Transboundary pollution game with potential shift in damages

What is it about?

Complex ecological systems exposed to pollution may suddenly and permanently shift to a dangerous regime. This paper examines strategic pollution decisions among countries that face the prospect of such a shift. Each country derives some flow utility from its own emissions, which are chosen unilaterally. But flow emissions by all countries increase the pollution stock in the world. In addition to generating global damages such as global warming, the pollution stock may trigger an irreversible and abrupt jump in global damages or catastrophe. We ask whether endogenous and exogenous threats of such a jump in damages or catastrophe mitigate the tragedy of the commons and examine their implications on welfare. Our analysis yields different emission responses to these threats as compared to the related literature that focuses only on the single-polluter case. For example, when the hazard rate is exogenous and countries commit to nonlinear strategies, we find that the threat of a possible jump in damages or catastrophe may induce a lower or larger emission level and initial welfare due to multiple equilibria. These results are maintained when the hazard rate endogenously depends on emission decisions.

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Why is it important?

Climate change is driven by polluters acting unilaterally and facing the common threat of crossing a bad threshold. Therefore, this paper enhances knowledge on how how to design environmental policies so as to mitigate our exposure to climate related risks.