By Suzi Kerr, Steffen Lippert and Edmund Lou – 

International agreements addressing climate change must overcome the difficulties implied by the absence of an institution with the power to ensure compliance. They have to be self-enforcing: the threat of future punishment must give participants sufficient incentives to comply with the agreed reductions in emissions voluntarily. The structure of the underlying game of choosing greenhouse gas emissions is what Albert Tucker named a Prisoner’s Dilemma (Rapoport and Chemmah, 1965). Every country has an incentive to increase their emissions unilaterally, to produce higher economic output, benefitting the individual country. The environmental costs or the increase in greenhouse gas emissions, however, are shared by the community of countries, leading to inefficiently high individual incentives to emit. In contrast, efficient global mitigation – low emissions by all countries – generates the greatest joint gains.

From folk theorems, we know that sufficiently patient players in a prisoner’s dilemma are able to sustain the first-best outcome as a subgame perfect Nash equilibrium. In the context of climate change, this means that, for patient countries, the loss of future cooperation is so large that short-run opportunistic increases in emissions today do not pay. Unfortunately, as we have learned from 30 years of climate negotiations, this theoretical insight does not easily transfer into reality.

Because we do not like where the rules of the game take us, we need to change them. The question is how. A first change of the rules of the game exploits the insight that a country’s payoffs from low or high emissions are critically dependent on its investments in compliance technology. In a recent paper, Harstad, Lancia and Russo (2018) show that, where countries face too high costs or too low benefits to sustain efficient climate cooperation, second-best strategies to sustain low emissions in the repeated climate cooperation game overinvest in green and underinvest in brown or adaptation technologies. This change in the investment increases the benefit and lowers the cost of mitigation and thereby reduces the country’s incentive to increase emissions. As for the first-best, sustaining these second-best strategies also require countries to be sufficiently patient.

An important challenge to the nearly thirty years of climate negotiations has been that the joint gains from efficient climate cooperation are unequally distributed across countries. Without resource transfers, many countries would not agree to a globally efficient agreement, and only partial agreements or agreements with lower than efficient mitigation levels can be sustained. Hence, a second rule of the game we can change concerns resource transfers among countries. Indeed, Fong and Surti (2009) show how side payments affect the optimal degree of cooperation in repeated prisoner’s dilemmas. In the case of climate cooperation, resource transfers relax the emissions compliance constraint of recipient countries with low benefits or high costs from low emissions. And if these transfers increase the payoffs of countries with high benefits from low emissions by sustaining low emissions in more countries, then it would clearly be in their interest to offer them.

Because, however, a country’s investment in compliance technology affects its costs and benefits from mitigation, its investment decisions need to be considered in the design of climate change agreements with resource transfers. In our paper, we build on Harstad et al.’s work and explore how to sustain higher levels of climate cooperation when not all countries have sufficiently high gains from low emissions to sustain Harstad et al.’s second-best equilibrium. In particular, we investigate side payments from countries with high benefits – we call them members of a climate club – to countries with low benefits – which we call applicant countries – with the aim of achieving a commitment to the efficient level of emissions by the applicants.

You can read the full article at the Coalition Theory Network


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