Transboundary Pollution Control and Competitiveness Concerns in a Two-Country Differential Game

Abstract

We analyze a transboundary pollution control problem in a heterogeneous two-country differential game in which each country’s regulator cares for the implications of environmental policy on its competitiveness. We characterize and compare the noncooperative and the cooperative solutions, showing that under both scenarios, the heterogeneous countries impose different tax rates despite such competitiveness concerns. This may suggest that, while implementing some kind of mitigation policy is necessary to combat climate change, a universally homogeneous environmental tax may not be either desirable or optimal.