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Bhavyaa Sharma & Vatsala Shreeti

There is no question about a significant human influence on the globally rising temperatures, especially through emission of greenhouse gases, particularly CO2. The consequences are innumerable and ominous, including rising sea levels, severe droughts and floods, increase in precipitation intensity and shifts in the natural balance of species in the ecosystem. In this context, Kyoto Protocol (1997) mandated that industrial countries, by 2008-12, should reduce their overall emissions by 5% from their 1990 levels, with different countries accepting different targets of emission. An important instrument through which many countries aimed to do this was the taxation of energy according to its carbon content, well known as the Carbon Tax. Needless to say, since it addresses the issue of a negative externality, it is a Pigouvian tax which aims to limit or reduce Green House Gases (GHG) emissions and in theory meets the criteria of a good taxation policy by bringing the private costs of emitting CO2 in line with the social costs of global warming and thus, is expected to stimulate energy saving and substantial investment in ‘Green Technology’. Since energy demand increases with incomes, one can expect the tax revenues to have a positive relationship with income.

At present, having realized the precarious condition of the environment, many countries have implemented carbon taxes in response to commitments under the United Nations Framework Convention on Climate Change. On July 1, 2010 India introduced a nationwide carbon tax of Rs. 50 per metric ton of coal both produced and imported into India. In 2012, a Carbon price of $23AUD per ton of emitted CO2 on selected fossil fuels was introduced in Australia and the revenue generated was used to reduce income tax and increase the transfer payments slightly. In Europe, most of the Nordic countries have introduced carbon taxes including Norway, Sweden and Finland. However, none of these countries have a uniform carbon tax regime with various exemptions for different industries. In 1993, the UK government introduced the Fuel Duty Escalator, an environmental tax on retail petroleum products designed specifically to reduce CO2 emissions in the transport sector.

As compared to an energy tax, which is a tax imposed on both fossil fuels and carbon-free energy sources according to their heat contents, carbon taxes do not burden nuclear energy, which could generate large scale electricity without emitting CO2 in that proportion. Since a carbon tax equalizes the marginal cost of CO2 diminution across fuels, a carbon tax proves to be more efficient than an energy tax in order to reduce CO2 emissions since the former effects CO2 emissions through price effect as well as a switch in fuel choice, while the latter hardly provides any incentives for fuel switching, making it more costly to reduce CO2 emissions. Jorgenson & Wilcoxen (1993) suggest that in 2020, the US GNP loss from an energy tax would be 20% greater than that resulting from a carbon tax aimed at reducing CO2 emissions. In order to reflect the rising costs of damages from the CO2 concentration in the atmosphere and signal the markets that CO2 emissions will eventually be heavily taxed, so as to incentivize innovations that make even the most ambitious emission targets seem realistic, the carbon tax rates should rise with time. The tax would impose a deadweight loss on a country with no existing distortions in the energy markets. However, when existing distortions from energy subsidies are considered or the revenues generated from the taxes are used to reduce a distortionary tax, as we saw in the case of some countries, the imposition of a carbon tax may also lead to a net gain.

Economists believe that there is a ‘double dividend’ from carbon taxes:

  1. Environmental dividend – through a reduction in emission of pollutants, not only CO2 but other pollutants associated with fossil fuels combustion.

  2. Economic dividend – through a reduction in the overall economic cost of raising government revenues.

This double dividend is further categorized into ‘weak’ and ‘strong’ double dividends, which are distinguished from each other in the literature. While the former holds that costs may be saved by using carbon taxes revenues to reduce other distortionary taxes as compared to the case where revenues are returned in a lump-sum way, the latter states that the economic dividend is ‘larger than the gross costs’ i.e. a ‘green tax swap’ would be costless since that would lead to a net welfare gain. The ‘strong double dividend’ proposition, however, has not garnered universal acceptance from scholars, because of various reasons. The existence of an economic double dividend depends on two effects of carbon tax:

  1. Tax- interaction effect: Since carbon taxes add to existing set of distortionary taxes, they may further affect overall employment and investment, thus raising the costs of reducing carbon emissions.

  2. Revenue-recycling effect: As shown earlier, carbon taxes may be used to reduce the level of other distortionary taxes, thus producing an economic gain. If the welfare gain from revenue-recycling effect is greater than costs arising from the tax-interaction effect, then there is an economic net benefit i.e., a strong double dividend.

The impact of carbon taxes on the environment has generally been considered to be positive, despite the various problems that hinder an effective estimation of their efficiency. For instance, The Dutch Green Tax commission in the Netherlands calculated that each Euros 450 m raised from its fuel taxes leads to a CO2 reduction of 1-1.5 million tonnes. However, estimating the effectiveness of carbon taxes simultaneously requires the impact of the different components of the carbon control policy package to be separated out, which is extremely difficult. However, since lower-income households spend a larger proportion of their income on energy than higher-income household do, a carbon tax is expected to have a regressive impact on the distribution of income, if the tax is passed on to the consumers in the form of higher prices for final goods and services. Smith (1992) calculated the distributional effects of a mixed carbon and energy tax at $10/barrel in the UK and concluded that the poorest 20% of the population would have to pay 2.4% of their total spending as increases of tax, as compared to the 0.8% & 1.4% for the average household and the top 20% of the population respectively, thus creating the need for adequate analysis and appropriate political attention in this field. A way of mitigating these impacts is to set a tax free allowance for essential use of energy, to incorporate the fact that some amount of energy is necessary to satisfy basic needs, above which the usage would be progressively taxed to incentivize reduction of energy consumption. Another possibility could be to use the revenues generated to reduce the labor taxes, income taxes or improvise the social-security benefits system so as to target those social groups that do not directly benefit from such tax cuts. At the same time, using revenue from a carbon tax to subsidize household investments that reduce CO2 emissions would help diminish households’ cost of adapting to higher energy prices, though this effect would be more visible in the case of higher-income households. A lump-sum redistribution of carbon taxes to the groups in question could be an option, however many scholars believe that this could reduce the scope of efficiency gains that could be achieved by using the tax revenues to reduce the distortionary taxes.

An alternative to carbon taxes, given the fact that some analysts consider them to have a negative impact on the international competitiveness in the economy; one could also see Carbon Emissions Trading as a possible option. Like a carbon tax, emission trading system is also a market-based instrument. Under this arrangement, emitters have access to emission permits which they can trade amongst themselves. In contrast to the tax, where the emissions adjust with the fixed increase in the price of carbon, here the quantity of carbon emitted is fixed, and the price of carbon adjusts accordingly. The latter is believed to be preferable when there is uncertainty about the damage function and there is a possibility that it may be very sensitive to greater than optimal emissions. The allocation can be done through auctions and ‘Grandfathering’ of the permits, which refers to the free allocation of the permits on the basis of some formula related to current emissions. Although, it is sometimes considered to be more efficient than a tax in terms of achieving a target, any relevant policy should combine taxes, permits and other forms of regulation and One affects the basic social consciousness about climate change and global warming.


  1. Dinan, T. (2012),Offsetting a Carbon Tax’s Costs on Low-Income Households, Working Paper No. 16, Working Paper Series, Congressional Budget office, Washington, D.C.

  2. Ekins, P. and Barker, T. (2001), Carbon Taxes and Carbon Emissions Trading, Journal of Economic Surveys, Vol. 15, pp. 325-376.

  3. Zhang, Z. and Baranzini, A. (2004), What do we know about Carbon Taxes? - An inquiry into their impacts on competitiveness and distribution of income, Energy Policy, Vol. 32, pp. 507-518.

Thinking Seeds: Green Economics

Green Trade & Commerce

Manisha Jain

Growing environmental consciousness has generated a parallel interest in liberalization of trade in Environmental Goods and Services(EGS).According to WTO, this has win-win-win objectives: for trade, environment and development. But the realization of these objectives is fraught with many obstacles, especially regarding market access of Developing Countries. Developing Countries are net importers of EGS. Lack of a universally accepted definition of EGS coupled with many other issues has rendered the trade-environment negotiations to proceed at a slow pace.

This article attempts to identify the Environmentally Preferable Products of Export interest to India using trade balance and Balassa’s Revealed Comparative Advantage Index.

First of all, owing largely to the dispersed and diffuse nature of environmental goods and to diverging perceptions of how one defines ‘environment’, environmental goods and services lack a universal definition; which proved to be one of the main barriers to progress in negotiations on liberalization of trade in EGS. However, according to UNCTAD (2003), an Environmental Good (EG) is considered any equipment, material or technology used to address a particular environmental problem or as a product that is itself “environmentally preferable” to other similar products because of its relatively benign impact on the environment.
Two categories of EGs have appeared in the WTO discussions (Sugathan, 2009):

  • TYPE ‘A; EGs -: These are traditional environmental goods required for end-of-the-line pollution abatement. They usually do not have inherently environmental characteristics; it is their ability to provide environmental services that qualifies them as environmental goods. E.g.-air pollution monitoring equipment, furnaces used in incineration.

  • TYPE ‘B’ EGs -: Environmentally preferable products (EPPs), which include any product with certain environmental benefits arising either during the production, use or disposal stage relative to a substitute or ‘like’ product. CFC-free refrigerants, chlorine-free paper, compact Fluorescent light etc.

There is no consensus regarding the definition of environmental services as well. The OECD has come up with seven broad groups of ES organized by environmental media (i.e. air, water, soil, noise) and including a distinct category of services like design, engineering, consulting.
History of Trade Negotiations
The foundation of the trade-environment interface was laid down in the Doha Ministerial Declaration, 2001. But so far, WTO members have not agreed on either a definition of environmental goods or, in the absence of a definition, criteria for or an agreed list of such goods. The majority of the goods introduced for discussions have mostly been limited to Type ‘A’ EGs.

Apart from the definitional and product coverage issues, another stumbling block in the negotiations has been the question of how to liberalize. There have been various approaches discussed so far-list based, project based, request and offer and hybrid approach.

Further, there are some key issues in this regard that need to be addressed:

  • The Dual Use Problem: Type ‘A’ EGs include goods like pumps, valves, tanks and containers, ceramic wares and furnaces used in incineration having both environmental as well as non-environmental uses. It would be natural then that countries will be worried about the import-led impacts of liberalization of dual use goods on domestic industries, trade deficits, employment and tariff revenues; as they may not favor providing differential treatment to the same goods when used for non-environmental purposes.

  • Market access to developing countries: A big challenge for the EGS negotiations is to include products of export interest to developing countries (Sugathan, 2009). According to Sugathan, EGs; being capital-and technology-intensive; are perceived to be of export interest only to developed countries and a few middle-income developing economies. Removal of barriers and non-trade barriers (NTB) by Developing countries would serve as an expansion of markets of developed countries and result in tariff revenue losses for the developing countries, which could have been utilized on social issues like poverty alleviation etc. The potential gains for developing countries are largely on the environmental front. It is this fact that had led to the argument that the developing countries do not have much to gain from these negotiations at least economically.

Therefore, in order to involve active participation by developing countries, it is essential to have a balance in the trade positions of developed and developing nations.

Developing countries are believed to have a comparative advantage in producing EPPs and these can secure them an appropriate, share of export gains. There is, however, the risk that a too broad liberalization of EGs would cripple nascent domestic environmental industries in the developing countries due to competition from imports. In the long term, domestic capacity building and technology transfer is more crucial to capture sustainable development gains than just trade in EGS.
Special and differentiated treatment to developing countries

The other possible avenue to make the trade negotiations compatible with developing countries’ interests is by giving them special and preferential treatment in the form of lower tariff cuts and longer compliance period to reflect the principle of less-than-full reciprocity. In the Indian context, a burning issue is that of the transfer of Environmentally Sound Technologies. Proponents of trade liberalization argue that trade leads to the transfer of valuable skills, technology and know-how embedded in such goods and services in the long run.

However, tariff reductions can prove to be a disincentive for Joint Ventures( JVs), which are the preferred and most effective way for technology transfer, at least in the case of India (Singh,2004). Reasonable import tariffs are often incentives for foreign investors to set up their production base in a country, but with drastic reduction in tariffs, they may prefer to export goods than open up subsidies/JVs.

The Environment Industry

In 2003, the global size of the environmental market was estimated by UNCTAD at US $500 billion, with the developed countries accounting for about 90 percent while in 2008, the estimated value was US $782 billion (Claro,Lucas,et al ;2007).

In 2005, developed countries imported USD252 billion (68.3 percent) of EG and developing countries USD117 billion (31.7 percent).

As far as India is concerned, in order for India to reap the benefits of Liberalization in EGS from a trade perspective, it is imperative to identify its export opportunities.

In this assessment, 2 key criteria are used –

  • The EGS which contribute positively to the trade balance of India

  • The EGS in which India has a comparative advantage ; determined by using Balassa’s Revealed Comparative Advantage Index (RCAI).

Comparative Advantage is a well-established concept in international trade, and it was first illustrated by Ricardo in 1817. According to the basic tenants of comparative advantage, a country should specialize and export items which they can produce at a lower cost vis-à-vis the world.

The Concept of Revealed Comparative Advantage Index:

The study utilizes the Balassa (1965) measure of computing the RCAI. The Balassa RCAI is the most commonly used empirical measure to analyze trade specialization patterns of a country and is used to ‘reveal’ a country’s ‘strong’ sectors by analyzing the actual export flows (Balassa, 1977; Yeats ,1997 ; Richardson &Zhang,1999; Yue ,2001;Serin&Civan, 2008; Batra& Khan,2009).

The assumption is that the pattern of exports reflects relative costs as well as differences in non-price factors. The RCAI of country i for product j is computed as the product's share in the country's exports in relation to its share in world trade:

Where xij and xwj are the values of country i's export of product j and world’s export of product j and Xit and Xwt refer to the country's total export and world’s total export. (Balassa ,1965)

A value of less than 1 implies that the country has a revealed comparative disadvantage in the product. A value of greater than 1 implies that the country has a revealed comparative advantage in the product.

Limitations of the Study:

The Balassa RCAI suffers from a number of potential drawbacks as an analytical tool. It does not explain what gives rise to comparative advantage-resource endowment, technology etc. Secondly, export growth rates for the different product categories have not been calculated.

Thus, environment protection alone is an insufficient basis to define a negotiating strategy and trade and developmental impacts also need to be analyzed. While negotiating at the WTO; two key areas must be kept in mind by any country:

  • Including EGS of export interest

  • Strengthening domestic capacity in EGS and improving access to technology

Trade liberalization of EGS opens risks as well as opportunities which must be weighed before arriving at a negotiating position.

India does not stand to gain much commercially in the short run, at least until EPPs are included. Most of the goods are technology and capital intensive and have dual uses as well. Some other goods in which India is expected to have export interests are: raw cotton materials and cotton textiles, apparel manufactured from natural wool and silk fibers, natural colorings and dyes.
EGs targeted for liberalization must be wide and selective (Hamwey, 2005). A broader category will incorporate goods of export interest of developing countries and will be consistent with Paragraph 16 of Doha Mandate. A selective approach would permit developing countries to exclude from liberalization, those goods which are of export interest and require tariff protection while flexibly liberalizing others in which they have clear import and environmental interests. China’s Common List and Development List approach can be used to achieve this objective. Another practical approach can be an initiative open for voluntary participation coming into effect when a certain number of members, constituting a specified percentage of trade in EGS, agree. Rest of the members can join gradually. This would be similar to the Information Technology Agreement.

India’s Project Approach deserves a special mention as it can bring a synergy between trade and environment goals, and serve developing country’s interests by giving policy space to governments and temporary tariff reductions for only those projects whose end use is indeed environmental.

Transfer of Environmentally Sound Technologies (EST) is important as well, perhaps more than trade in just EGS. Intellectual Property Rights serve as barriers to accessing EST and must be weakened to avert the looming ecological crisis. This will be in concordance with principle 20 of the Stockholm conference and the agreement on TRIPS and public health.

Green Accounting & GDP

Soumya Bhowmick,

Jadavpur University

“Prosperity consists in our ability to flourish as human beings --- within the ecological limits of a finite planet. The challenge for our society is to create the conditions under which this is possible…” says UK Economist Tim Jackson.

Our traditional System of National Accounts (SNA), which gives us the measures of GDP, GNP (performance indicators) does not take into account the value of natural resources that are used in the production processes as well as the impact of all the sectors of the economy on environmental degradation; therefore this system gives us and the policy makers a false impression of the wealth, income and performance of a nation. Hence, green accounting is a much desired system which asks for the incorporation of these missing tenets relating to the environment so as to achieve sustainable development in the economy.

1993 onwards, the UN has developed a framework to incorporate green accounting into traditional SNA and the improvisation process continues. For supporting the development of environmental accounts, the UN, European Commission, International Monetary Fund, OECD, and the World Bank issued a handbook in 2003 referred to as the System of Environmental and Economic Accounts (SEEA-2003). There have been two main approaches to green accounting, the first being a method to create separate or ‘satellite’ accounts that would take care of the valuation of natural resources present, used and depleted, but this account is only linked to and not integrated with the traditional SNA. The latter method talks about completely modifying the traditional SNA and incorporating environmental accounts into it.

In early 1990, The United Nations Statistical Division (UNSD) proposed a new accounting framework referred to as the Integrated System of Environmental and Economic Accounts (IEEA) which integrates environmental accounts into the traditional SNA. The IEEA has led to the conceptualization of green indicators such as the Eco-Domestic Product (EDP) – an environmentally adjusted measure of GDP, instead of traditional performance indicators such as the GDP and GNP which did not have any environmental considerations for an economy. In the long run, the IEEA and green indicators will develop and finally take over the traditional SNA and allow each economy to indulge in an all-inclusive growth that would pave the path for sustainable development and hence secure our future.

Despite the fact the countries such as India face great difficulty in implementing such a concept, as measurement of environmental depletion and valuation of aggregate natural resources is not quite feasible and involves large costs, India’s progress in developing such a framework has been commendable. Better accounting should be characterized by environmental considerations and green accounting is the key towards a green economy. Green accounting if executed properly can give us a totally different story about India’s GDP which was worth 1847.98 billion $ in 2011.


  • Proper segregation of environmental data based on its use in different administrative units and keeping them updated.

  • Accounting dexterity is required to get rid of the problem of double counting in the environmental accounts.

  • Effective primary surveys and authentic company documents should be checked to get accurate values of environmental data.

  • Delegating and segregating work to groups of economists and accountants with target deadlines for better results.

  • Implementation of Government policies so as to promote Green Accounting and its awareness.

  • Strict legal policies for companies so that they inculcate green accounts in their company accounts.

  • Government should fund a pool of research work on Green Accounting that will add to the resources for faster implementation of this technique.

  • Economies should set and work towards target deadlines for full fledged Green Accounting.


  1. United Nations Environment Programme (1997) : Global Environment Outlook – 1, Global State of the Environment Report.

  2. United Nations Environment Programme (2011) : Towards a Green Economy: Pathways to Sustainable Development and Poverty Eradication - A Synthesis for Policy Makers.

  3. United Nations Economic and Social Commission for Asia and the Pacific (2009) Eco-efficiency Indicators : Measuring Resource-use Efficiency and the Impact of Economic Activities on the Environment.

  4. INTOSAI – Working Group on Environmental Auditing (2010) : Environmental Accounting: Current Status and Options for SAIs.

  5. Nick Hanley, Jason Shogren and Ben White : Environmental Economics In Theory and Practice.

  6. Thomas Titenberg : Environmental Economics and Policy.

  7. Maniparna Syamroy (2011) : Accounting For Air and Water Resources: A Case Study of West Bengal.

  8. http://www.unep.org/search.asp?sa.x=0&sa.y=0&sa=go%21&q=GREEN+ACCOUNTING&cx=007059379654755265211%3Ajkngxjgnyii&cof=forid%3A11

Mitigation of Climate Change: A Game Theoretical Approach

Osama Safeer

Lahore University of Management Sciences, Pakistan

As the world progresses in the wake of the most happening century in human civilization, suddenly, the earth seems too small a place to hold too many a people – billions of them, who are, as a whole, economically driven to improve the standard of their lives in the material sense of the word. To establish a fundamental point, climate change caused by global warming is not a temporary phenomenon or a passing phase, part of the natural fluctuations of the earth’s climatic conditions over time. Kaya’s identity directly implies that a more populous country will inevitably be more likely to pollute more and that a more developed country needs to be more efficient in its energy usage as well as technology of production to offset the increasing effect of greater output on green house emissions. As two general representatives of the developed world, the EU and the USA can be seen to have extremely high emissions per capita and relatively speaking, the developing countries can do little to cut down emissions since they are not heavy contributors in the first place. Even historically the increase in greenhouse emissions can be traced to industrial revolution and the countries that enjoyed high growth rates as a result of it, since we have already proven that emissions, and hence global warming, are caused singularly by growth in total economic production in terms of fuel consumption. Therefore, it can be established that developed countries have developed at the expense of climatic change and continue to do so.

Economic theory predicts that market mechanism is unlikely to guarantee a solution in that aspect as managing the environment presents the classic case of market failure in the form of tragedy of the commons. Similarly, the entire planet benefits from the reduction in emissions by any single agent, since climate change mitigation meets the non-excludability and non-rivalry criterion of a public good. Therefore, there is incentive for every agent to free-ride, and wait for the others to take action, as a result of which efforts to reduce global warming will always be underprovided. The source of market failure lies in the absence of political collectivization and alignment of interests under a cooperative framework. The idea of marketable permits inspired by Coasian solution to assign private rights to externality could be applied, but that cannot be achieved globally since there exists no single universal authority. Any settlements between countries are purely voluntary and based on self interest. Together with the political strategic considerations involved, the issue forms a classical case of the prisoner’s dilemma scenario.

The prisoner’s dilemma can be applied to the problem of mitigating climate change. From an individualistic paradigm of analysis where player one is one economically active agent and player two refers to the set of all other economically active agents in a defined system.

Let our lone economic agent P1’s strategies be defined by:


Similarly P2’s strategies are:

The payoffs,,respectively are described as follows:



Cut Emissions

Continue Pollution

Cut Emissions

Improved Environment for everyone; moderate and sustainable levels of development.

P1 loses out on forgone profits, others reap high economic profits as well as sharing the benefits of P1 cutting pollution.

Continue Pollution

P1 reaps commercial success AND free rides on a better environment ensured by reduced emissions of others. Others save the environment but face heavy private opportunity cost.

Everyone disregards environmental considerations, attains private gains but the environment suffers. Not the best outcome, but better for P1 than getting stuck forgoing profits for nothing while the others’ cheating continues environmental hazard.

We see that from an individualistic paradigm, the Nash equilibrium outcome is continued pollution from each member of the set of all economically active agents. Similarly, it would be rational for each government to not make serious efforts to implement laws, create regulations on industry or invest in green technology, since that would come at the cost of forgoing opportunity of economic growth.

However, other forms of political collectivization exist to further economic interests. In the context of mitigation of climate change, a most interesting and widely debated framework is that of collectives of developing vs. developed nation. It is pleaded that developing countries have more to lose by foregoing economic development in favor of environment, compared to the developed since the former has chronic issues such as poverty and poor health facilities to address while the latter has a smaller incremental improvement in its quality of life to forego from emission cuts. The costs of cutting emissions are also higher for the developing countries, since they are far behind on the learning curve of environment friendly technologies. Climate change will hit the developing countries harder.

Developed countries are historically to blame for bringing the sword of climate change so close to everyone’s neck by rampant industrialization. Nash Equilibrium occurs for both players continuing to pollute, since for each strategy of the other block, each block has an incentive to continue polluting. Unless there comes to form a real enough political pressure on the developed countries that can be translated into an economic cost in terms of ‘punishments’ that are imposed by developing countries and the countries currently in transition, economic rationale surrounding the situation will remain the same.

Economic theory predicts that nothing will change unless economic incentives and payoffs do. Encouragingly, there is a growing realization that limits and quotas must also be coupled with punishment (The Economist, 2007). Interestingly, economic theory already suggested this ‘responsive’ approach, where cooperators are collaborated with for mutual benefit, and cheaters are punished. In context of climate change, the game is ‘played’ repeatedly, or even continuously every time there is major decision regarding energy production, or regarding environmental legislation, or every year at conferences on environment. This is called the Iterated Prisoner’s Dilemma (IPD) Case, wherein a country cannot simply cheat-and-run; knowing that managing the environment is an issue over which it has to engage with the rest of the world repeatedly over time – ‘forever and ever’, to be exact. While the dominant strategy for each game in this iterated continuum still remains to cheat, but the fact that the game will be played repeatedly for unknown number of times means that countries will be able to respond to each other’s actions, form strategies over time, have the opportunity to collaborate and cooperate. An alternate outcome than the disastrous continued pollution by everyone is possible, based on the increased weight of future outcomes as the payoffs for strategy (continue pollution, continue pollution) continue to worsen.

Since dramatic climate changes, displacement of billions of people and sinking of metropolitans is no small negative pay off, therefore growingly (cheat, cheat) begins to give the payoff’s of a disaster as well. The payoffs grow so low and the weight attached to the future grows so high that (cheat, cheat) ceases to be an equilibrium and countries, out of their own incentive, will be pushed away from such a strategy. The countries are now set forth in a dynamic game, not happy to be mutually irresponsible but still battling to beat the other, and not yet settling for mutual cooperation. Surprisingly, then, the simplest strategy ‘tit-for-tat’, which simply responds to cooperation with cooperation and punishes deception with defecting itself as well, turns out to be mutually and individually beneficial in the long run. Hence cooperation is evolved in a framework where deception seemed as the only rational option in a non-iterated setting and impending doom breaks away the equilibrium from (cheat, cheat) as there is a simultaneous growth in incentive to cooperate.

Each passing year is like another iteration of the game, with time to get emissions in check consistently running out. Unfortunately for developing countries, to create an analogy with prisoner’s dilemma, they have a bigger stake, are the faint-hearted of the two criminals, and worse, were barely involved in the crime in the first place that landed them in this situation! Both for their own benefit and for that of world at large, it is important to exert substantial political and social pressure – since, with the corporate sector’s interests aligned even more firmly to short run profits, only government regulations and policies can have meaningful impact. Theoretical possibility of a breakthrough exist, where incentive would actually be to begin cooperating and caring for the planet – but whether that would happen before the tipping point when it is too late or not remains the biggest question.


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Environmental Policies- A Problem of Strategic and Coordinated Implementation

Shomak Chakrabarti

Presidency University, Kolkata

Global warming and greenhouse gases are terms familiar to almost everyone living in this century. South Asia is no exception to that. In fact, South Asia has been a major contributor to these problems. The total amount of carbon dioxide emitted by South Asia has almost doubled from 735 million tons in 1990 to 1264 million tons in 2002. This increase can be attributed to increasing energy demands, especially by thermal power plants and the automobile sectors as well as industrial emissions. Industries in South Asia have paid negligible attention to the latter while taking measures against pollution. At the same time, the contribution from individual households, arising particularly from the use of wood, charcoal and kerosene oil as household fuels coupled with inadequate ventilation, has had a detrimental impact on the air quality that surrounds us. The resultant highly contaminated indoor air is often a more severe health hazard than outdoor air pollution. High levels of urban air pollution have attracted growing attention from the government, civil society, and industry in South Asian countries. In India, the Environment Protection Act of 1986 clearly jots down the rules and regulations that are to be followed in order to prevent the pollution of the ecological system. It provides for the Environmental Impact Assessment to ratify a project before its implementation. Similar laws regulate the pollution levels of all the member states of South Asia. However, all these countries have a high pollution level. When one starts tracing the roots of this paradox, we see most of the aforementioned environmental legislations having analogous geographic restrictions. This myopic behaviour on the part of the countries’ policy makers have often led to the age of the economic problem of “the tragedy of commons”. Natural resources like air and water cannot be confined to a particular country and with the current policy framework; each country would try to benefit from the hard work of the other countries without paying for it, thereby leading to the tragedy of commons.
This article thus shows that a grand coalition of the entire member states working together to solve the problem of air pollution or any form of air pollution will lead to a socially desirable equilibrium.
Gkk<0, gpp <0, gkkgpp-gpkgkp>0

The model builds a skeleton of an international economy, denoted by E. The total number of agents in the economy is given by i. The agents are partitioned into the K countries, with ik denoting the number of agents living in country k. Thus, it follows that ∑ik=I. Each country k produces some amount of private goods, yk= gk (pk,k) using the inputs capital (kk) and a pollution emitting input (pk). The accumulation of capital is given by the standard equation kk= (1-µ)k0 + ek ; where ek is the investment in each country, k0 is the initial stock of capital which is given for

From the National Income Identity C=Y-I, Consumption in country k would be given by xk= gk(pk,kk) – ek. The countries in the economy E would therefore have a social preference ordering described by the utility function ui=v(z).(gk(pk,kk) – ek), where

z = -(1-ᵠ)z0-∑pk

denotes the overall ambient pollution level in the economy, z0 being the initial pollution stock and ᵠ being the natural rate of degradation of the pollutants. v(z) denotes the valuation of the environmental quality by the agents in the economy E. We maintain the standard assumptions of a neoclassical type utility function.

A feasible set in the international economy is a vector (x,p,z) ϵ RxRkxR such that

k(gk (pk,kk) – ek) ≥ ∑xi and

z = -(1-ᵠ)z0-∑pk.
A feasible set basically implies that the supply of private goods must not be less than the demand for the private good by the agents in the international economy and that the ecological damage function incorporates the pollutants emitted from all the countries that make up the international economy.
A Pareto optimum of the international economy E is a feasible state (x,p,z) such that there exists no other feasible state (x*,p*,z *) for which agents attain a higher utility.
Mathematically, the Pareto optimum feasible state of the economy can be solved by maximizing the joint utility function of all the agents in the countries that make up .
We proceed to describe the building blocks of the international economy E– the individual countries. These countries can be considered to be a sub-economy of E, formally denoted by, Ek(p-k) , and are obtained by restricting the set of agents to and for a given vector of polluting inputs other than the country k itself, i.e.,-k = (p1,p2,…pk-1,pk+1,…pk) . It is natural to believe that, by itself, India will have no control over the amount of pollutants released into the environment by Bangladesh or Pakistan. In what follows, we will use the term individual country k and sub-economy Ek (p”-k) interchangeably.

A feasible state in the country k, is a vector (x,p,z) such that,

(gk (pk,kk) – ek) ≥ ∑ixi where iϵ ik

p-k = pk = (p1,p2,…..pk) i.e. pollution levels of other countries are given and,

z = -(1-ᵠ)z0 - ∑jpj – pk for j≠ k and jϵI.
The feasible state of a country is again simply the fact that the supply of the private good in the country is never less than the demand of the private good by agents living in country k .
Now we proceed to find the Pareto optimal solutions to both these cases. For the international economy, the Pareto optimal solution is obtained by maximizing the joint utility of all the individuals that live in all the countries that comprise the international economy. Mathematically, it can be shown as follows:
ii[v(z)(gk(pk,kk)- ek)] where i subject to z = -(1-ᵠ)z0 - ∑pk
& kk = (1-µ)k0 + ek.
Solving the first order conditions, we get the Pareto optimal levels of investment and pollution emitting input,


It is quite easy to show that the Pareto optimal allocation of the international economy E (x0, p0, z0) exists and is unique.

As for the domestic economy or the sub-economy, the Pareto optimal solution is obtained by maximizing the joint utility of all the agents living in that country. It is formally shown as below:

Max ∑iui = ∑i[v(z)(gk(pk,kk) – ek)] where 
Subject to z = -(1-φ)z0 - ∑jpj – pk for j≠ k and jϵ ik & .kk = (1-µ)k0 + ek .
Solving the first order conditions, we get,

 =  (.)

Analogous to the case of the international economy E, we can conclude that the optimal solution to the maximization problem for the sub-economy exists and is unique due to the neoclassical assumptions.

The feasible state of the sub economy Ek  induced by the Pareto efficient allocation (x*,y*,z*) is called the political equilibrium of the sub economy.

Once the political equilibrium for the sub-economies are determined given the vector of external emissions, we can indeed find the state of the international economy E that can occur in the absence of any form of international co-ordination. An international noncooperation equilibrium is defined as a state of the economy (z,p,x), such that for all k in the state, (x*,y*,z*) is a political equilibrium of the sub-economy EK(p’’-k) .
In this case, each country acts as benevolent social utility maximizers and maximizes the utility of the agents living in their respective countries. This can be explained in the form of a non-cooperative game with the countries acting as players in the game. The strategy of country k is a vector Tk = {(pi,xi) 0≤pi≤p* , 0≤xi≤x*} , for iϵik. Thus T = ΠkTk denotes the joint strategy space of the entire k-person game. The payoffs of the players can be the joint utilities of all the agents living in that country. Hence, the payoffs of each country k is given uk = ∑iui for iϵik and for all kϵK, U = Πkuk denotes the joint payoff space of the game. This completes the structure of the k-person non-cooperative game defined in its characteristic form by [k, T, U].
For this game [k, T, U], the joint strategy choice [(x1,p1), (x2, p2)……. (xi, pi)] for iϵik, is a Nash equilibrium for country k (or sub-economy Ek(p”-k)) if it maximizes the joint utility function of all the agents living in country k. The optimization problem can then be written as,
Max ∑iui = ∑i[v(z)(gk(pk,kk) – ek)] where  for each kϵK

Subject to z = -(1-φ)z0 – for j≠k and jϵik

and kk = (1-µ)k0 + ek
It is worth noting that the above equations are identical to the solution of the Pareto optimal allocations of country k. So the solution to this problem is identical to the Pareto optimal problem done before. Therefore the solution is:

 =  (.)

We can conclude by saying that the k-person non-cooperative game produces a Nash equilibrium where each country’s strategy is to produce their Pareto optimal allocation, given the vector of emissions from the other countries. Although one might tend to conclude that this Nash equilibrium is a socially desirable equilibrium, we see that this Nash equilibrium is not compatible with the Pareto optimal equilibrium of the international economy E. Comparing the two cases, we can say that the net investment on capital goods is indeed the same in both the cases and thus the Nash equilibrium gives us an international political equilibrium for capital goods. But the same cannot be said about the pollutant emitting input. We first note that . Hence from the well-known theory of diminishing marginal returns to inputs, we can say that the Nash equilibrium pollutant emitting input allocation is larger than the Pareto optimal level in the international economy E as a whole . Formally, this can be written as,

We can coin this apparently peculiar anomaly as the Pinocchio Paradox. This is a paradox that the famous character from English Literature called Pinocchio falls into. In terms of our paper, suppose the Environment Board announces that the pollution emitting level is more than the Pareto optimum level. The government, benevolent to its citizens, brings the allocation to its own Pareto optimum level. But because the government is not seeking to bring the allocation to the international Pareto level, the polluting input level is still higher than socially desirable. Hence a paradox – the government claims it has reached Pareto, yet the polluting input level is above Pareto optimal!
The inefficiency of the non-cooperative equilibrium gives us some incentive to look into the matter of international cooperation in the form of international agreements to improve the allocation of polluting inputs in the international economy E. The basic aim of an international agreement, through a co-operative pan and contracts binding to the nations that agree to them, is to try and achieve the Pareto optimal allocation level of the international economy and share the costs involved in such a change in allocation between the countries involved. Formally, an international agreement among the countries K or a subset of it is a pair  consisting of a vector of emission changes  with respect to international non-cooperation levels such that , and a total cost sharing rule ) such that 
In terms of foregone consumption, the total cost of allocation change is given by :

The induced environment quality after the International Agreement will thus be

Thus, the utility of each country k in the international economy E becomes

For an international agreement to come into existence, the countries must be involved in some collective decision making process. This can be done at two separate levels – the domestic level and the international level. In short, each country ratifies a particular international agreement by means of simple majority voting. In the simple majority voting games, there would be a winning coalition that which declares a particular vector of abatements and a cost sharing rule α which is its Nash Equilibrium. For any international agreement involving all countries, the co-operative game  is the ratification voting game bearing on the cost share  to country k. with k denoting the number of countries in the international economy E.  simply denotes all the subsets that contain the majority of the countries forming the international economy.
The optimal value of the cost sharing rule given by the maximization of the game will be given by,

This basically leads us to the conclusion that the international agreement ratified by the countries depends on the consumption pattern of the private good in each country. A country with more consumption of the private good requires a larger amount of pollution emitting inputs and consequently has to bear a larger cost to bear the damage to the environment. For at least one country, the cost of abating the pollution emitting input to the international Pareto optimal level must be positive. Thus there exists a country k (or sub-economy for which

For that country, the consumption of private good is obviously lower. Hence higher utility is reached at the Pareto optimal level only through improvement in environmental quality, i.e., through the function  .

With the knowledge of the international agreement ratified by the countries given to us, we proceed to see which winning coalition will ultimately be formed in the international economy. This leads us to the coalition formation game with the countries as players. The countries act simultaneously and announce a coalition to which they wish to belong. Any defection from a coalition induces the remaining players to split up as singletons. In the context of this coalition formation game, we may restrict our strategy choice to only those that will be ratified by the individual countries. Any other international agreement will not be ratified by the individual countries and thereby will not lead to a political equilibrium in the respective country. Once a coalition is announced, ratified agreements are automatically generated by the majority voting game in each country. As a result, we associate with each coalition structure a series of international agreements with the property of being simultaneously ratified by the respective countries. For each coalition structure, there exists a unique ratified international agreement.
The strategy profile for which all the countries declare the grand coalition is a Nash equilibrium of the coalition formation game. Any country acting as a singleton would definitely be closer to the Pareto optimum of the international economy if it decides to become a member of the coalition. Similarly, there would be no incentive for a country within the coalition to deviate from it. Hence the grand coalition would ultimately lead to the Pareto efficient outcome of the international economy. the solution to the optimization problem of the coalition formation game would then be a replica of the Pareto optimum optimization problem for the international economy. Thus the cooperative game and the coalition formation game will ultimately lead to a political equilibrium in each country as well as a political equilibrium in the international economy.
The cost sharing ratio for the countries in the international economy would depend on the consumption pattern of private goods in the respective countries. While it is possible to transfer some amount of private good, a better way to bring about the sharing of costs is to issue pollution permits in proportion to the costs borne by each country. This would bring us to the topic of markets for pollution permits. It is worthwhile noting that implementing the Gale-Shapley algorithm of deferred acceptance would ultimately lead to efficient solutions. Following this algorithm, when polluting countries offer the non-polluting countries to buy pollution permits from them, through a proper mechanism design, none of the polluting countries will have to go for their least preferred choice, leading to optimal strategies in the market for pollution permits.
Although some countries may refrain from revealing their true preferences, but Shapley has shown that there will exist a revelation principle in which showing the true preferences will be the optimal Bayesian strategy for every country.
Pollution regulation acts have been implemented in almost every country in the world and the list of pro-environment innovations is never-ending. However, we have been myopic in our behaviour. While we may be striving for Pareto optimal allocations within our country so as to maximize our own social welfare, we duly forget that we are part of a single planet called the Earth. The Pareto optimal allocation of many countries taken together will not coincide with the Pareto optimal allocation within individual countries. In the absence of international co-operation, the pollution levels in the economy will not be Pareto optimal for the international economy, even though each country individually attains Pareto efficiency. International cooperation in the form of a grand coalition of all the countries will induce the countries to produce at the Pareto efficient levels of the international economy. The international agreement reached by the countries in the coalition will be ratified by each individual country through majority voting, thereby leading to a political equilibrium in each country. The cost of abating pollution can also be efficiently shared through proper design mechanisms. What the countries need to pay attention to now is the development of appropriate mechanisms to ensure Pareto optimality.
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2. “Stable international agreements on transfrontier pollution with ratification constraints”, S.Currarini, H.Tulkens

3. “Game theory and International Environmental Cooperation”, M. Finus, New Horizons in Environmental Economics.

4. “Microeconomic Theory”, A.Mascolell, M.D.Whinston, J.R.Green, Oxford University Press

5. “An introduction to Game theory”, M.J.Osbourne, Oxford University Press

6. “Economic Growth”, R.Barro, X.Sala-i-Martin, McGraw- Hill,Inc.

7. “ClimateChangeandGameTheory: A MathematicalSurvey”,P.J.Wood

8. “South Asian Environment Outlook (2009)”, UNEP, SAARC

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10. “The Environment (Protection) Act 1986”, India.

11. “Environment Protection Act 1997”, Nepal.

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