Climate change, innovation, and inequality

Abstract

This thesis consists of three essays on the interface of applied microeconomic and macroeconomic theory, with the common theme of studying the role of financing constraints in various economic issues. The first chapter tackles the problem of deriving optimal climate policies in a world characterised by credit constraints. Credible implementation of climate change policy requires a large proportion of current fossil fuel reserves to remain unused. This issue, named the Carbon Bubble, is usually presented as a required asset write-off, with implications for investors. For the first time, we discuss its implications for macroeconomic policy and for climate policy itself. We embed the Carbon Bubble in a macroeconomic model exhibiting a financial accelerator: if investors are leveraged, the Carbon Bubble may precipitate a fire-sale of assets across the economy, and generate a large and persistent fall in output and investment. We find a role for policy in mitigating the Carbon Bubble. In the second chapter, we analyse the role of financing constraints in motivating innovation. Is there a thing as too much capital when it comes to the financing of innovative projects? We study a principal-agent model in which the principal chooses the scale of the experiment, and the agent privately observes the outcome realizations and may privately choose the novelty of the project. When the agent has private access to a safe but non-innovative project, the principal starves the agent of funds to incentivise risk-taking. The principal quickly scales up after early successes, and may tolerate early failures. If the principal is equally informed about the outcome, the agent is well-resourced, resembling a large R&D department. In the third chapter, we investigate if inequality hinders or fosters innovation. We study an occupational choice model in which agents differ in observable wealth and unobservable innovative talent. Investors deposit their wealth in banks, whereas entrepreneurs contract with banks to obtain credit to set up risky firms and can privately choose the novelty of the technology used and the effort exerted. Since financial contracts can be made contingent only on wealth, up to five wealth classes form endogenously and, in general equilibrium, the interest rate adjusts to clear the credit market. In a quantitative illustration, we show that increased inequality can lead to a decrease in both the average quality of the innovators and the number of successful innovations, and to an increase in the number of non-innovative entrepreneurs.