Prices vs quantities for international environmental agreements

Abstract

Does the choice between price-based or quantity-based regulation matter for the formation of an international environmental agreement (IEA)? We introduce abatement cost uncertainty in a standard coalition formation model and let countries choose their preferred regulatory instrument. It is shown that a coalition of cooperating countries is more likely to prefer a quantity regulation than non-cooperating countries. However, uncertainty also aggravates free-riding whenever the endogenous preference of the coalition is to implement quantities, which implies lower equilibrium participation than in the benchmark case without uncertainty. A restriction to price-based agreements can lead to higher participation, but does not necessarily raise global welfare. Tradable quantities can both increase participation in the agreement and achieve higher global welfare. Overall, our results suggest that free-riding incentives in global public good problems with uncertainty may be underestimated if the strategic implications of instrument choice are ignored.