Optimal Climate Policy Mix for Green Transition: A Growth Model with Endogenous Labor Supply

Abstract Existing literature supports combining green research and development (R&D) subsidies and carbon taxation for economic sustainability, but often assumes an exogenous labor supply. This overlooks key interactions, especially regarding existing subsidies for traditional R&D sectors, common in developing countries focused on growth. This paper introduces a variety‐expansion endogenous growth model featuring endogenous labor supply and stochastic components. It analyzes how labor supply endogeneity and the level of existing brown sector support influence the optimal mix of green R&D subsidies and carbon taxation, deriving closed‐form solutions: when labor supply is endogenous, the relationship between the optimal carbon tax and green R&D subsidies can be complementary or substitutive, depending on the level of labor disutility. It also investigates how the optimal climate policy mix should change when a social planner emphasizes a faster green transition. The model is calibrated using data from China, and numerical results validate the paper's theoretical insights.