Directed Technical Change Model and Catastrophic Risk: The Role of Government Intervention

This study aims to investigate the impact of investments in the clean sector and the influence of an endogenous discount rate, dependent on the probability of natural catastrophe, on the evolution of climate change. The research seeks to include new insights into understanding whether economic agents, given environmental dynamics, cooperate with each other or the intervention of a social planner is necessary to mitigate climate change crises. The research contributes to a deeper understanding of the behaviour of economic agents in addressing climate risk. The study adopts a theoretical approach following the Romer (1990) expanding variates model and Acemoglu et al. (2012) and Campiglio et al. (2024) directed technical change model, both belonging in the economic literature of endogenous growth. Specifically, it utilizes a model that integrates direct technical change, based on Schumpeterian dynamics, while, in the background, representing the evolution of climate through the level of carbon emission and the dynamics of catastrophe likelihood. The results reveal that as the point of no return approaches, economic agents do not cooperate with each other by directing investments in the clean research and development sector but, on the contrary, intertemporal preferences on consumption increase. This indicates that the intervention of a social planner is necessary. These findings provide evidence that the role of the state in addressing one of the major crises of the up coming decades is critical. By implementing targeted Pigouvian carbon tax, dependent on the costs of environmental damage and on the uncertainty caused in economic agents, and subsidy policies, governments can incentivize agents to reduce carbon dioxin emissions to address their negative externality.