The paper addresses the dynamic-incentive effect of environmental policy instruments when innovation is uncertain and occurring in very complex industrial subsystems. The case of end-of-life vehicles (ELVs) is considered, focusing especially on the effects of a European Union Directive, adopted in 2000, which stipulated economic instruments of a free take back type, and on the voluntary agreements now in place in many EU countries. The systemic and dynamic features of the innovation process stimulated by policy, and aimed at reducing ELV externalities, are highlighted. Coherent sequences of single innovations taking place in both upstream (car making) and downstream (car recycling/recovery) of the ELV system can give rise to different innovation paths that are sensitive to cost-benefit considerations and technological options by industrial actors. The impact of economic instruments, in particular free take-back and recycling fees, on the choice of the innovation path is considered. Economic instruments initially allocate incentives to one specific phase of the ELV innovation chain. However, technological and economic flexibility available to actors may make individual cost-benefit conflicts prevail over inter-industry cooperation for innovation, and the system may even be induced along an "undesired" innovation path. Furthermore, the system may be characterised by "incentive dissipation" at some stage of the innovation process. The lack of incentive transmission between different industries can in fact prevent the creation of new recycling/recovery/reuse markets giving rise to outcomes unexpected ex ante. The effect of economic instruments on technological dynamics is highly uncertain.
The implication for policy is a need for an integrated approach, through enforceable VAs, in order to create a shared inter-industry interest for innovation, while reducing the risk of adversely influencing by economic instruments the cost-benefit considerations of single industries. Integrated Product Policy, together with best practice approaches at the technical level, is therefore suggested as the most promising framework for systemic problems such as ELV.