Essays on Envronmental Economcs: Envronmental Complance, Polcy and Governance Jng XU Supervsor: Inés Macho Stadler A dssertaton Submtted to Departament d Economa d Hstòra Econòmca of Unverstat Autònoma de Barcelona In partal ful lment of the requrements for the degree of Doctor n Economcs 0
Acknowledgments I would lke to take ths opportunty to express my grattude to many people. Ths thess would not have been accomplshed wthout ther gudance, help and support. Frst and foremost, I owe my deepest and most sncere grattude to my supervsor Inés Macho Stadler, for her patence, nspraton, advce and gudance through my study n Unverstat Autònoma de Barcelona. More mportantly, her admrable characters, the serous manner to do research and the enthusastc atttude to enjoy research, wll keep n uencng me for all my lfe. It has always been a pleasure to work wth her. Besdes, I am ndebted to many of my professors and colleagues for ther helpful comments. In partcular, I am very grateful to Mchael Creel for hs encouragement and help n the emprcal part of my thess. I would also want to thank Davd Pérez Castllo and Pau Olvella for ther nsghtful advce. In addton, the thess has bene ted from suggestons of Pedro Rey, Antono Fretas, Nuno Alvm, Xaver Martínez-Gralt, Bng Guo, Kebn Ma and comments from varous workshops where I presented. The tme spent n IDEA program at Unverstat Autònoma de Barcelona s gong to be a non-forgettable memory. I would lke to show my grattude to all professors, students and secretares for creatng a frendly envronment together. I also want to thank my frends n Barcelona, n partcular Francsco Garca, for hs careful revson of my research paper. Though beng far from me, I am more than grateful to my parents and sster for ther love, care and encouragement. I am also deeply ndebted to my boyfrend. He s always there accompanyng me, carng for me and supportng me through these years. Lastly, I want to acknowledge the nancal support of doctoral scholarshp from Unverstat Autónoma de Barcelona and Generaltat de Catalunya for the rst year and the fellowshp from FPI of Mnstero De Cenca e Innovacón De España up to now. I am also grateful to the research project ECO009-0766 n Span.
Contents Introducton Internatonal Envronmental Agreements wth Agenda and Interacton between Pollutants 5. Introducton.................................. 5. The Model................................... 9.3 Sequence aa.................................. 6.4 Sequence Aa.................................. 9.5 Comparsons of D erent Negotaton Sequence............... 34.6 Concluson................................... 39 3 Optmal Delegaton of Enforcement: Centralzaton versus Decentralzaton 45 3. Introducton.................................. 45 3. The Model................................... 49 3.3 Comparsons between Centralzed and Decentralzed Enforcement: Case C = +................................. 57 3.4 Extenson: Comparson between Centralzed and Decentralzed Enforcement: Case C > +........................... 6 3.5 Extenson: Combnaton of Centralzed and Decentralzed Enforcement. 65 3.6 Concluson................................... 70
3.7 Appendx................................... 73 4 Insde- rm Incentve and Corporate Envronmental Performance 8 4. Introducton.................................. 8 4. The Theoretc Model............................. 86 4.3 The Equlbrum and Analyss........................ 89 4.4 Emprcal Analyss.............................. 96 4.5 Concluson................................... 08 4.6 Appendx................................... 0 v
Chapter Introducton Despte an ncreasng envronmental awareness of ctzens worldwde, actve measures and cooperaton endeavored, and more envronmental protecton legslatons enacted n all the countres, more envronmental problems arse. The envronmental degradaton, n terms of both scale and gravty, has become a major obstacle for the long-term economc development. The rght to development must be ful lled so as to equtably meet developmental and envronmental needs of present and future generatons, wrtten n Agenda whch s an actve plan on sustanable development ntated by Unted Natons. Provdng the complex nature of envronmental problems, multlateral actons to be taken globally, natonally and locally are called for to acheve the goal of sustanablty. Hence, the thess expects to shed lght on ths ssue through envronmental economcs and governance, whch conssts of polces, nsttutons, practces and stakeholders related to the management of the envronment. Envronmental governance, consdered n partcular wth economcs, s a whole system of management encompassng roles of government, busness and households at all organzatonal levels. Hence, my thess tends to convey the dea of ntegrated envronmental governance, wth ts three chapters focus on the governance at the nternatonal, natonal and rm level, respectvely. Though lnked by the same theme, each chapter s
self-contaned and can be read ndependently. In the second chapter, I nvestgate global envronmental governance, where achevng a greener envronment necesstates cooperaton across countres. The chapter studes nternatonal envronmental agreements, wth ts nnovaton n takng nto account multple pollutants wth cross-e ect and the negotaton sequence. It ams to answer, for example, does cooperatng on one type of agreement facltate later negotatons? Whch countres jon whch agreement? And does the negotaton agenda matters n the sense of partcpatons? By analyzng the membershp outcome n each negotaton sequence, I nd that a cooperaton n the rst stage can facltate later negotatons and countres are prone to cooperate on the pollutant of common concern. The model also mrrors the frcton between developed countres and the developng countres, suggestng that developng and developed countres cooperate only f ther envronmental concerns or the abatement costs are smlar. Most mportantly, except for symmetrc cases, the membershp outcome s d erent n d erent negotaton agenda. On one hand, ths can be used by some countres to better sut ther bene ts, by means of proposng the preferred negotaton agenda. On the other hand, besdes transfer, ssue leakage, threats and multple agreements as dscussed n Carraro and Snscalco (998), the negotaton sequence can serve as another nstrument to possbly enlarge the partcpatons of envronmental treates. The thrd chapter nvolves envronmental governance on the natonal level. Specfcally, I analyze when the envronmental polcy s predetermned, how to dstrbute envronmental enforcement power when there are two possble levels of enforcementrun by central or local authortes. I analyze rms complance behavor and the optmal nspecton strategy under centralzed, decentralzed and mxed enforcement set-up. Comparng the welfare mpact, only when there s a large heterogenety n nspecton e ectveness across regons, the decentralzed enforcement s preferred. In the extenson where the central authorty s more concerned about the envronment than the local ones due to an nternatonal pressure, I nd that under some cr-
cumstances each jursdctonal level prefers the opposte as to the superor enforcement structure, whch may lead to tensons and further problems between d erent organzatonal levels. Besdes, a mxed enforcement wth one regon self-governed and the other under central regulaton s studed, whch causes even more strategc behavors than the fully decentralzaton case. Ths chapter brngs the envronmental federalsm lterature to a new perspectve of envronmental tasks other than polces by takng nto consderaton complance problems. The mplcatons of the essay can be generalzed to nternatonal treates, where no robust ncentves are provded for countres complance even f they ntally partcpated n the agreement. Snce the lack of enforcement may nduce envronmental crss, the future polcy desgn should pay more attenton on the natonal and regonal nsttutons. Besdes cooperaton worldwde and regulatons by governments, envronmental governance deserves more attenton on the busness unt,.e., the rms. In partcular, the envronmental volatons are documented as the most frequent form of corporate llegalty (Hll et al.99), yet few research s carred out to explore the organzatonal obstacles that n uence the rms envronmental resource allocatons. Thus n the fourth chapter, I look nto the envronmental governance wthn the rm. Tryng to open the black box, ths chapter studes whether and how a rm s characterstcs, n partcular ts corporate governance, a ect the envronmental complance behavor. Besdes a general deterrent e ect of envronmental regulaton, ths essay provdes a novel angle n explanng the heterogenety of corporate envronmental performance. By both theoretcal and emprcal means, I nd that the mpact of rm s corporate control on the degree of envronmental volaton exhbts an nverse-u trend. Comparng to no sgn cant relatonshp found n McKendall et.al (999), Halme and Huse (997), ths model better captures the relaton between rms corporate structure and ts envronmental performance. Hence, addtonal to conventonal expectaton that an mprovement of a rm s corporate governance should lessen ts envronmental ncomplance, the reverse e ect can also take place. 3
Bblography [] Carraro, C. and Snscalco, D., 998. Internatonal Envronmental Agreements: Incentves and Poltcal Economy. European Economc Revew. 4, 56-57. [] Halme, M. and Huse, M., 997. The In uence of Corporate Governance, Industry and Country Factors on Envronmental Reportng. Scandnavan Journal of Management. 3(), 37-57. [3] Hll, C., Kelley, P., Agle, B., Htt, M., and Hosksson, R., 99. An Emprcal Examnaton of the Causes of Corporate Wrongdong n the Unted States. Human Relatons. 45, 055-076. [4] McKendall, M., Sanchez, C. and Sclan, P., 999. Corporate Governance and Corporate Illegalty: the E ects of Board Structure on Envronmental Volatons. The Internatonal Journal of Organzatonal Analyss. 7(3), 0-3. 4
Chapter Internatonal Envronmental Agreements wth Agenda and Interacton between Pollutants. Introducton The 009 Copenhagen Clmate Congress has attracted ntensve attenton and dscusson on the topc of clmate change. The envronment and clmate change s recognzed by governments, organzatons, and ndvduals as one of the greatest challenges of the present. As s known to all, the envronmental qualty s consdered a publc good, and achevng a greener envronment needs cooperaton wthn and across countres. E orts have already been made wth new agreements beng sgned and ths s a clear sgnal that countres are startng to cooperate n the shadow of a potental envronmental crss. The well-known Kyoto protocol, entered nto force snce 005, ams at reducng green house gases at the global level. It has been sgned by 9 countres, except that Unted States has not rat ed t. The 989 Montreal Protocol on Substances That Deplete the Ozone Layer, sgned by 97 partes, s regarded as the most successful envronmental treaty from both membershp and mplementaton pont of vew. Moreover, the Conventon on 5
Long-Range Transboundary Ar Polluton (CLRTAP) has been sgned only by Europe and North Amerca, and the Stockholm Conventon on Persstent Organc Pollutants are sgned by almost all of the countres except US and Russa. Every envronmental agreement s sgned by d erent partes. In envronmental economcs, the lterature on ths ssue has been mostly focused on the coalton behavor for nternatonal envronmental agreements (IEAs). For nstance, Barrett (994) concludes that IEAs can do lttle to mprove on the non-cooperatve outcome when the number of countres s large. Followng ths argument, many papers afterwards focus more on the partcpaton behavor and the ways that may lead to enlargement of the membershp. In ths lne, Carraro and Snscalco (993) analyze the bene t of transfers, Barrett (997) dscusses the e ect of trade sanctons, Eccha and Marott (998) emphasze the role of nternatonal nsttutons, and n Botteon and Carraro (998), they focus on the burden sharng rules n the treates. Furthermore, Carraro and Snscalco (998) dscusses several mechansms such as transfer, ssue leakage, threats and multple agreements. On the contrary, Hoel and Schneder (997) argue that the prospect of recevng a transfer for reducng one s emssons tends to reduce the ncentve a country mght have to commt tself to cooperaton. Hoel (997) studes the e ect of a country settng a good example by unlateral reducng harmful emssons, the result turns out to be that the total emsson s even hgher than when both countres act sel shly. Besdes, Rubo and Ulph (007) use a dynamc model to analyze an endogenous change of membershp n response to the stock pollutant. Among prevous lterature, t s usually assumed that there s one pollutant, and there s one agreement. However n realty, many envronmental agreements are sgned n a sequental way. For example, shortly after 989 the Montreal Protocol on Substances That Deplete the Ozone Layer was sgned, countres agreed on the Framework Conventon on Clmate Change n 99, whch eventually evolved to become the Kyoto Protocol. So some natural questons arse, f the agreements have been dscussed and sgned sequentally, why have countres chosen to sgn the agreements n a partcular sequence? Does cooperatng on one type of agreement facltate later negotatons? And 6
whch countres jon whch agreement? Does the negotaton agenda matters n the sense of partcpatons? These questons are manly what ths paper tres to approach. Assumng untl now that countres usually negotate agreements on each pollutant sequentally and that each pollutant s consdered as one ndependent ssue on a country s agenda, I want to study the coalton behavor of countres when pollutants are no longer ndependent. In fact, pollutants are ndeed, correlated. And t can happen durng the producton process, the abatement procedures, or even n the ar after the emsson as argued n Legras and Zaccour (008). In ths paper, I focus on the pollutant correlatons n abatement process. For example, the catalytc converter nstalled n the car does not only absorb the SO x, but also some of NO x. So far, the lterature has not dscussed much the case of multple pollutants. Caplan and Slva (005) brought forward an e cent mechansm to control correlated externaltes, and the followng work by Caplan (006) compared tax and permt markets n such mechansm. Kuosmanen and Laukkanen (009) conclude that optmal abatement may focus on a sngle pollutant. Slva and Zhu (009) dscuss that the cutbacks n global pollutant can yeld "double dvdends" for non-partcpatng countres, and ther later work n Slva and Zhu (0) combne the trade e ect n the nternatonal envronmental agreements wth correlated transnatonal pollutants. In ths paper, where pollutants are correlated, I want to analyze countres partcpaton decson n nternatonal envronmental agreement and how the sequence of negotaton on each pollutant matters. Consderng a model of two countres, they face the envronmental damages caused by two pollutants. One pollutant s global, whch makes each country su er the same damage from the total emsson. The other pollutant s local, and ts damage has a spllover e ect on the neghborng country. These two pollutants can correspond to global warmng gases and ar pollutons, where the lnks between them are analyzed extensvely n EEA report (004). The correlaton between two pollutants can be postve or negatve, meanng they are, ether substtutes or complements, respectvely. In the model, I assume that the two countres are cooperatng to mprove the envronmental qualty by means of nternatonal treates, and negotate 7
on countres abatement oblgatons for each pollutant sequentally. Ths paper allows for d erent sequences of negotaton: countres ether rst negotate on the local pollutant and later on the global one or countres negotate rst on the global and later on the local pollutant. Solvng the problem by backward nducton, I attan the partcpaton behavor and the correspondng abatement level on each pollutant for both countres under each sequence. The equlbrum outcome under both negotaton agendas s not the same, whch ver es the expectaton that the negotaton sequence does matter n countres partcpaton decsons. If n the rst perod countres successfully reach an agreement on one pollutant, ths facltates the negotaton for the subsequent stage, compared to the case n whch an agreement faled durng the rst round. Ths paper s also able to show that countres wth smlar concerns on a pollutant can easly reach an agreement on that pollutant, rrespectve of other parameters. In addton, f countres can only be successfully cooperatng on one pollutant, they sgn an agreement on the ssue for whch concerns are more smlar. Besdes, the correlaton e ect of pollutants plays an mportant role n negotatons among countres. The probablty of agreement s hgher when the pollutants are complements than when they are substtutes, snce beng complements nduces savngs n the abatement cost, therefore facltatng the negotaton process. Also, the spllover e ect has an n uence on the negotaton outcome, n the sense that the possblty of reachng cooperaton s decreasng n the spllover parameter of local pollutant. For the relatve abatement cost parameter for local pollutant, the closer t s to the abatement cost of global pollutant, the easer the negotaton would be. To explan the results more clearly, three representatve llustratons are presented. The rst consders symmetrc countres wth the same concern on each pollutant, where they always cooperate. Second, f one country s generally more envronmentally concerned or more developed than the other, they can reach an agreement n all stages f ther concern s su cently smlar, otherwse ther cooperaton fals. Ths s the stuaton that mrrors the frcton between developed countres and the developng countres 8
group n nternatonal envronmental agreement negotatons, due to the huge gap n both technologcal e cency and concern over pollutants. The thrd case corresponds to asymmetrc countres where they generally regard the envronment the same, but one s more concerned about the local or natonal envronment. One concluson s that, when pollutants are complements, the negotaton agenda that starts wth the local pollutant acheves a larger membershp than the other sequence. Hence, to ensure full partcpaton, t s better for the countres to negotate rst on the local pollutant and then on the global one, or say, to negotate startng from an easer ssue. The rest of the paper s organzed as follows. In the next secton, I descrbe the model and assumptons. Secton.3 solves the model for one spec c negotaton agenda, leavng the equlbrum of the other sequence to be solved n secton.4. It s followed by secton.5 where the comparsons of both negotaton sequences are presented. The last secton concludes.. The Model.. Basc settng There are two neghborng countres, or two unons, ndexed by subscrpt ; =,. In each country, multple pollutons are emtted from varous producton processes. To better account for d erent characterstcs of emssons, I assume that there are two pollutants. One pollutant s a global pollutant such as carbon doxde causng global warmng, and the other s a local pollutant, for example ntrogen oxde NO x or other ar pollutants. The man d erence between these two pollutants les n the externaltes they create. For the global pollutant, each country su ers the same from total emssons of both countres, whle the local pollutant has only a partal e ect on the neghborng country. Ths spllover e ect may be d erent dependng on countres relatve locaton, as well as other nature condtons. 9
Each country s concerned about the envronmental qualty. To mprove t, they make e orts on polluton reductons. The abatement levels for both global and local abatement are denoted as A and a (A > 0; a > 0) for country, = ;. The abatement of pollutants occurs at a cost. In lne wth Moslener and Requate (007), I assume ths cost functon to be convex and to have the followng form (more about jont abatement cost can be referred to Beavs and Walker, 979): C(A ; a ) = A + a + A a = ; It represents the total cost of abatng the global pollutant (A ), abatng the local pollutant (a ) and the cost correlaton between them (A a ). I assume 0 < <, ndcatng that abatng a local pollutant s less costly than abatng the global one. Ths s n accordance wth the stylzed fact of the current technologes, for example, the cost of carbon capture for abatng carbon doxde s more than ten tmes the abatement cost of sulfur oxde SO x. Besdes, I assume a correlaton between two pollutants, snce the abatng process of a target pollutant s very lkely to have an e ect on another pollutant. Spec cally, the correlaton makes the pollutants ether substtutes or complements. When > 0, abatng one pollutant ncreases the cost of abatng the other. An example of ths correlaton can be found n abatement technologes such as carbon capture, where the carbon doxde s removed but other ar pollutons SO x and NO x ncrease by 30% due to the addtonal energy consumpton. Ths tends to ncrease the total abatement cost, and the two pollutants are sad to be substtutes. Smlarly, when < 0, abatng one pollutant absorbs the other at the same tme and decreases the total abatement cost, makng the pollutants as complements. No matter whch knd of correlaton there s, the correlaton e ect n general can not be large, hence I mpose another assumpton 4 > 0; to avod an unrealstc large correlaton between two pollutants and unrealstc equlbrum outcomes. Assumpton < 4; suggests that the correlaton e ect between two pollutants s not too large. 0
Wth the use of abatement technologes countres can bene t from the mprovement of the envronmental qualty. I de ne the country s revenue functon as: (A + A j ) + (a + a j ) = ; In ths expresson, measures the spllover e ect to the neghborng country, whch s assumed to be symmetrc. Besdes, and are country spec c, representng the margnal revenue (or concern) for reducng the global and local pollutant, respectvely. Therefore, the objectve functon of country s addtve of both bene t and cost functon, and s gven as follows: W = (A + A j ) + (a + a j ) A a A a = ; The welfare functon s n lne wth Barrett (997), but wth an extenson to multple pollutants. From the welfare functon, one can explctly see the externaltes of both pollutants. To try to deal wth the publc "bad", countres may want to cooperate on polluton reducton by means of nternatonal envronmental treates. To mtgate the massve complexty and negotaton costs, at each pont n tme countres focus the negotaton of an agreement on one partcular pollutant, as s also the case n the real world. They negotate on the respectve abatement level for each country so that t maxmzes the total welfare of both countres. Wthout cooperaton, countres choose ther own abatement level strategcally. I call ths status quo when no agreement s sgned. As often observed n some agreement falures, f the e cent abatement level makes one country worse o comparng to the status quo, t wll surely drop the agreement. That s also the reason why every envronmental treaty s sgned by d erent representatves of countres. Hence, t s assumed that only when both countres Other possble ways of negotaton, say bndng agreements, whch lower the abatement oblgaton for some countres just to pull them n the agreement, are not consdered. One reason s that a full membershp can always be acheved under some forms of negotatons. In ths way the agenda problem does not exst. In fact, countres cannot tolerate any cutdown of the abatement oblgaton for other countres.
are better o wth the envronmental agreement, they agree to sgn t. Otherwse, they mplement ther own natonal envronmental polcy, dsregardng externaltes to other countres. Ths s consstent wth the trade agreements, that only when the countres can be bene ted from the agreement wll they agree on the treates. In ths negotaton process, I assume that no monetary transfer s beng carred out. Even f the government s wllng to provde monetary ncentves for other country to protect the envronment, rasng the fund s not only complcated and costly, but also d cult due to the need of ganng the consensus of ts ctzens. In fact, monetary transfer s hardly observed n envronmental treates, and mposng condtons to allow transfers s unrealstc. Furthermore, once the agreement s sgned, there s commtment and countres wll enforce the agreement. The tmng of the game s as follows, and the sequence of negotaton s exogenous.. Countres negotate on one pollutant (global pollutant A or local pollutant a), f both countres can be better o wth an e cent abatement oblgaton, they agree to sgn the envronmental treaty and the abatement level for each country s settled. If t makes one country worse o, the negotaton fals and the countres don t do anythng.. Countres negotate on the other pollutant (a or A), f both countres choose to cooperate, they sgn the agreement and decde the correspondng abatement level on that pollutant, otherwse, no measure s taken. 3. If at some of the prevous stages no agreement s reached, countres decde smultaneously and strategcally ther abatement level of that partcular pollutant.
Negotate on cooperated Negotate on cooperated Country whch ddn t jon decde Producton abatement on A/a abatement on a/a on ts abatement For each country, For each country, f proftable, jon. f proftable, jon. Fgure : tmng of the game.. 3rd stage of the game Note that f n both stage and, countres succeed n reachng an agreement, there would be no outcome from stage 3. Only when n any of the prevous two stages the negotaton fals, the countres decde the abatement level of that pollutant n the 3rd stage. The equlbrum of the stage 3 s only contngent on the negotaton outcome of the prevous two stages, but not on the negotaton sequence. Hence, t s solved backwards, the stage 3 s ndependent of the negotaton agenda, and the soluton can be one of the followng stuatons. Countres have formed an agreement on the local pollutant (^a ; ^a ), but not on the global one. Hence, at stage 3, each country makes a decson on the abatement level of global pollutant A that maxmzes ts own welfare, gven the cooperatve local pollutant abatement. Max A W (A ; ^a ; ^a j ) = (A +A j )+ (^a +^a j ) A ^a A ^a ; j = ; ; 6= j The rst order condton and the equlbrum level of global pollutant abatement s: A ^a + = 0 = ; 3
A (^a ; ^a j ) = ^a ; j = ; ; 6= j (.) Note that n equlbrum, the global pollutant would be a functon of the agreement on local pollutant (^a ; ^a j ) n general. In ths smple model, the choce of abatement level s ndependent of the choce of the other country, but ther natonal welfare does depend on the other country s move. The equlbrum level of global pollutant abatement s decreasng n the agreement abatement level of local pollutant ^a f pollutants are substtutes ( > 0), and ncreasng otherwse ( < 0). The result s so, as expected, because emsson reducton s costly, and even more costly when one abates more. Hence, when pollutants are substtutes, choosng to control more one pollutant decreases the capablty to control the other. On the contrary, when pollutants are complements, the process whch abates one pollutant reduces the other at the same tme, whch encourages a country to control both envronmental problems. The countres have formed an agreement on the global pollutant ( ^ A ; ^ A j ), but not on the local one. Smlarly, each country maxmzes ts welfare wth respect to ts own abatement level of the local pollutant, gven the agreed level of global pollutant negotated n the prevous stage. The resultng equlbrum of local pollutant abatement s as follows. It s a decreasng functon of the abatement level on the other pollutant when > 0, otherwse t s ncreasng f < 0, whch agan shows how the correlaton e ect plays a crucal role n the equlbrum of envronmental regulatons: a ^ A + = 0 = ; a ( ^ A ; ^ A j ) = ^ A ; j = ; ; 6= j (.) After the prevous two stages negotatons, no coalton s agreed upon. In ths case, both countres choose ther own natonal polces,.e., the abatement level 4
of both pollutants, n a non-cooperatve way. Ths yelds the Nash equlbrum outcome. A = a 4 = = ; 4 One would expect that the abatement level of an agreement s hgher than the noncooperatve abatement level. Gven ths, I estmate the comparson of these three cases: ) For the rst and thrd cases on abatement level of the global pollutant, f I consder that pollutants are substtutes > 0, the level of abatement of the global pollutant A when no agreement s reached (thrd case) s hgher than when countres have agreed on the local pollutant A (^a ; ^a j ) n the rst case, and the opposte f pollutants are complements < 0. That s, f ^a > a, then A > A (^a ; ^a j ) when > 0, or A (^a ; ^a j ) > A when < 0. ) Wth respect to the second and thrd cases on the abatement level of local pollutant, smlar results yeld. When > 0, the local pollutant of country, a s hgher when no agreement s reached (thrd case) than when an agreement s reached over the global pollutant (second case), a ( A ^ ; A ^ j ). On the other hand, f pollutants are complements wth < 0, each country mposes a strcter regulaton on the local pollutant..e. f A ^ > A, then a > a ( A ^ ; A ^ j ) when > 0, or a ( A ^ ; A ^ j ) > a when < 0. Comparng the abatement levels between the stuaton n whch there s only one agreement and non-cooperatve outcome, the relatonshp s summarzed n the followng table. abatement level on > 0 < 0 One agreement Nash One agreement Nash agreed pollutant > > the other pollutant < > The table reads as, when pollutants are substtutes ( > 0), the abatement level on the pollutant s always hgher than the Nash outcome, ndependently of whch pollutant 5
the countres have reached an agreement on. However, the abatement level on the other pollutant whch s not ncluded n the treaty s lower than the non-cooperatve stuaton. When pollutants are complements, the comparson result s d erent. Under the stuaton n whch there s only one agreement, the abatement levels of both the agreed pollutant and the other pollutant are hgher than the outcome under no agreement. In general, when pollutants are substtutes, countres abate more on the pollutant whch s n the agreement, but abate less of the other pollutant, comparng wth the absolute non-cooperatve case. It makes the envronmental regulaton strct n one dmenson, but lax n the other. In contrast, when the pollutants are complements, comparng wth the Nash equlbrum, the countres mpose a strcter regulaton towards both pollutants, makng the non-cooperatve strategy the least desrable one from the envronmental perspectve. Solvng the game further backwards from thrd stage on, the outcome s d erent wth respect to the sequence of negotatons. I dscuss n detal both sequences n two sectons below..3 Sequence aa Ths secton consders the case where the countres negotate on local pollutant a at stage and then at stage on global pollutant A. By backward nducton, I calculate the equlbrum outcome of the abatement level over A and then the one over the local pollutant a..3. Stage Dependng on whether the countres have formed an agreement or not on the local pollutant n the rst stage, the equlbrum outcome s d erent. I then ntroduce the two cases, and dscuss them one by one.. Countres have formed an agreement on local pollutant a n the rst stage (^a ; 6