Green capacity investment under subsidy withdrawal risk

Abstract Subsidies initially installed to stimulate green capacity investments tend to be withdrawn after some time. This paper analyzes the effect on investment of this phenomenon in a dynamic framework with demand uncertainty. We find that increasing the probability of subsidy withdrawal incentivizes the firm to accelerate investment at the expense of a smaller investment size. A similar effect is found when subsidy size as such is increased. When subsidy withdrawal risk is zero or very limited, installing a subsidy could increase welfare. In general we get that the larger the subsidy withdrawal probability, the smaller the welfare maximizing subsidy rate is. Therefore, a policy maker aiming to maximize welfare should try to reduce subsidy withdrawal risk.