Carbon leakage: the role of sequential policy setting
We analyze non-cooperative environmental policy when the only strategic interaction between countries is through bilateral transboundary pollution, i.e., countries are closed or small open economies. Under simultaneous moves, there is no carbon leakage. However, in the sequential-move game, carbon leakage occurs; the leader sets its pollution tax lower than that in the simultaneous-move game and lower than the marginal damage from own pollution, while the follower sets its tax higher than that in the simultaneous-move game. The only motive behind the leader's underregulation of own pollution is to reduce the incidence of transboundary pollution from the follower. If pollution is a pure global public bad, aggregate pollution is higher in the sequential-move game than in the simultaneous-move game. The leader (follower) obtains higher (lower) welfare than that under simultaneous moves. Hence, if countries can choose to be leaders or followers, they choose to move first to set environmental taxes.
Volume (Year): 17 (2012)
Issue (Month): 01 (February)
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