Transboundary Pollution Control and Competitiveness Concerns in a Two-Country Differential Game

We analyze a transboundary pollution control problem in a heterogeneous two-country differential game setting in which regulators care for the implications of environmental policies on the competitiveness. We characterize the noncooperative and the cooperative solutions, showing that under both scenarios, in the presence of competitiveness considerations, heterogeneous countries will generally set different carbon taxes. This suggests, while implementing a mitigation policy is necessary to combat climate change, a universally homogeneous policy may not be optimal. Moreover, when countries are symmetric, except for their degree of competitiveness concerns, under noncooperation introduction of such concerns lowers the abatement policies in both countries, however, the self-effect is stronger than the cross-effect. Nevertheless, under cooperation, an increase in country j's competitiveness concerns leads to more stringent policies in country i, while, the self-effect could be either positive or negative. The latter result emphasizes the importance of cooperation to tackle pollution in the presence of competitiveness concerns.