Domestic Effects of Environmental Policies with Transboundary Pollution

Transcription

1 Domestic Effects of Environmentl Policies with Trnsboundry Pollution Michel Cvgnc * Isbelle Péchoux ** November Introduction Environmentl issues hve emerged s one of the centrl points in the debte over moves towrds trde liberlistion (the Single Europen Mrket, the Uruguy Round of GATT nd especilly NAFTA. A lrge literture hs studied the effects of interntionl trde on globl pollution. Generlly, two effects re pointed out: trde might decrese environmentl qulity by rising the scle of economy ctivity nd by providing dirty industries incentives to relocte in countries with lxer environmentl policies. Conversely, interntionl trde brings income gins which my increse the demnd for environmentl qulity involving new investments in less polluting technologies (Copelnd nd Tylor, 1995; Bruvoll nd Fæhn, A third effect of trde liberlistion is to mke governments unble to use trde instruments to protect domestic industries. So, governments might seek to weken their domestic environmentl policies s mens of covert protection. Hence, the common wisdom is tht free trde leds governments to relx their environmentl stndrds to gin competitive dvntge over their trding prtners. Severl uthors hve developed vrints of the bsic Brnder nd Spencer (1985 model to show tht governments my indeed be tempted to engge in eco-dumping, tht is to sy, to soften their environmentl policies with respect to the first-best rule of equting the socil * Toulouse School of Economics (LERNA ** Toulouse School of Economics (ARQADE We thnk two nonymous referees of REL for their very constructive remrks. DOI: /rel

2 114 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 mrginl vlue of pollution with the mrginl cost of dmge (Conrd, 1993; Ruscher, 1994; Ulph, 1996, However, s the export tx required in the Bertrnd-type model of Eton nd Grossmn (1986, strtegic distortions of environmentl policies sometimes induce over-optiml regultion (Brrett, 1994; Kennedy, In fct, the results depend strongly on the nture of competition (whether goods re strtegic substitutes or strtegic complements. This is becuse the environmentl policy is concerned by two gols in these models: trgeting domestic emissions while lso providing strtegic dvntges for domestic firms. However, pollution might cross ntionl borders. Pollution of the Gret Lkes in North Americ nd the River Rhine in Europe re two exmples of trnsboundry pollution. In such cses of trnsboundry externl effects, the environmentl policy hs triple role to ply: trgeting domestic emissions, providing strtegic dvntges for domestic firms nd trgeting imported pollution. In most of the ppers quoted bove, the environmentl policy ims only one representtive sector (one exception is Hoel, However, empiriclly environmentl constrints re not uniform cross sectors. In Europe for exmple, differentited txes on oil products mounts to txing differently polluting emissions of sectors using this sme input (e.g. fishery sector nd rod trnsport sector. In some cses, differentition in emission txes between sectors is less visible t first glnce. One exmple is the Swedish chrge on nitrogen oxides (Swedish Environmentl Protection Agency, The emissions of NO x re chrged ccording to given unit tx without discrimintion between firms but the tx revenue is then returned to firms in proportion to their production. So, it follows tht the clener sector is finncil winner: the unit cost in the clen sector is llevited with respect to the dirty sector. Following these empiricl observtions, we use multi-sector economic model. Consequently new issue rises involving the distribution of emissions mong sectors. So, the min objective of this pper is to evlute the domestic effects of environmentl policies. In prticulr, we ddress the question: do the strtegic interctions between governments led to n efficient distribution of emissions mong ntionl sectors in ech country? We use two-country model ssuming tht there re two production sectors in ech country. From theoreticl point of view, these sectors re independent in terms of trde. Hence, firms do not internlise ny of the externl effects: production choices in one sector re not influenced by the production choices in the other sector. This ssumption llows us to identify clerly the impct of regultory policies on the distribution of emissions between sectors. In our model, representtive firms in ech sector re duopolies with differentited products tht cn be either strtegic substitutes or strtegic complements. Goods re sold in third country (e.g. s in Brret, 1994 or Ulph, Production genertes trnsboundry pollution nd we

3 Michel Cvgnc et Isbelle Péchoux 115 ssume tht country is more sensitive to environmentl qulity thn the other one. The government of ech country is in chrge of the environmentl policy nd cn either use emission quots or environmentl txes. We nlyse these policies from two different perspectives. First nd s usully, regultory policies re evluted with respect to the totl level of emissions they implement s well s the distribution of these emissions between countries. Second, using our two-sector model, we re ble to evlute environmentl policies ccording to the ntionl level of emissions nd their distribution between domestic sectors. The min results re s follows. Whtever the environmentl policy, if the goods of the sector re substitutes, the totl mount of polluting emissions is higher thn the optiml level. On the other hnd, if goods re complements, the totl level of pollution my be lower thn the optiml level. Exmining the distribution of emissions between countries, we show tht, whtever the environmentl policy, the country very sensitive to pollution will implement n excessively low emission level, wheres the country less concerned by environmentl issues will implement n excessively high pollution level. Then, we consider domestic emissions. If both governments use emission quots, we bring out domestic efficiency with respect to both the level nd the distribution of these emissions within ech country. If both governments regulte pollution with tx policy, this will led to inefficiencies in both the level of domestic emissions nd their distribution between sectors. However, when symmetric environmentl policies cross countries re considered, we show tht the distortions rising from regultory policies re not linked to the nture of the instrument used but depend on the governments bility to use the instrument in strtegic wy. In prticulr, the quot policy no longer leds to domestic efficiency when the foreign country regultes by txes. So, trnsversl outcome rises from our results: when the foreign country uses tx policy, whtever the environmentl policy used by the domestic one, the ltter implements inefficiencies in both the level nd the distribution of its emissions. The pper is orgnized s follows. Section 2 presents the model. In prticulr, we define four criteri with respect to polluting emissions s well s their distribution between countries nd sectors. Section 3 ddresses benchmrk sitution in which there is no regultory policy. Section 4 evlutes environmentl policies using emission quots while section 5 considers regultory policies by mens of txtion. Section 6 focuses on the symmetric cse in which countries do not choose the sme environmentl instrument. Finlly, section 7 concludes this pper nd proposes directions for future work.

4 116 Recherches Économiques de Louvin Louvin Economic Review 76(1, The model We consider two-country model with two production sectors in ech country. These sectors re independent from the trde point of view. In ech sector, we ssume differentited duopoly between the firms of countries nd b which sell their products in third country. Firms compete in quntities in simultneous gme where the functionl forms of inverse demnds re common knowledge. Using p i, p b i nd y i, y b i to denote the price nd quntity produced by ech firm of sector i (i 1,2 in countries nd b, we hve b b b sector 1: p 1 α 1 β 1 y 1 γ 1 y 1 nd p 1 α 1 β 1 y 1 γ 1 y 1 sector 2: p 2 α 2 β 2 y 2 γ 2 y b 2 nd p b 2 α 2 β 2 y b 2 γ 2 y 2 with α i > 0 nd β i > γ i 0, i 1,2 nd for the quntity spces where prices re positive. In ech sector i 1,2 the consumers willingness to py for the good produced by the firm of one country is lwys decresing in quntity nd decreses [increses] with the quntity of the good produced by the firm of the other country when γ i > 0 [γ i < 0]. Hence, in ech sector, goods re either substitutes, independent, or complements ccording to the sign of γ i. By ssuming liner demnd, we obtin liner best-response functions tht simplify the nlytics. However, s fr s the results re concerned, the determining fctor is not the linerity in itself for the best-response functions but their slope tht is negtive when goods of sector re substitutes nd positive when goods re complements. Becuse we cn choose α 1 nd α 2 freely in inverse demnds, we normlize the unit cost of production to zero for ech firm. From the pollution point of view, sector 1 is ssumed to be clener thn sector 2. More precisely, trnsboundry-pollution levels re e 1 y b 1 nd e 1 y 1 in sector 1 nd e 2 y 2 nd e 2 y b 2 in sector 2 with e 1 < e 2. We ssume country is more sensitive to pollution thn country b. This sitution might rise from the greter frgility of the ecosystem in country nd/or greter interest of its residents for environmentl qulity. The sensitivity of ech country is modelled using two prmeters, respectively d nd d b, where d > d b. Using Π i nd Π b i to denote the respective profits of the domestic firms in sector i (i 1,2, the countries welfre functions W nd W b re W (y 1, y 1 b, y 2, y 2 b Π 1 (y 1, y 1 b Π 2 (y 2, y 2 b d [e 1 (y 1 y 1 b e 2 (y 2 y 2 b ] W b (y 1, y 1 b, y 2, y 2 b Π 1 b (y 1, y 1 b Π 2 b (y 2, y 2 b d b [e 1 (y 1 y 1 b e 2 (y 2 y 2 b ].

5 Michel Cvgnc et Isbelle Péchoux 117 Equilibri in ech sector cn be evluted considering the mounts of production, the levels of emissions nd their distribution between countries nd sectors. This evlution is provided from two different perspectives: both countries globl welfre, i.e. mximizing (W W b with respect to the totl mount nd to the distribution of polluting emissions, domestic efficiency in ech country with respect to the mount nd to the distribution of emissions tht mximize, respectively, W nd W b for given choices of production in the foreign country. We use four evlution criteri 2.1 Optiml mounts of emissions Mximizing totl welfre W W b leds to equlize, for ech sector, the sum of mrginl firms profits nd the sum of mrginl dmge of pollution Π ' & Π ' & e i (d d b Π ' & Π ' & i 1,2 (1 The four equtions llow us to determine the four optiml polluting emissions denoted by e 1 y 1 *, e 1 y 1 b *, e 2 y 2 * nd e 2 y 2 b *. 2.2 Optiml distribution of emissions between countries Let us consider E given mount of pollution generted by both countries. The optiml distribution of emissions E between countries is the solution of Mximize W (y 1, y b 1, y 2, y b 2 W b (y 1, y b 1, y 2, y b 2 subject to e 1 (y 1 y b 1 e 2 (y 2 y b 2 E We obtin Π ' & Π ' & Π ' & Π '& for i 1,2. (2 In ech sector, the profit functions of rivl firms re symmetric. It follows tht the optiml distribution of totl pollution E is such tht e 1 y 1 e 1 y 1 b nd e 2 y 2 e 2 y 2 b. (2 2.3 Efficient mounts of emissions for country For given choices of productions in the foreign country, mximizing country j s welfre W j (j,b, requires tht the mrginl profit nd the mrginl dmge of pollution re equlized for ech sector

6 118 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 Π ' & e i d Π ' & nd e i d b for i 1,2. (3 2.4 Efficient distribution of emissions in country For given choices of production in the foreign country, let E j be the domestic polluting emissions in country j (j,b. The optiml distribution of emissions E j between sectors in country j is the solution of Mximize W j (y j j 1, y 2 subject to e 1 y j 1 e 2 y j 2 E j with foreign productions given. We obtin Π ' & * for j,b. (4 3 Equilibrium levels of production without regultion Ech firm chooses its production non-coopertively, without internlising ny externl effect. In the third country, the corresponding Nsh equilibri (y 1 N,y 1 bn nd (y 2 N,y 2 bn for sectors 1 nd 2 re given by, Π ' & which leds to Π ('( &( ( *(,,, Π ' & 0 nd 0 for i 1,2 (5 y 1 N y 1 b N α 1 /(2β 1 γ 1 nd y 2 N y 2 b N α 2 /(2β 2 γ 2. (5 Using the criteri specified in section 2, the following proposition is strightforwrd. Proposition 1 Considering the cse without regultion ( If goods of the sector re substitutes, the totl mount of emissions is higher thn the optiml level. If goods re complements, the globl level of pollution my be lower thn the optiml one. (b The totl mount of pollution is optimlly distributed between countries. (c Inefficiency of domestic emissions: given the equilibrium productions in the foreign country, country could increse its welfre by reducing polluting emissions in the two sectors. (d Efficiency for the distribution of domestic emissions: given the equilibrium productions in the foreign country nd for n unchnged totl level of

7 Michel Cvgnc et Isbelle Péchoux 119 domestic pollution, country cnnot increse its welfre by rellocting emissions between domestic sectors. Proof. See ppendix A. The intuition of this proposition is the following. Firms do not tke into ccount the effect of their production on the rivl firms profits. If goods of sector i re substitutes (γ i > 0, this effect is negtive. It follows tht production, nd hence pollution, re over-optiml. If goods of sector i re complements (γ i < 0, the effect of firm s production on the rivl s profit is positive. For strongly complement goods (for high vlue of γ i nd for wek environmentl dmge (for low vlue of e i (d d b, the emissions re sub-optiml. Moreover, firms do not internlize the negtive externl effect of their production on the environment. For given choices of production in the foreign country, ech country would enhnce its welfre if emissions in both sectors decresed. 4 Evluting regultory policy with quots In this section, we consider policy gme where governments use environmentl quots s policy instruments. The timing of the gme is s follows Stge 1: in ech country the government chooses emission quots simultneously for both domestic sectors. Stge 2: the firms simultneously choose their productions with respect to the legisltion. At the second stge, if the emission quots re binding, firms will use their rights to pollute to the mximum. Consequently, t the first stge of the gme, governments know tht choosing quots is equivlent to deciding the production level in both domestic sectors. At stge 1, the Nsh equilibrium (y Q 1, y Q b 2, y Q b 1, y Q 2 is then chrcterized by -.'( & - ( & - & - which cn be rewritten s ' ( & ( & & 0 nd 0 for i 1,2(6 - - e i d - - Π ' & Π ' & nd e i d b for i 1,2. (6 Compring equtions (6 nd (5 shows tht quots re ctully binding for firms. We obtin the following proposition.

8 120 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 Proposition 2 In both countries, governments use quots s policy instruments. ( If goods of the sector re substitutes, the totl mount of emissions is higher thn the optiml level. If goods re complements, the globl level of pollution my be lower thn the optiml one. (b The totl mount of pollution is not optimlly distributed between countries: the country very sensitive to pollution implements n excessively low emission level, wheres the one less concerned with environmentl issues implements n excessively high pollution level. (c Domestic efficiency: given the production levels in the foreign country, country cnnot increse its welfre by chnging its domestic level of emissions or the lloction of these emissions. Proof. See ppendix B. Result ( follows from the fct tht governments do not tke into ccount the effect of their ntionl productions in the foreign country neither on firms profits nor on environmentl dmge. Let us now consider result (b. Country evlutes the environmentl dmge induced by one unit of production in sector i t e i d. This country is greener thn country b. Hence, its evlution is higher thn tht retined by country b, tht is e i d b. It follows tht productions re such tht y i Q < y i b Q. However, from the socil welfre point of view, the unit trnsboundry environmentl dmge is e i (d d b whtever the emitting country. Given tht profit functions re symmetric, the optiml distribution of productions should stisfy the equlity y i y i b. 5 Evluting regultory policy with txes In this section, we ddress policy gme in which governments use txes s environmentl policy instruments. The timing of the gme is s follows. Stge 1: governments choose pir of txes simultneously for their two domestic sectors, respectively, (t 1, t 2 nd (t b 1, t b 2. Stge 2: firms simultneously choose their production levels. - At the second stge, the best-response functions of the firms implemented by the countries nd b, through ny vlues t 1, t 2 nd t b 1, t b 2, re y i (y b i ;t i nd y b i (y i ;t b i for i 1,2. This leds to the Nsh equilibrium vlues for productions: y i (t i,t b i nd y b i (t i,t b i for i 1,2. - At the first stge, the countries welfre functions re W j (t 1,t b 1,t 2,t b 2 for j,b.

9 Michel Cvgnc et Isbelle Péchoux 121 It follows the Nsh equilibrium vlues for pirs of txes: (t 1, t 2 nd (t 1 b, t 2 b. - Unwinding the gme gives the equilibrium (y 1 T, y 2 T, y 1 b T, y 2 b T implemented by the tx policies. We prove in ppendix tht the equilibrium cn be chrcterized by Π ' & γ Π ' / / / / * 0 * 0 β β & γ nd Π ' & γ Π ' & / / / / * 0 * 0 β β Then, we obtin the following proposition. γ for i 1,2. (7 Proposition 3 In both countries, governments regulte pollution with txtion policy. ( If goods of the sector re substitutes, the totl emissions re over-optiml. If goods re complements, the totl pollution my be sub-optiml. (b The globl mount of emissions is not distributed optimlly between countries: the country very sensitive to pollution implements n excessively low emission level wheres the one less concerned with environmentl issues implements n excessively high pollution level. (c Domestic emissions inefficiency: given the productions in the foreign country, one country could increse its welfre by chnging its domestic level of emissions in ech of its sectors. More precisely, if goods of the sector re substitutes, the mount of domestic emissions is higher thn the efficient level; if goods re complements, the mount of domestic pollution my be lower thn the efficient one. (d Domestic distribution inefficiency: given the productions in the foreign country, nd without chnging its totl level of pollution, one country could increse its welfre by rellocting emissions mong its domestic sectors. Proof. See ppendix C. Considering the reltions (7, intuitions of the results re s follows. Government (s n exmple uses txes to chieve three gols: to mke its firms internlize domestic environmentl dmge generted by their production (the term e i d to modify strtegiclly best-response functions of their firms in order to / / increse their equilibrium profits (the term γ Π ' & β to reduce the environmentl feedbck due to trnsboundry emissions (the term γ * 0. β

10 122 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 It follows tht confronted with the trnsboundry chrcter of pollution, countries consider two possibilities: The effect of commercil support, net of the environmentl feedbck, is positive: / γ Π ' & 3 β / * 0 2 > 1. This pplies if goods of sector i re substitutes or if goods re complements when Π i /y i b >e i d. In this cse, government provides commercil support setting environmentl / / tx lower thn the Pigouvin level: Π ' &. < * 0 The effect of commercil support, net of the environmentl feedbck, is / / negtive: γ Π ' & 3 * This pplies if goods of sector i re < β complements with Π i /y b i < e i d. In this cse, government does not provide ny trde support but rther retins trde penlty, choosing n / / environmentl tx higher thn the Pigouvin level: Π ' &. > * 0 When evluting domestic efficiency in ech country, we consider productions in the foreign country s given. In this cse, the only gol of the government is to mke its firms internlize environmentl dmge generted by their production. So, for given productions in the foreign country, the government would set txes t the Pigouvin levels, nd would then implement, in ech sector, equlity between the mrginl profit nd the mrginl dmge of pollution with respect to criterion (3. 6 Domestic efficiency with txes but not with quots In this section, we point out tht distortions resulting from regultory policies re not linked to the instrument used but depend on the possibilities for government to use the instrument in strtegic wy. We consider the policy gme in which country prefers pplying n emission-quot policy wheres country b dopts tx policy. The timing of the gme is s follows Stge 1: governments choose emission quots nd txes simultneously. Stge 2: firms choose simultneously their production levels. In this new competition context, regultory policies my hve opposite domestic effects compred with those described in the two preceding sections. Now, we nticipte tht regulting by txes my led to domestic efficiency but regulting by quots leds to domestic inefficiency.

11 Michel Cvgnc et Isbelle Péchoux 123 In order to obtin the result, it is useful to consider the gme in which country does not use regultion (or, equivlently, sets quots t non binding levels wheres country b plys tx policy. Using the result (7 bove, we know tht in this cse the Nsh equilibrium (y i,y i bt implemented by the tx policy for sector i is given by Π ' & / 1 nd / / Π ' & ' & * 0 γ Π 3 * 0 2. (8 β With no pollution (e i 0, the best-response functions of the countries would collpse with the best-response functions of their firms nd the Nsh equilibrium (y b i, y T i would be the Stckelberg point with the country b s leder (here we recognize the results of Brnder nd Spencer, 1985 nd Eton nd Grossmn, As e i increses, the best-response functions of the countries move to lower quntities. Moreover, reltion (8 shows tht country b reduces its strtegic distortions in order to reduce the environmentl feedbck due to trnsboundry emissions. So, the Stckelberg point moves to lower y T i. It follows b tht s e i increses, depending on the nture of goods, we obtin figure 1 (when goods re substitutes or figure 2 (when goods re complements. We drw the figures for given e i > 0. BR i nd BR b i re the bestresponse quntities of countries nd b to foreign productions, y i (y b i is the best-response function of firm i in country without quot nd S is the Stckelberg point. 6.1 Goods re substitutes On the line BR b i we put the point V such tht W b (y V b i,y V i equls W b (y S b i,y S i. Let us now consider the first stge of our policy gme in which country uses n emission-quot policy wheres country b uses tx policy. The best-response policy of country b to quot higher thn e i y V i is to implement the Stckelberg point S setting tx lower thn the Pigouvin level. V However, the best response of this country to quot lower thn e i y i is to set tx t Pigouvin level. b The isowelfre curve of country is tngent to the best-response line BR i t point E. Following the prmeters vlues, y E i my be under or bove y V i. In the first cse, the best response of country to the best-response policy of country b is to select the quot e i y E i. In the second cse, the best response of country is to select the quot e i y V i becuse W (y V i,y bv i is higher thn W (y S b i,y S i.

12 124 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 Figure 1 It follows tht when goods re substitutes, the equilibrium (y i QT, y i b QT is such tht -/ Π ' & -/ 6.2 Goods re complements < * 0 -/ -/ nd Π ' & e i d b. b We nme W the point where the line BR i intersects the firm s best response in country if no quot ws used. Let us consider the first stge of the policy gme in which country uses quots nd country b uses txes. The best-response policy of country b to quot lower thn e i y W i is to set tx t Pigouvin level. A quot e i y m i such tht the line y m i intersects the b line BR i between y W i nd y S i is not binding on the line BR b i. It follows tht the best response of country b to quot e i y m i between e i y W i nd e i y S i is to set tx lower thn the Pigouvin level in order to implement the point m where the line y m i intersects the best-response line y i (y b i of the foreign firm. Given quot higher thn e i y S i, the best response of country b is to implement the point (y S b i,y S i setting tx lower thn the Pigouvin level.

13 Michel Cvgnc et Isbelle Péchoux 125 Figure 2 The best response of country to the best-response policy of country b depends on the per unit environmentl dmge of production (e i d. With no pollution (e i 0, the isowelfre curves of country collpse with the isoprofit curves of its firm nd not using quot is better for country. As e i increses, the lines BR i nd BR i b move to lower quntities. Moreover, reltion (8 shows tht point S moves to lower quntities s well. So, there exists threshold vlue for e i d from which the best response of country to the best-response policy of country b is to select the quot e i y i E. It is the cse when the isowelfre curve of level W (y i E,y i b E is bove the isowelfre curve of level W (y i S, y i b S. It follows tht when goods re complements, the equilibrium (y i QT, y i b QT is such tht low vlue of e i d -/ -/ -/ -/ Π ' & Π ' & : 1 nd < e i d b high vlue of e i d -/ -/ -/ -/ Π ' & Π : ' & < * nd e i d b 0. Using the criteri (3 nd (4, the following proposition is strightforwrd.

14 126 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 Proposition 4 Country uses quot policy nd country b uses tx policy. ( When the foreign country uses tx policy, regultory policy with quots leds to domestic emissions inefficiency (given the levels of production in country b, country could increse its welfre by reducing its emissions nd to domestic distribution inefficiency (given the levels of production in country b, nd without chnging its totl level of domestic pollution, country would be ble to increse its welfre by rellocting its emissions between domestic sectors. (b When the foreign country uses quot policy, we must distinguish two cses. Goods re complements nd crete low environmentl dmge: regultory policy with txes leds to domestic emissions inefficiency (given the levels of production in country, emissions in country b re too high nd to domestic distribution inefficiency (given the levels of production in country, nd without chnging its totl level of domestic emissions, rellocting emissions in country b would be welfre improving. Goods re substitutes or goods re complements nd crete high environmentl dmge: regultory policy with txes leds to domestic efficiency (given the levels of production in country, country b cnnot increse its welfre by modifying its domestic emissions or the distribution of these emissions. Finlly, we propose summry of ours results in the following tble. Columns restte the four criteri we presented in section 2. Lines represent environmentl policies of countries. We distinguish the two polr cses: goods re substitutes nd goods re complements with low emission intensity.

15 Michel Cvgnc et Isbelle Péchoux 127 Globl mounts of emissions Criterion (1 Optimlity of inter-country distribution of emissions Criterion (2 Ntionl emissions Criterion (3 Efficiency of intr-country distribution of emissions Criterion (4 No regultion Substituts Over-optiml Yes Too high Yes Complements Sub-optiml Yes Too high Yes Quot - Quot Substituts Over-optiml No Efficient Yes Complements Sub-optiml No Efficient Yes Tx - Tx Substituts Over-optiml No Too high No Complements Sub-optiml No Too low No Quot - Tx Substituts Over-optiml No Complements Over-optiml No Quot: Too high Tx: Efficient Quot: Too high Tx: Too high Quot: No Tx: No Quot: No Tx: No

16 128 Recherches Économiques de Louvin Louvin Economic Review 76(1, Conclusion This rticle nlyses environmentl regultions for trnsboundry-polluting ctivities. In our model, governments cn use two types of instruments, emission quots or environmentl txes. These environmentl policies hve triple role to ply: trgeting domestic emissions, providing strtegic dvntges for domestic firms nd trgeting imported pollution. First, we consider symmetric cses where governments use the sme environmentl instrument. In such context, we show tht the country very sensitive to pollution implements n excessively low emission level wheres the one less concerned with environmentl issues implements n excessively high pollution level. This result holds whtever the environmentl policy used. When nlysing domestic emissions, we find there is domestic efficiency with respect to both the level nd distribution of these emissions in the cse of the quot instrument; however, if governments regulte pollution with tx policy, we show tht the level of domestic emissions nd their distribution mong sectors re both inefficient. The lst step of the pper is to ddress the symmetric cse where governments do not choose the sme environmentl instrument. We point out tht distortions rising from regultory policies re not linked to these policies themselves but depend on the possibilities for governments to use these policies in strtegic wy. In prticulr, the quot policy no longer leds to domestic efficiency when the foreign country does not use quot but regultes by txes. So, trnsversl result rises: when the foreign country uses tx policy, whtever the environmentl policy used by the domestic one, this ltter implements inefficiencies in both the level nd the lloction of its emissions. A possible extension of this work is to nlyse to wht extent countries re ble to coordinte their environmentl policies. Some uthors hve discussed the impct of hrmonizing environmentl regultion interntionlly (Cremer nd Ghvri, 2004; McAuslnd, 2005; Li, nd Hu, However, n issue rises involving the cceptnce of interntionl greements by countries. The first difficulty is the free riding problem. Generlly, country might be better off prticipting in n greement rther thn hving no greement t ll. However, even if this country would usully be better off when other countries prticipte, it my prefer to remin outside the greement nd serch for its own self-interest. The second difficulty is tht, in some cses, country might be worse off prticipting in n greement thn it would be without ny greement. For exmple, s shown by Knbur nd Keen (1993 in different context, hrmoniztion to the common optiml policy could hrm one country with respect to the non-coopertive outcome. Generlly,

17 Michel Cvgnc et Isbelle Péchoux 129 environmentl greements re thought of s emission-level contrcts. However, in n imperfect competition context, our pper shows tht the instruments used mtter beyond the environmentl greement. In environmentl negotitions, n instrument cnnot be preferred or excluded solely on its own merits. It must be evluted in reltion to the strtegic trde opportunities tht it provides, becuse the ltter motivte strtegic distortions tht re welfre-reducing. References Brrett, S. (1994. Strtegic Environmentl Policy nd Interntionl Trde. Journl of Public Economics 54: Brnder, J. A. nd Spencer, B. J. (1985. Export Subsidies nd Interntionl Mrket Shre Rivlry. Journl of Interntionl Economics 18: Bruvoll, A. nd Fæhn, T. (2006. Trnsboundry effects of environmentl policy: Mrket nd emission lekges. Ecologicl Economics 59 (4: Conrd, K. (1993. Txes nd Subsidies for Pollution-Intensive Industries s Trde Policy. Journl of Environmentl Economics nd Mngement 25: Copelnd, B. R. nd Tylor, M.S. (1995. Trde nd Trnsboundry Pollution. Americn Economic Review 85 (4: Cremer, H. nd Ghvri, F. (2004. Environmentl txtion, tx competition, nd hrmoniztion. Journl of Urbn Economics 55 (1: Eton, J. nd Grossmn, G.M. (1986. Optiml Trde nd Industril Policy Under Oligopoly. Qurterly Journl of Economics 101: Hoel, M. (2005. The Triple Inefficiency of Uncoordinted Environmentl Policies. Scndinvin Journl of Economics 107: Knbur, R. nd Keen, M. (1993. Jeux Sns Frontières: Tx Competition nd Tx Coordintion When Countries Differ in Size. Americn Economic Review 83: Kennedy, P. (1994. Equilibrium Pollution Txes in Open Economies with Imperfect Competition. Journl of Environmentl Economics nd Mngement 27: Li, Y. nd Hu C. (2008. Trde greements, domestic environmentl regultion, nd trnsboundry pollution. Resource nd Energy Economics 30 (2: McAuslnd, C. (2005. Hrmonizing tilpipe policy in symmetric countries: Improve the environment, improve welfre? Journl of Environmentl Economics nd Mngement 50 (2: Swedish Environmentl Protection Agency (2006. The Swedish chrge on nitrogen oxides Cost-effective emission reduction. Informtion fcts. Nturvrdsverket. Ulph, A. (1996. Interntionl Trde nd the Environment: A Survey of Recent Economic Anlysis. In H. Folmer nd T. Tietenberg (eds, The Interntionl Yerbook of Environmentl nd Resource Economics 1997/98, Edwrd Elgr,

18 130 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 Ulph, A. (1997. Environmentl Policy Instruments nd Imperfect Competitive Interntionl trde. Environmentl Ressource Economics 7: Ruscher, M. (1994. On Ecologicl Dumping. Oxford Economics Ppers 46: Appendix A Proof of proposition 1 ( To evlute the totl level of emissions in both sectors t the Nsh equilibrium, we compre equtions (5 nd (1. Thus, we distinguish two cses Goods of sector i re substitutes (γ i > 0. In this cse, we hve Π b i /y i < 0 nd Π i /y b i < 0 in eqution (1. Since mrginl profit functions re decresing, we cn conclude N e i y i > e i y b N i * nd e i y i > e i y b i * for i 1,2. Goods of sector i re complements (γ i < 0. In this cse, we hve Π b i /y i > 0 nd Π i /y b i > 0 in eqution (1. For strongly complement goods (high level of γ i nd for wek environmentl dmge (low level of e i (d d b, we my hve Π ' & Π ' & > e i (d d b. In this cse, the emissions of sector i re sub-optiml. (b Nsh equilibri ssocited with sectors 1 nd 2 re described in eqution (5. They stisfy the optimlity condition (2. The distribution of totl pollution is optiml. (c To evlute domestic levels of emissions, for given choices of production in the foreign country, we need to compre equtions (5 nd (3. Since the mrginl profit functions re decresing, the levels y N b i nd y N i re too high in ech sector. (d Finlly, we evlute the distribution of domestic emissions cross sectors. At the Nsh equilibrium, mrginl profits re nil in ech sector. Hence, efficient condition (4 is stisfied. B Proof of proposition 2 ( Compring equtions (6 nd (1, we distinguish two cses If goods of sector i re substitutes (γ i > 0, we hve Π b i /y i < 0 < e i d b nd Π i /y b i < 0 < e i d.

19 Michel Cvgnc et Isbelle Péchoux 131 It follows tht e i y i Q > e i y i * nd e i y i b Q > e i y i b * for sector i (since mrginl profit functions re decresing. If goods of sector i re complements (γ i < 0, we hve Π i b /y i > 0 nd Π i /y i b > 0. This positive trde effect, coming from the rivl firm, my be higher thn the environmentl dmge, tht is Π i b /y i > e i d b nd Π i /y i b > e i d. In this cse, we hve e i y i Q < e i y i * nd e i y i b Q < e i y i b * for sector i. (b Eqution (2 chrcterizes optiml distribution of ny given totl mount of emissions: for ech sector, productions re the sme in both countries. Equilibrium productions resulting from quot regultion re determined by equtions (6 nd i 1,2. These productions re such tht for i 1,2. Country is more sensitive to pollution thn country b (d > d b. Hence, the difference bove is negtive nd y i Q < y i b Q. Consequently, for ech sector, the emission rtio in country is too low compred with the emission rtio in country b. (c We check tht the Nsh equilibrium (y 1 Q, y 2 Q, y 1 b Q, y 2 b Q chrcterized by eqution (6 stisfies the efficiency conditions (4 nd (5. C Proof of proposition 3 We first prove the reltions (7. At the second stge, the best-response functions of the firms implemented by the countries nd b, through ny vlues t 1, t 2 nd t 1 b, t 2 b re nd for i 1,2. At the first stge, the equilibrium pirs of txes (t 1, t 2 nd (t 1 b, t 2 b re such tht nd * ' 0 * ' γ β α γ α β * ' 0 * ' γ β α γ α β '0 * γ β * ' β γ β α * ' β γ β α ' 0 * Π Π

20 132 Recherches Économiques de Louvin Louvin Economic Review 76(1, Π 5 Π 5 * 0 ' for i 1,2. Using 5 * β nd 5 γ β * β γ * 4β in the first reltion, nd 5 * β nd in the second reltion, the Nsh equilibrium (y 1 T, y 2 T, y 1 b T, y 2 b T implemented by the tx policies cn be chrcterized by Π ' Π ' We cn now prove the proposition 3. nd for i 1,2. (7 ( Compring equtions (7 nd (1 leds to distinguish two cses. If goods of sector i re substitutes (γ i > 0, we hve Π i b /y i < 0 nd Π i /y i b < 0. Hence, in eqution (7, we hve (for j,k,b nd j k / γ Π ' & 3 β 7 Therefore & < * 0. / / / / Π ' & Π7 ' & < e i d j < e i (d d b. In sector i, emissions re over-optiml. If goods of sector i re complements (γ i < 0, we hve Π i /y i b > 0 nd Π i b /y i > 0. This positive trde effect, coming from the rivl firm, my be lower thn the environmentl dmge, tht is Π i /y i b < e i d nd Π i b /y i < e i d b. In this cse, in eqution (7 we hve (for j,k,b nd j k Mrginl profit nd Π k i /y j i enough to stisfy 5 γ β * β γ Π ' γ * 4β / / / / * 0 * 0 β β & γ Π ' & & γ / / / / * 0 * 0 β β / / γ Π ' & 3 β * 0 2 > 1 7 / * 0 2 < *9 90<:; γ Π ' 7/ γ / & Π ' / / & / > * 0. (here γ i < 0 cn be high

21 Michel Cvgnc et Isbelle Péchoux 133 Π ' / & / / / Π7 ' & > e i (d d b j,b. In such cse, emissions re sub-optiml. (b Equtions (7 determine the equilibrium productions implemented by governments / & β '4β γ 3α γ γ * 0 '( 2 β γ 3α * 0 '( 2 β β ( β ( β γ γ 4 4 nd / & β '4β γ γ γ 3α * 0 '( 2 β γ 3α * 0 '( 2 β β ( β ( β γ γ These productions re such tht / / for i 1,2. for i 1,2. The denomintor of the expression is negtive nd d is higher thn d b ; it follows tht the difference y i T y i bt is negtive nd y i T < y i b T. But eqution (2 requires y i y i b. Hence, for ech sector emission rtio in country is too low compred to the emission rtio in country b. (c To evlute the efficiency of emissions in both countries, we need to compre equtions (7 nd (3. We cn use the results estblished t point (. If goods of sector i re substitutes (γ i > 0, we hve Π ' for j,b. For given output in country k, country j should decrese y j i to enhnce its welfre. If goods re complements (γ i < 0, we my hve / / Π ' & > * 0 In this cse, for given output j increse y i to enhnce its welfre. 4 for j,b. in country k, country j should (d The distribution of domestic emissions in given country cn be nlyzed by compring equtions (7 nd (4. From eqution (7 we cn compute 4 * '0 0 ' β γ '4β β γ γ / & 7 / / < * 0 7 /

22 134 Recherches Économiques de Louvin Louvin Economic Review 76(1, 2010 / / / / Π( '( & ( Π ' & / / ( γ( γ( ( γ γ 3 (2 3 (2 *( * β( *( β * for j,b. Generlly, this difference is non-zero nd efficiency condition (4 is not 7 / 7/ stisfied. For pir of productions ' implemented by the government in foreign country k, country j could increse its welfre by rellocting ( & / / its emissions '*( * cross domestic sectors. (