Behavior in a Dynamic Environment with Costs of Climate Change and Heterogeneous Technologies: An Experiment

Purpose – This study investigates the effect of heterogeneity in an environment with a dynamic public bad. Methodology/approach – Every period agents decide on own level of production that generates private revenue and emissions. Emissions lead to pollution that acts as a public bad and accumulates over time. Our treatment variable is the emission propensity of agents' production technologies. We characterize the Markov perfect equilibrium and social optimum and employ a laboratory experiment to compare the observed behavior to theoretical predictions. Findings – We find that the observed production levels are between the Markov perfect equilibrium and social optimum. With experience, the strongest adjustment and lowest level of pollution is achieved in the heterogeneous treatment with high average emission propensity. When the costs of climate change are not severe, institutions are most necessary to create incentives for environmentally friendly behavior. Research limitations/implications – The results of this study apply to the case when heterogeneity is exogenous and the only way to reduce emissions is by reducing production. Natural extensions include the option to invest in clean technologies, the availability of communication, the group size, and endogenously emerging and exogenous regulatory institutions. Practical implications – Our results suggest that under relatively favorable conditions heterogeneous countries are less likely to achieve sustainability without external enforcement. Under unfavorable conditions the impending common threat of significant damage leads to higher levels of voluntary cooperation. Originality/value of the chapter – This is the first study to address the practical problem of coordination among technologically diverse countries, and fundamental questions regarding the effect of heterogeneity in environments with a dynamic public bad.