

22

23

24

25

26

27

28

29

30

Diffusion of Clean technology

Diffusion of Dirty technology

Non owners

Profits of the producer of clean technologies are higher on average - by 126% with PRODINT than in its absence. The income of the clean technology adopter can fall by an average of 5%, since PRODINT make it more affordable, with a positive impact on the cost of living of the middle-class, since through the adoption of energy-saving good their use cost fall.

Periods

Average with PRODINT

Average without PRODINT

Economics Web Institute (2009)

Valentino Piana, Director, Economics Web Institute Tel. +39 349 36 10 476 e-mail: director@economicswebinstitute.org Website: www.economicswebinstitute.org

7. Conclusions The preliminary results of the test of PRODINT are very encouraging. It seems to have a strong and systematic effect on fostering the adoption of clean technology even for fairly small amount of tax. Further experimentation should involve both modelling exercise and expert discussion on domains of applicability in geographical and sectoral terms. Bibliography Barrett S., Environment and Statecraft: The Strategy of Environmental Treaty-Making, 2003. Brekke K. A. and Johansson-Stenman O., Behavioural Economics of Climate Change, 2008. The

Duval R., An Overview of Alternative Instruments to Reduce Greenhouse Gas Emissions and Interactions across them, OECD, 2008. Ecosecurity, Market Sentiments on Climate Change Policy Post-2012, 2007. International

Hamond J., Merriman H., and Wolff G., Equity and distributional issues in the design of environmental tax reform, 1999. Kahneman, D., and Tversky, A., Prospect Theory: An Analysis of Decision under Risk, 1979. Moser S. C., Dilling L., Creating a Climate for Change Communicating Climate Change and Facilitating Social Change, 2007. Nelson R., Winter S., An Evolutionary Theory of Economic Change, 1982. Piana V., Dynamic Competition with Bi-Directional Product Differentiation, Bounded Rational Consumers, Innovation, Advertising, and Finance, 2003. Piana V., Pro-diffusion-of-innovation tax, Economics Web Institute, 2008. Rogers E. M., Diffusion of Innovations, 2003

Author: Valentino Piana For further information please contact:

Economics Web Institute (2009)