Second Best Environmental Policies under Uncertainty

Abstract

We construct a strategic environmental policy model of an international duopoly. Governments use environmental policies, such as an emissions standard or a tax, to control pollution and for rent shifting purposes. Contrary to firms, however, governments are unable to perfectly foresee the actual level of demand and the cost of abatement. Our results suggest that not only the presence but also the absolute level of uncertainty matters for the optimal choice of the environmental policy instrument. Moreover, the optimality conditions under strategic behavior may lead to welfare losses relative to the cooperative outcomes because of under‐regulation and lack of policy coordination between the two countries.

Carbon tariffs and environmental policy: Taxes versus standards

“…They find these two policies are equally efficient in a closed economy with no uncertainty. Many papers have reexamined the argument of Baumol and Oates (1988) in various extensions, such as the fixed number of firms and free entry into the market (Lahari & Ono, 2007), the degree of privatization in the mixed duopoly model (Naito & Ogawa, 2009), uncertain pollution reduction costs for symmetric oligopolistic firms (Heuson, 2010), differentiated pollution emission standards (Kato, 2011), cross-ownership between duopolistic firms (Bárcena-Ruiz & Campo, 2017;Dong & Chang, 2020), the number of private firms in mixed oligopoly (Bárcena-Ruiz et al, 2019), open economies (Antoniou et al, 2012;Chang & Sellak, 2023;Chiou & Chen, 2022;Ulph, 1992Ulph, , 1996, and interest groups (Lai, 2003). Although these studies provide several important insights, they overlook the impact of carbon tariff policies imposed by importing countries on the welfare of exporting countries that adopt emission taxes or standards.…”

The Impact of Foreign Ownership on the Choice between Emission Taxes and Emission Standards*

“…He further finds under both environmental regulations that full foreign ownership will reduce social welfare. Antoniou et al (2012) consider an international duopoly model in a third country with uncertain demand or cost of abatement and compare the welfare effect of emission taxes and emission standards, indicating that the magnitudes of demand uncertainty and cost of abatement affect the optimal choice of the emission tax and emission standard. Barcena-Ruiz and Campo (2017) analyse how partial cross-ownership impacts the government's choice between emission taxes and emission standards, showing without cross-ownership that emission taxes and emission standards produce the same social welfare.…”