Group for Research in Decision Analysis

A trade-environment coalition game

Lucia Sbragia Durham University Business School, United Kingdom

We observe several interconnections between international environmental problems and trade issues. However, the traditional literature on International Environmental Agreements (IEAs) has not paid enough attention to those links. It is well known that the existence of positive spillovers (public good effect) when IEAs are formed exacerbates free riding incentives and leads to less cooperation. Since countries are linked via trade, a natural way to sustain cooperation is to include trade sanctions into the IEAs, knowing that negative spillovers (club good effect) exist when a trade coalition is formed.

Inspired by the work of Barrett (1997), we propose a model which links the problem of international environmental cooperation with international trade. We consider production and abatement as the choice variables. We broaden Barrett’s model by considering a more general class of trade sanctions via differential tariff treatment. In particular, we adopt tariffs that are proportional to the quantity imported from another country.

The IEA foresees that a representative signatory country decides its optimal emissions by maximizing the aggregate welfare of the coalition and sets to zero the tariffs on the goods of all the other signatories. Whereas, those tariffs are kept against non-member countries. Thus, the economic coalition created by the environmental agreement generates a negative externality towards the non-signatories.

We introduce two static games. The first one is an environmental game, where in the first stage governments decide simultaneously whether to be part or not of the agreement. In the second stage, pollution abatement levels are chosen simultaneously. The second one is a production game, where each representative firm decides its optimal production effort given the abatement standard of its own country. We compute the size of the stable IEA, and we study the effects of tariffs on this size as well as on emissions, production, and welfare of countries.