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Strategic Issues in

Global Climate Change

Harry Clarke

27th Australasian Economic Theory

Workshop Auckland
Climate change

• Examine prospects for reaching a

global cooperative agreement to
mitigate GGEs.

• ‘Common property’ problems involve

textbook Prisoner’s Dilemma issues .

• How do side policies,

embarrassment effects, carbon
leakages & policy commitments
affect this?

• US & China provide > 50% of GGEs.


• 13 countries provide 30% then a fringe

of ‘small’ countries - like Australia -
provide 20%.

• Problem to derive an international

• Each country may/may not gain from
unilateral mitigation – depends on
‘size’ & ‘moral suasion’ impacts.

• Each gains most if all mitigate.

• Irrespective of stance of others each

may gain most by not mitigating.
Model 1: US & China

• Choices: mitigate (M) or not (DM).

• National benefits πu πc are actual

environmental costs/benefits – don’t
reflect ‘prestige’ or ‘embarrassment’

• Spill-overs to other party Buc & Bcu.

Carbon leakages

• Without global GGE tax (or freely

traded carbon quotas) can be carbon

• If US (u) controls GGEs but China (c)

does not there is a cost to u of Luu &
gain to c of Luc.
The game.

Two Country Game with Carbon

Leakage M DM

M πc +Buc, πu +Bcu πc -Lcc, Bcu+Lcu


DM Buc +Luc, πu -Luu 0,0

• Spill-overs & leakages impact

• For US to have dominant strategy


πu > max(Lcu , Luu)

• US must gain more than it loses by

mitigating alone (Luu) or gains by being
Carbon leakages
• Tighten conditions for each country
to find it ‘individually rational’ to
unilaterally mitigate.

• But empirically important? Evidence

from EU experience – suggests

• In some cases ‘side’ policies can

Side policies for

• ‘Destination accounting’ based on GGE


• Main difficulty is probable illegality of

specific ‘border taxes’ under Article 1 GATT.

• Practical difficulties - assessing carbon

content of goods produced with different
Side policies

• Also problems with rebating taxes

local firms pay on exported output.

• Can do this ‘lump-sum’ to limit

disadvantage & incentive to divert
high GGE outputs overseas. With
output-based rebate there is a
distorting incentive to export high
GGE goods.

• Leakages increase likelihood of PDs –

more likely countries have dominant
strategies of not mitigating.

• Countries can lose a lot by going it

alone in mitigating. Can also gain a
lot by not mitigating when others do.
‘Embarrassment’ costs

• Increase payoffs when all other

countries mitigate but you don’t.

• If large can transform PD to an

Assurance game with (M,M) & (DM,DM)
being Nash equilibria but where each
prefers (M,M).

• Prospects for co-operation

PD structures

• PD obtains when local pollution

issues are insufficient to drive
mitigation but the outcome where
both mitigate is collectively rational.

• Less standard outcome - collectively

best if one country mitigates.
Requires payoff asymmetry + side-
u compensates c with $ε to
(10 > ε > 0)


Two Country Game M DM

M 0.5+ε, 6-ε ε, 10-ε

China DM 1,-4 0,0


• Transfers make sense if one country

has high MWTP for GGE mitigation
but faces high abatement costs.

• Can be understood using public

goods model.
M W TP u+ M W TP c
MCmin lies in
China to
cutback M W TP M C m in
level G.

Aggregating E
MWTPs - all A
cutbacks in
China. A' E'

Cost AEG*0.
M W TP c F
Of this B G G E c u tb ac k s
principle 0
suggests G c G* G
FE’A’B paid
by US.
Benefits principle implemented by
GGE quota allocation.

• This can be implemented by appropriate

quota allocation.
A striking (&
implausible) result

• Assumes all low cost options in China & that

US can compensate China for making cuts
with a price covering mitigation costs.

• But general implication sound - efficiency-

driven transfers from rich to poor
countries can meet GGE targets at
minimum cost.

• Rationale for CDM under Kyoto.


• Non-co-operation in common property

management resolvable using

• Penalties on a single non-mitigator can

turn PD into Assurance game.

• If imposed on all game can become one

where all have dominant strategies
to mitigate.
What penalties?

• Might impose retaliatory tariffs

(‘Kyoto tariffs’) against non-
mitigators as Europe threatened to
do to US.

• Strange & costly! - penalises all who

would otherwise derive enhanced
Gersbach proposal

• All industrialised countries contribute

initially to a Global Refunding
System (GRS).

• Each country receives refund

proportionate its GGE reduction over
previous year relative to global GGE
reduction over previous year.

• Each country sets its own GGE taxes

but all tax revenue paid to GRS.
Non-PD games

• Leadership games - sometimes possibile.

Might make sense.

• Chicken games – can only work with carbon

leakages. Each prefers to be sole mitigator but
prefers joint mitigation to ‘frying’.

• Assurance games – as observed, can arise

with ‘embarrassment’ or with punishments.
Otherwise – to arise naturally - need carbon
Multi-country models

• N = 3. US, China & Europe.

• Interesting because of asymmetrical

mitigating incentives (compare US &

• Nothing much changes unless

account for carbon leakages.
Main leakage results

• A non-mitigating country
thinking about mitigating will
focus on:

– Carbon leakage costs accrued as

consequence of mitigating.

– Carbon leakage benefits forgone by

‘holding out’ & hoping everyone else
Mitigation contagion

• If an extra country mitigates does

that enhance mitigation incentives of
current non-mitigators?

• Some improvement - less carbon

leakage losses but still enhanced
prospects of large gains by holding
out to be last non-mitigator.
Moral suasion effects

• Insights from behavioural economics &

‘reciprocity ‘ literature.

• When do people cooperate though not

individually rational to do so?

• If they see others doing so or attempting to

do so (irrespective of consequences).

• Results for individuals not groups. For

groups evidence goes both ways.
Self-serving biases - may
limit reciprocity

• Perceptions of ‘fairness’ converge on self-


• Rich policymakers may avoid ethics of

developing country needs because of

• Cognitive dissonance may lead emitters to

deny damages.

• Policy implication – force negotiators to

Intermediate & ‘no
regrets’ policy

• Few results.

• China might pursue ‘no regrets’

options with low spill-overs.

• Implications for other countries?

If China commits to ‘no

(rather than not mitigating)

• Case for US to mitigate fully is

strengthened - now smaller potential
carbon leakage losses
Repeated game view &

• Analysis well-known. For brevity I’ll ignore.

• Numerous ways of dynamising.

• Consider ‘now’ /‘future’ setting with 2

countries (China, US).

• Ignore carbon leakages.

• Suppose GGE control a luxury good with

low quantity demanded ‘now ‘ in China.
Dynamics - China

• Faces development imperatives ‘now ‘ providing

incentives to forego mitigation. Some incentive
for positive mitigation because future income

• Also faces severe impacts ‘now’ from unmitigated

change & high adjustment costs of reorienting
energy consumption entirely in ‘future’ to less
polluting sources.

• Will recognise US has increased commitment to

mitigate tempered by an increased US capacity to
adapt & increased US incentives to mitigate due
Dynamics - US
• May place higher weight on environment now &
retaining quality into the future.

• Face lower future impacts & adaptation costs

from unmitigated change.

• Will recognise incentives China faces to under-

supply mitigation now but to more fully mitigate
in future.

• Recognition China faces severe costs of

adaptation in future which tempers pressure to
shift mitigation responses forward.

• These notes throw light on the

insight that it is important for nations
to put themselves ‘in the shoes of
others’ to resolve climate change
Thank you