Instrument choice and stranded assets in the transition to clean capital

Abstract

This paper compares the impact of different climate mitigation policies — mandates, feebates, performance standards, and carbon pricing — in a Ramsey model with clean and polluting capital, irreversible investment, and a climate constraint. These policy instruments imply different transitions to the same balanced growth path. The optimal carbon price minimizes the discounted social cost of the transition to clean capital, but may prompt premature retirement of existing polluting capacities and significant private costs in the form of stranded assets. Second-best mandates and feebates affect new investment decisions without providing incentives to under-use existing polluting equipment. These instruments lead to higher discounted social costs, but smoother abatement costs, and do not result in premature retirement or stranded assets. A phased-in carbon price can avoid premature retirement but still result in stranded assets, that is in a drop of wealth for the owners of polluting capital. We discuss a potential trade-off between the political feasibility and cost-effectiveness of climate mitigation policies.