Competition or Coordination: Strategic Environmental Policymaking Across OECD Countries

This paper explores how countries strategically interact in setting environment policies. This paper directly estimates the causal effect of other countriesâ changes in environmental policies on home countryâs policy choice. Considering that the strategic interaction can be caused by distinct mechanisms, this paper also disentangles different underlying mechanisms and explores the role of interjurisdictional competition for capital, transboundary pollution spillovers, and coordination in determining the observed interactions. I build a simple theoretical model which incorporates distinct mechanisms of interaction and derives ways to differentiate them empirically. In the estimation, I use a panel dataset consisting of 26 OECD countries for the period of 1990 to 2012 and use spatial econometrics with the Generalized Methods of Moments (GMM) continuously updated estimator (CUE) with Instrumental Variable (IV). To deal with endogeneity issue, I use other countries' political characteristics as instruments for other countries' environmental policies. A new composite index is used to measure environmental policy, which is the Environmental Policy Stringency (EPS) index developed by the OECD. This index captures multiple dimensions of environmental policies and is comparable across countries. Use of this index is a significant improvement in how environmental policy is measured in previous research. This paper finds that there is positive and statistically significant effect of other countries' environmental policies. And the interjurisdictional competition and transboundary pollution spillovers play limited roles in causing the effect. The coordination across EU countries mainly drive the effect, which is further reinforced after adopting euro as a common currency. This paper contributes to the literature on two fronts. First, most of the papers in the literature estimate environmental interaction at the subnational government level, such as across states. The evidence on countries is extremely limited. This paper directly estimates interaction pattern across OECD countries. Second, there are very few empirical papers in the environmental policy literature that disentangle the mechanism behind the strategic interaction. This paper provides empirical evidence on the potential causes and finds that interjurisdictional competition does not play a significant role in setting a countryâs environmental policy. This result implies that since interjurisdictional competition is limited, the possibility of a ârace to the bottomâ would not be a serious concern. Moreover, instrument variables in this paper also show improvement compared with the literature.