Optimal control of upstream pollution under asymmetric information

This paper derives optimal bribes to reduce upstream transfrontier emissions in the presence of asymmetric information on the polluter's concern for the environment. In a model in which the starting point for the negotiations on emission reduction is a Cournot-Nash equilibrium, it is shown that transfers from the victim induce the polluting country to exaggerate its concern for the environment. As a consequence, in the second best solution, abatement of all but the least caring type is distorted downward and optimal bribes may be such that more caring types turn them down. These results are in sharp contrast to earlier policy proposals derived for a non-equilibrium starting point. They indicate that under asymmetric information the binding incentive problem is to prevent the polluting country from claiming not to care about the environment and that optimal bribes from the victim should be restricted to sufficiently environmentally concerned polluters.