Revisiting the Theory of International Environmental Agreements with Heterogenous Players

We study an n-country pollution linear-quadratic differential game in which countries differ in their sensitivity to environmental damages while contributing to a common pollution stock. Such heterogeneity implies that countries value environmental quality differently and disagree on the desirable long-run environmental outcome. Consistently with the rising literature on carbon dioxide removal (CDR), we also allow for (optimal) negative emissions. We characterize the unique linear Markov-perfect (MPE) equilibrium and compare it to a centralized benchmark that maximizes aggregate welfare. We show that the inefficient steady-state pollution level at the MPE depends systematically on the distribution of damage sensitivities: intriguingly, holding average damages constant, more evenly distributed damages lead to more long-run pollution. Optimal negative emissions arise when the distribution of damage sensitives is asymmetric enough. We next show, among others, that while polarized damages reduce equilibrium pollution, they do generate distributional tensions. We therefore suggest a mechanism combining Pigouvian taxation with lump-sum transfers that can found an International Environment Agreement redistributing gains and implementing the first-best allocation despite divergent incentives.