International Positive Production Externalities under a Transfer Payment Scheme - The Case for Cooperation

Abstract

In the present work we tried to find out whether the existence of positive international externalities generate an incentive for cooperation between different governments and if the adoption of a transfer payments scheme moderates that intensive. In order to do so we adopted a simple economic model incorporating the international linkage of national economies. A well-defined Symmetric Long Run Nash Equilibrium exists, while the related tax rate proves to be non-state contingent. On the other hand, the cooperative solution is identical to Barro's (1990) well-known solution for the tax rate, financing some public factor. Utility proves always to be higher when countries cooperate than when they play Nash to each other. We then added a transfer payment scheme. Again, a Symmetric Nash Equilibrium in national policies exists, is unique and lower than the one chosen in the absence of transfer payments, i.e. a moral hazard problem is at work. On the other hand, the cooperative solution is not affected at all by the existence of a transfer payment scheme in an ex-post symmetric framework. The adoption of a transfer payments scheme not only does not weaken the intensive to cooperate, but it also intensifies it, since a moral hazard problem arises on the top of the free riding problem.