Climate Coalition Formation When Players are Heterogeneous and Inequality Averse

In this paper, we study the formation of international climate coalitions in the case players are perfectly heterogeneous and inequality averse. The paper provides an analytical solution for the optimal contribution of an arbitrary coalition member to a linear and pure public good. Based on empirical estimates for the parameters the model is then applied to the problem of climate mitigation policies. We provide a full stability analysis of all coalitions that can be formed by the twelve world regions from Nordhaus’ RICE model. As it turns out, only four two-player coalitions are internally stable. For a wealthy country leaving a coalition, its absolute payoff increases more than its disutility from additional advantageous inequality. A poor country improves its welfare by dropping out since its absolute payoff increases and, at the same time, disutility from disadvantageous inequality is reduced. Introducing suitable transfer schemes, however, large coalitions consisting of economically divergent countries turn out to be internally stable.