Green Subsidies with Demand Distortions

Credit constraints and other demand distortions are pervasive in lower-income contexts. A model of clean technology adoption shows that demand distortions can increase the welfare gains from green subsidies. This arises through two channels: shifting the marginal adopter toward higher private and social benefits, and increasing demand elasticity. We test this by cross-randomizing purchase price subsidies, usage subsidies, and access to an interest-free loan for a US$84 induction stove among 2,134 charcoal users in Kenya. Usage subsidies of 75% have a precise zero effect on adoption and usage. Purchase price subsidies, however, generate large welfare gains. Credit constraints raise the subsidy’s efficacy by 35%–73%, up to US$10–US$12 in observable welfare gain per subsidy dollar. This demand distortion also lowers the subsidy cost of abatement by 41%, to US$12 per tCO2e. This operates through the two channels identified in the theory: credit constraints raise the marginal adopter’s positive externality by 19% and fuel savings by 30%, and lower the subsidy cost per marginal adoption by 29%. In a counterfactual without demand distortions, the abatement cost rises to US$137 per tCO2e. Contexts with large demand distortions could offer many cost-effective opportunities for climate change mitigation financing.