Speaker: Susanna B. Berkouwer

Title: Green subsidies with demand distortions

Abstract: Standard Pigouvian theory predicts that externalities should be corrected at the margin. However, demand distortions such as credit constraints or behavioral biases create a wedge between marginal benefit and marginal cost. While these distortions can lower aggregate abatement, they can increase the efficiency of green subsidy spending. In theory, this happens through two channels: by shifting the marginal adopter toward higher private and social benefits and by increasing demand elasticity. We test these predictions by cross-randomizing fixed cost subsidies, marginal cost subsidies, and loan access for an induction stove among 2,100 charcoal users in Kenya. Marginal cost subsidies that lower electricity costs by up to 75% have a precise zero effect on both adoption and usage. Fixed cost subsidies abate CO2e at US$10.3 per ton, and demand distortions are responsible for making this cost low: relaxing credit constraints raises abatement costs to US$16.8 per tCO2e. Demand distortions furthermore increase the socialwelfare gain from US$16 to US$25 per subsidy dollar. These efficiency gains operate through the two hypothesized channels: demand distortions lower the subsidy cost per marginal abatement by 30% and increase the marginal positive externality by 14%. Without any distortions, counterfactual simulations suggest costs would reach US$137 per tCO2e.