Developing countries and environmental protection: The effects of ex ante versus ex post contracting

In the 1992 Rio Earth Summit, developing countries (DCs) were adamant that in order to protect the environment for the future, new institutions were needed that would channel resources from the wealthy developed countries to the poor DCs. With this backdrop, I analyze the problem faced by an asymmetrically informed supranational governmental authority (SNGA) that wishes to design an International Environmental Agreement (IEA). The SNGA cannot contract directly with polluting firms in the various DCs; instead, the SNGA must deal with such firms through their governments. I study this tripartite hierarchical interaction and focus on the properties of the optimal ex ante and ex post IEAs, which can be implemented by the SNGA in two different scenarios. The analysis suggests that IEAs are not inherently doomed due to a basic monitoring and enforcement problem stemming from national sovereignty. Further, desirable levels of pollution abatement can result in a number of contractual settings.