Games governments play: An analysis of national environmental policy in an open economy

In this paper we study some of the consequences of national environmental policy in a strategic international setting. Two broad questions are analyzed. First, we examine the circumstances under which the pursuit of environmental policy by a country in a Cournot game will make that country worse off when the incidence of pollution is domestic. Second, we study the effects of environmental regulation by means of alternate price control instruments in a Cournot game in which national governments care about international pollution, but polluting firms do not. It is shown that there are plausible theoretical circumstances in which the pursuit of environmental policy in a strategic setting is not necessarily a desirable objective. Further, it is shown that in choosing between alternate pollution control instruments, national governments typically face a tradeoff between instruments which correct more distortions but are costly to implement and instruments which correct fewer distortions and are less costly to implement. In particular, a dominance result for a tariff policy is obtained; this result favors protection, i.e., the use of tariffs, from an informational standpoint alone.