The Choice of Environmental Policy Instruments and Strategic International Trade

Abstract

In this paper I examine the question of the choice of environmental policy instruments in the context of a model of strategic international trade between countries, and I show that in such a model there is a preference for the use of standards rather than taxes as policy instruments. The paper employs a simple model of two countries who are the sole producers of a commodity sold on the world market. Production uses an input which is directly related to the emission of a pollutant, and each country has a fixed target for the emissions level it wishes to achieve. If trade is modelled as a one—shot Cournot equilibrium, the countries are indifferent about policy choice. If trade is modelled as a Stackelberg equilibrium, then both countries are better off (in terms of producer surplus) if the follower uses standards. Finally, if trade is modelled as a two— stage Cournot game in capacity and output then the choice of standards by both countries is a Nash equilibrium, and Pareto dominates the choice of taxes by both countries. These results arise from the superior commitment properties of standards.

Comments by participants at the conference, and by Larry Karp and Tony Venables are greatfully acknowledged.