Economic Policy for the Environment: The Role of International Cooperation

Abstract

In a normative approach, this paper studies the use of economic policy when environmentally harmful externalities of production/consumption cross the countries' frontiers. In a model with two countries, one of the countries produces an air polluting good, while the other produces a good that destroys its rain forest. Pollution destroys the ozone layer, and the rain forest helps in rebuilding it. Two solutions will be analyzed: the cooperative solution, where the two countries implement the globally optimizing solution; and the non-cooperative solution, where each country separately implements the national best allocation. The main result of this paper is that, absent worldwide coordination, the implementation of environmental policies could actually worsen welfare. The reason is that the countries would take the opportunity to introduce protectionist policies to exploit their monopoly power in the world market for goods.