Adaptation and the Allocation of Pollution Reduction Costs

We consider a game of abatement of a transboundary pollutant. We use a time-consistent Shapley value allocation of the cost of pollution reduction, and study the sensitivity of such an allocation to countries' adaptation to pollution. A country's adaptation to pollution is captured by a change in its damage function. We show that if there is a reduction in the damage cost of one country only, this can harm the other countries. Some countries may end up worse o¤ even in the case where all countries experience a uniform decrease in their damage from pollution. An important policy implication of our analysis is that the Shapley value approach to the allocation of abatement costs doesn't necessarily provide the right incentives for all players to act on reducing pollution damage. We determine conditions under which a uniform fall in all countries'pollution damage benefits all countries.