International Environmental Problems, Issue Linkage and the European Union

Tilburg University

International Environmental Problems, Issue Linkage and the European Union

Kroeze-Gil, J.

Publication date:

2003

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Citation for published version (APA):

Kroeze-Gil, J. (2003). International Environmental Problems, Issue Linkage and the European Union. CentER,

Center for Economic Research.

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.*.

TILBURG *1 * UNIVERSITY

-1 ...

UNIVERS ITEIT * * VAN TILBURG

_S*.

-BIBLIOT MEEK

TILBURG

International

Environmental

_Problems,

Issue

_Linkage

International

Environmental

_Problems,

Issue

_Linkage

and

the European Union

Proefschrift

ter verkrijging van de_{graad van} doctor aan de

Univer-siteit van _{Tilburg, op gezag van} de rector magnificus,

prof. dr. F. A. van der DuynSchouten, in het openbaar te verdedigen ten overstaan van een door het college

voor promoties aangewezencomInissie in de aula van de

Universiteit _{op vrijdag} 28 november 2003 om 10.15 uur

door

Jardena Kroeze-Gil

Acknowledgements

What started asa_{project for}four_{years, endeduptaking} 10_{years. As I considered this}

difference, I came up with the following formula to explain why these 10_years

in

effect

equal

₄

_years:

10 - 4 · 'baby'- 'school

holidays' = 41

1. (22 +3.i l+2 1· +2. 1) 4

Theformulareveals many 'time-stretching' causes ofthisextensive period.

_{First of all, I}

gave birth to my four children. Secondly, I have been at home with my childrenduring their school holidays. Finally, the formula reveals that I have worked part-time. All

thesespecial circumstances have beenmadepossible bytheNetherlands Organization for Scientific Research (NWO), who sponsored the project and always granted mywishes.

Also_{mysupervisor Henk Folmer}deserves_{mygratitude at this point. Henk respected my} wishes, continued to support me and maintained his confidence ina successfulresult.

One important aspect ofmy project is not contained in the formula: the dramatic conclusion in the formofmeningitis. I ceased my attempts to includethis illness in the formulainorderto prevent furtherheadaches...

Whattheformulacannotexpress ismygratitude to thepeople around me. I owe many

thanks tomybrother Thomer for allthe pictures inthisthesis. We usedallpossiblemeans

ofcommunication between the United States and_{Tilburg, to} achieve thefinal result. I thankJossi,Nira, Jonni and Gigifor_{their listeningears, their support andfor being there} when I desperately needed them. I thank my Omi and Opi,for their wiseand progressive

idea, that 'a woman should be ableto_{support herself'. Unfortunately, Opi did not live}

to seethe completion of thisthesis. I owe many thanks toEline vanderHeijden, for her 'tipsandtricks'

to

finalizethis_{thesis, for}her_{invaluable advice and for our many pleasant}

conversations. _{The involvement and friendship}ofEline and her_{family areveryimportant}

to Ine.

I

further thank Aartde_{Zeeuw, for his good advice; Pham Do Kim Hang,}for_{being one}

step ahead ofme; Jeanne Bovenberg, for correcting my English; Corina, Jolanda, Marja

and Nicole, for theirsupport; Yvonne and Huub, for their continuousinterest and help; Barbara Baarsma, for her motivatingwords; Nathalie, Deborah and Marcel.

Viii _{Acknowledgement}

Tamar. Words cannot_expressmygratitude to John, for hisconstantsupport,

encourage-ment, help, patience andlove. Without John I would not havecome_{this far. My}children

were not even born when I started this project. Their births, their existence and their

unconditional love have made me a better and more_{balanced person,} which isreflected

in thisthesis.

Contents

Acknowledgements

Vii

1 Objectives and

Outline 1

1.1 Objectives . . . 5

1.2 O u t l i n e. . . 7

2

International

Environmental Problems and Multilateral Environmental

Agreements 9

2.1 Characteristics

of

International Environmental

Problems...

2.2 Properties ofaMultilateral Environmental_{Agreement . . . 12}

2.3 Approaches, Obstacles and Instrumentsfor

Solving IEPs . . . 16

2.3.1 _{Market, Non-Cooperative and Cooperative}

_{Approach . . . 16}

2.3.2 Reasonsto _Cooperate

. . . .1 8

2.3.3 The Full _Cooperative

_{Approach . . . .}

19

2.3.4 Instruments toOvercome

Obstacles . . . 20

2.4 Issue

Linkage . . . .2 3

2.4.1 ReasonsforIssue

_{Linkage . . . 23}

2.4.2 DrawbackstoIssue

_{Linkage . . . 24}

2.4.3 Applicability

of

IssueLinkage . . . . . . .2 5 2.5 _Existing

Multilateral

Environmental

_{Agreements . . . 26}

2.5.1 Global MEAs . . . 27

2.5.2 MEAs onaSmaller Scale and on Common

Resources . . . 31

2.5.3 An MEA in

the European

Union . . . 35

2.5.4 Summary

. . . .

.3 6

2.6 Conclusions . . . .3 7

3 A Synopsis of Environmental Policy in the European Union 39

3.1 Institutionsand

Decisions . . . 42

x Contents

3.1.2 Decision

_{Making in the EU . . . 45}

3.1.3 Types

of

Decisions . . . .... . . , ,

. . . .5 0

3.2 Principlesof Environmental Policy . . . . . . . . . . . , . . . .5 2 3.3 A History of Environmental

Policy . . . 53

3.4 The

Fifth

Environmental Action Programme . . .

... 56

3.5 Progress of the 5th EAP

... 59

3.5.1 General conclusions . .

...60

3.5.2 Progress per Target

Group . . . 61

3.6 Revision of the 5thEAP

. . . .6 3

3.7 Global Assessment of the 5th EAP . . . .

· · · . .6 4

3.8 The SixthEnvironmental

Action

Programme . . .

. 66

3.8.1 Four

_Priority

Areas

. . . , , , . . . .6 6

3.8.2 Approachesto policy

making . . . 69

3.8.3 The European Union in thewider

world . . . 70

3.8.4 Progress of the decision-making process on the 6th EAP . . . . . . 71

3.9 Conclusions . . . .7 2

4 A Review

of

Issue Linkage 75

4.1 ReasonsforLinkage. . . .

.7 6

4.2 Methodologies and Results

. . . .

. . . .7 7

4.2.1 _{The Edgeworth Box}

. . . , , . . , . . . .7 8

4.2.2 Atwo-dimensional coordinate system .

, . . . .8 1

4.2.3 Linkage of twounilateral issues . . . .. . . .. 82

4.2.4 Two PlayersLinking

M

Prisoners' Dilemma Games ina_Dynamic

_Setting...

. . . . .9 1 4.2.5 Two PlayersLinking TwoPD Games in aDynamic

Setting . . . 96

4.2.6 NPlayers Linking

M

Issues ina Static

Setting . . . 104

4.2.7 N PlayersLinking

M

Issues in aDynamic

Setting . . . 105

4.2.8 A Multi-Stage

Sanctioning Game . . . 107

4.2.9 Linking a Club Good toaPublic Good inaMulti-Stage Game . . . 110

4.3 Results from Simulationand

Experiments . . . 113

4.3.1 Linkage of RkDandEnvironmental Cooperation:

A

Simulation . . 114

4.3.2 InstitutionalDesign: anExperiment . . . 116

4.4 Arguments Against Issue

Linkage . . . 121

Contents xi

5 Interconnection of Cooperative

Games 127

5.1 Introduction . . . . .

. 127

5.2 Games inCharacteristic

Function Form . . . 128

5.3 InterconnectedGamesin Characteristic

Function Form . . . 133

5.4 Conclusions . . . 139

6

Modelling Imperfect Reversibility with Modified Permutation Games 141

6.1 Introduction

. . . 141

6.2 _Analytical

Framework . . . .1 5 5

6.2.1 _{General Theory}

. . . .

. 155

6.2.2 Modified Permutation

Games . . . 164

6.3 Results forthe

Interconnected Game . . . 165

6.3.1 ProcedureforDetermination oftheParameters ...165

6.3.2 Analysis . . . .

. 167

6.4 Modified

Mirror

Game versus Exact

Mirror Game . . . 170

6.5 Examples . . . 174

6.5.1 3 Games and4

_{Players . . . 174}

6.5.2 5 Games and3Players

. . . .

. 177

6.6 Summary and

Conclusions . . . 181

7 Summary and Conclusions 183 7.1 SummaryofChapters 2 t o 6. . . 183

7.2 The

_{Applicability}

ofIssue_{Linkage and the European Union . . . 190}

7.3 Future

R e s e a r c h. . . .

.

. . 192

A Proofs of Chapter

6 193 A.1 Proofs of

Section 6.2 . . . 193

A.2 Proofsof

Section 6.3 . . . 199

A.3 Proofs of

Section 6.4 . . . 203

Bibliography

205

Chapter 1

Objectives and Outline

Stockholm, Washington, Montmal, Base4 Rio deJaneiro, Kyoto.

What do these cities have in common?

First of all, they are

all large cities across the world, close_{to water (river, lake or ocean), with more than170,000inhabitants (actually}

Rio is the largest of them with more than 10 _{million inhabitants). All cities have an}

international airport and aurban

rail

_{system (such}as _{metro or tram). In all} cities one

can study at a _{university and one can go to an art} museum _{or enjoy} a classical music

concert. Even more

striking, in

all cities there has been an

ATPl

Tennis event and the

rock-band

_AC/DC

has _{performed a live show.}

But secondly and moreappropriate for this thesis, in all ofthesecities amultilateral

environmental _{agreement (MEA) has been signed} on_{international environmental}

prob-lems (IEPs)2. The participants in theseagreements areall independentcountries. What

do they then haveincommon? _Theysharetheirconcern overthe environment-_nationally

and internationally.

Despite existing treaties and despitethegeneral concern over the_{environment, it has}

proved to be difficult to

initiate

andagree on international environmental

policy. Two

important reasons for the difliculties in international environmental policy making are

(see, among others, Hunter et al. (2001) and _{Morand-Francis (1998)): 1)} the absence

of an international

institution that

can enforce environmental_{policy; and 2) the lack of}

internationally bindingenvironmental principles.

1 ATP stands for AssociationofTennis Profesionals.

2Stockholm, 1972: Declamtion ofthe _{United Nations Conference on}theHuman Environment;

2 1. Objectives and Outline

International institutions

No globalinternational institution exists that canenforceenvironmental _{policy. The}

United Nations _{Environment Programme} (UNEP), created in 1972, isconsidered to be theprimaryenvironmentalagency. Its missionis _(citedfrom United_{Nations (1979))}

to facilitate international coopemtion in the environmental jield; to keep the world environmental situation under review so that probtenz of international

signijicance mceiveappropriate considemtionbygovernments; andtopmmote

the acquisition, assessment andexchange of environmental knowledge.

The UNEP, however, has no powerto enforceinternational environmentalpolicy. In

ad-dition to

UNEP, governments created the UN Commission on Sustainable Development (CSD) in 1992 to coordinateandintegrate environmental and economicissueswithin the

United Nations. Unfortunately, also the CSD's role is limited to providing a political

forum for discussion, without any operational mandate or

authority

The result is that international environmental policyis

still

spreadacross a collectionoftreaties, each

ad-dressing aglobal environmental issue. The _{governance of}the treaties is spread across

many different _{international institutions,}

with

diffuse, weak and sometimes conflicting authorities'3. Somehave argued _{(Runge (2001), among others) that a}new Global

Envi-ronment Organization (GEO) should beestablished

to

tacklethis distribution. The main

reasons for a new GEO are:

• the inappropriateness of theexisting institutions asacenterfortransnational envi-ronmental expertiseand_activity;

• the increasing and widespread number of environmental issues, which cannot be

adequatelymanagedthrough existingagencies oruncoordinated MEAs; and • the necessity of separate

institutional

authority for environmental problems, less

subjective

to

interests andinfluence ofspecific countries.

Themain tasks of such a new GEO would be:

• to coordinate environmentalefforts and MEAs by providingatransparent source of

information on_{global environmental}issues;

3Such astheUnitedNationsEnvironmentProgramme (UNEP), the Commission on Sustainable De-velopment (CSD), theOrganization oftheUnited Nations for FoodandAgriculture (FAO), the Global Environment _{Facility (GEF),} the General Agreement on Tariffs and Trade/ World 'Ikade

Introduction 3

• to specifya_{dispute settlementprocess,}in_{which non-governmental and} governmen-tal organizationsand_{other interested parties could}

participate;

• to support developingcountries intheformulationoftrade, development and envi-ronmental_{initiatives; and}

• to establish environmental policies, instead

of

usingtrade policies, forexample, to

protect theenvironment.

Environmental principles

The last task for a newGEO_directlyrelates tothesecond_difficulty

in

environmental

policymaking: there existno _{internationally bindingenvironmental principlesthatguide}

policymaking

with

regardto internationalenvironmental_protection. Reasonsfor_setting

such_{bindingenvironmental principles are(from Hunter et al. (2001)):}

• to achieve a more balanced integration ofenvironmental protection and other eco-nomic goa]slike_trade;

• tomakeenvironmental policy_{more effective;}

• to establish minimum _{environmental standards; the Polluter} Pays Principle, for

example,ensures

that

polluters are held responsibleforenvironmental damage they

cause; and

• to provideasubstantivebasis_{for coordinating}theactivities

in

environmental_policy between the many existinginternational institutions,especially between a new GEO andinternational institutionsconcerned

with

otherissues, such asthe

_GATT/WTO

andthe _{World Health Organization (WHO).}

Althoughthere are_{important difficulties in international policy makingon}

environmen-tal

issues,already more than400multilateralagreements exist4. _{However, the}difficulties

concerning theabsence of an_{international institution and the lack}

of

_{internationally}

bind-ingenvironmental principles are

still

reflected inthe_{existingagreements.} Enforcement of environmental policyis _{rarelyagreed upon; and even if}

it

would be included in a_treaty

or protocol, the rules and principlesneededtoenforcethe agreement are notbinding, but

on a_voluntarybasis.

4 1. Objectivesand Outline

Issue linkage

The existing literaturehas proposed issuelinkage as a tooltoovercometheobstacles

to solve IEPs. Issue linkage uses the fact that countries aze mostly involved in several

issuesof_{negotiation simultaneously,} whichcreates possibilitiesforcountriestoexchange concessions orto threaten_{non cooperating countries. For instance, in}a_{two-country case,}

a country that suffers fromtransboundary pollution may beanimportanttradepartner of

thepollutingcountry. The suffering country canlink trade tothepollutionproblem in two ways: 1) itcanoffertradeconcessions tothe polluting country inexchangefor cooperation on the pollution

problem; and 2) it

can threaten to impose trade restrictions on the polluting country, if the pollutingcountryrefusesto cooperate on thepollutionproblem.

Linking an IEP to anotherproblem (or in fact toseveralotherproblems) and negotiating

on_{the problems together, mayyield}asolutiontoseveral_{problems simultaneously,}whereas

the problems separatelycould notbesolved.

An example is the linkage by Germany, the United Kingdom, the Netherlands and

Sweden_(theso-called_{group offour)}betweenthe Common_{Agricultural Policy (CAP) and} the enlargement ofthe_{European Union (EU). The}group of four madetheenlargement of

the EU dependent uponthe reform of the CAP, thereby establishing the linkagebetween two independent issues _(seefurtherdetails

in

chapter 3).

Recent _examples ofissue linkage that emphasize interdependency between countries include the linkage between the War on Terror and freetrade _agreements between the

United States and arabic countries, such as _{Jordan, Morocco and} Egypt _(see Business

Today Egypt (2002) andWhite House Office ofthe Press Secretary (2002)); the linkage

between_improvementinChina's record

in

humanrights andtheUnitedStates' extension

ofChina'sstatus of "most favored _{nation" (see Lacy and Niou (2000)); and}the Russian

indefinitepostponement ofitsratification oftheUnitedStates-Russian StrategicOffensive

Reductions Tteaty on the reduction of_{nuclear arms,} inresponse to the United States'

final ultimatum to Iraq.

Duetoincreasedinterdependency among countries, the possibilities ofapplyingissue

linkage haveincreased. This is the case, forinstance, in the EuropeanUnion and for the Asia-Pacific Economic Cooperation.

This thesis uses game theory to formalize issue _linkage. Game theory deals with the

strategic interaction and interdependencies betweendecisionmakers. Thesedecision ma-kers have to make choices. _{The complete set} ofstrategies determine the outcome. The decisionmakers have some_{knowledge on the available strategies of}theothers and of each decisionmakers' _{preferences on the outcomes.}

Traditional_gametheoreticanalysis isrestricted toone issue. The strategies determine

1.1 Objectives ₅

of

the traditional model,

within the

game theoretic setting. In this expansion 1 follow

the usual _{division of traditional game theory into cooperative game theory and} non-cooperativegametheory.

Coopemtive game theory

In cooperativegametheory itis assumedthat _{players can makebindingagreements,}

thereby forming coalitions. These _coalitions, their stability, and the

total

net benefits coalitions canachievefor_{themselves, is the}focus

of

cooperativegametheory.

A cooperativegame describesthepossible setsof actions thateachcoalition can take.

An outcome ofa cooperative game is aspecification ofthe coalition thatis formed and

the

joint

action

it

takes.

Non-coopemtive game theory

Non-cooperativegametheoryisconcerned withthe individual _{player, who maximizes} a net benefit

function. This

net benefit _{function depends on the} net benefit

maximiz-ing behavior ofthe other players. Non-cooperativegame theory focuses on the_analysis of _{different strategies} available to the _{players, alwaystaking into} account the_strategic (re)action oftheotherplayers.

In this thesis I analyzeissue _{linkage in both} a_{cooperative setting (in chapter 5) and a}

non-cooperativesetting (inchapter 6).

The followingsection formulates the objectives ofthisthesis. I conclude_{this chapter with}

an outline ofthethesis.

1.1 Objectives

Achieving cooperation on IEPs is

still

a_{major problem, both}

in

_{practice and intheory.}

Issue linkage isan interesting approach to stimulatecooperation. Issue linkage requires

situations

of

mutual _{interdependency}

with

_respect toseveral different issues. Such situ-ations occur frequentlyin_{systems like the EU,} which unites a_{plurality ofindependent}

countriesinnumerous _{areas, such} as_{legislation, trade and}theenvironment.

In

the existing economic _{literature on IEPs,} game theoretic models have been used extensively because theycan addressboth mutual_{interdependencies and the}institutional setting. From this literature, the work done in Folmer et al. (1993) and inCesar and de

Zeeuw (1996) forms thebasis onwhich the research forthisthesis builds.

Folmer et al. ₍₁₉₉₃₎ introduce the_concept ofinterconnection, modellingissuelinkage

in a

_{non-cooperative game-theoretic setting. Specifically, they formalize the concept of}

6 1. Objectives and Outline

each_{constitutingisolated game is} a_{repeatedgame,}resulting in aso-called tensor game. The Nash equilibrium was used

to

_{compare results for interconnectedgames}

with

results of

their constitutingisolatedgames. Theirmainresults are: 1) for each Nashequilibrium of the direct sumgamethere exist corresponding Nashequilibria oftheconstitutingisolated games andviceversa; and 2) the set of Nashequilibria ofthe tensor gameis_{larger than}

and completely contains the set ofNash _{equilibria of} the _constituting isolated games.

The lastresult has led tothe theme 'interconnectionmay sustain more cooperation' for

tensor games. Several issues remained open for further research. This thesis addresses

some ofthese issues, such as interconnection of cooperative games; investigation of an

applicable solution concept for thenewly formulated interconnected game; andaddition of refinements (suchaspower_{asymmetry between countries).}

Cesar and de Zeeuw (1996) also model issue linkage in a _{non-cooperative setting.}

Specifically, issue linkage between two

bi-matrix

games was considered for two types of offsetting asymmetricgames: asymmetric prisoners' dilemma games and suasiongames.

The full _{cooperative outcome was used as the} solution concept. Their main result is:

linkage oftwomirror image asymmetric games makes

it

possible

to

sustain the full co-operativeoutcome as a subgameperfectrenegotiation-proof equilibrium. However, it was stressed thattheassumption that the two issues areexact mirror images isquitestrong.

A topic for furtherresearchwould therefore be to delineate more precisely, inthespace of

bi-matrix

games,whichgames can belinked inorder to make the

full

cooperative outcome

sustainable. This willbeaddressed inthis thesis.

Summarizing the_above, theobjective of

this

thesis is toanswer the followingquestion:

How caninternational environmental problems be solved with use of issue linkage, and is this applicable in the European Union f

To provide ananswer tothis_{question and}in

_{light of}

_{my personal preference} toconduct

theoreticalanalysis, I formulated threemainobjectives forthisthesis:

• Development ofthe theory of intemonnection in a cooperative game theoretical set-ting. This comprises the definition of interconnection of

M

issues for

N

players,

the formulation ofa solution concept for the interconnected cooperative game, as well as the comparison between

the

outcome ofthe interconnected game and the outcomes of theconstituting isolatedgames.

• Expansion of the theory

_of

intemonnection in a non-cooperative setting. This

coIn-prisesthe analysis of the parameters of

M

imperfectlyreversed_{strategicgames with}

1.2 Outline 7

game is aPareto improvement of the

strictly

dominantNash equilibrium5.

• Examination of the applicability

_of

issue linkage in the conte:Et

_of

environmentat

problems within the EU. The focus lies on _{transboundary pollution problems, as} well ason_{other problems}that_{require common decision making}within the EU.

1.2 Outline

In light of

the previously stated objectives, this thesis isorganized into seven chapters.

Chapters 2 and 3 provide the context for the application ofissue linkage. Chapter 4

reviews the literatureon issue linkage and placesthe thesis in a broader

context. It is

mainly intended to assess the theoretical base of issue linkage, on which the

theory in

this thesis builds.

In

chapters 5 and 6 I provide the theoretical part on issue linkage. Chapter7summarizes_{the previous chapters and concludes}thisthesis.

Chapter 2 _{provides insight into} thenature of_{IEPs, especially into the complexity of} solving IEPs.

In particular, the line

of argument is _given for _using issue _{linkage as a}

tool to _{solve IEPs. The chapter addresses the} main characteristic ofIEPs. Thereafter

threeapproaches to solve IEPs are presented, from which the

full

cooperative approach is selected and further analyzed. Instruments to overcome some obstacles to the full

cooperative approachare _{subsequentlydiscussed,} from which issue_linkage isselected as the fundamental theme ofthisthesis. The chaptercontinues withadetailed discussion on

issuelinkage. Finally,some_existingmultilateralenvironmentalagreements aredescribed. A synopsisofenvironmental_{policy in the EU and backgroundinformation for} apply-ing issuelinkagetoenvironmentalpolicy in the EUarepresentedin chapter 3. Thefirst

part of

the chapter is a_{description of}the institutions of the EU anda precise

explana-tion of

the_{decision-making procedure,} astheseaffect environmental _{policymaking. The} second part of the chapter goes into EUenvironmental_{policy. Themain principles of EU}

environmental_policyare_{elucidated, as well as}the

Fifth

andSixth Environmental Action

Programme.

Chapter 4 reviews the mathematical economic literature on issue _{linkage of two (or}

more) independent or separable issues, complemented with the main results from this literature. _{Different ways}

to

define_linkagearedescribed and threeclassesof_{methodologies} to_{model linkage are}then discussed. The review continues

with

_{experimental results and}

resultsfromsimulations fromtheeconomicliteratureon_{issue linkage. Finally,arguments} fromtheliteratureagainst issuelinkage arepresented and evaluated.

'Cesar andde_{Zeeuw (1996)}refertoperfectreversibilityasexactmirrorimage. I use the term perfect

8 1. ObjectivesandOutline

Chapter 5 analyzes theconcept of interconnection in acooperativegametheoretical setting. Theseparate issues aremodelled as _games

in

_{(adjusted) characteristic} function

form, assumingtransferablepayoffs. Refinementsofpower asymmetrybetweencountries and asymmetry between issues are included in thetheory. Linking is _{achieved by}

sum-ming the adjusted characteristic functions of theseparate games. This results in a new

gameincharacteristicfunction form, theso-called interconnected game (in characteristic function form). The core is used as thesolutionconcept oftheinterconnected game. It is

formallyshown

that

issuelinkagecanindeed achieve_{cooperation between}players, where

it

otherwise wouldnot occur.

Chapter6 extendsthe analysisofissue_{linkage in} a _{non-cooperativesetting with two}

innovative elements. The first innovative element

of

chapter 6 is

that

issue linkage is defined for

N

countries_linking

M

issues, instead ofmostmodels of two countries linking

two issues, asinCesar and de Zeeuw (1996). Thesecondinnovative elementofchapter 6 is

that

issuelinkage under impelfectreversibilityisanalyzed. Conditions forthe parameters

of theseparate games arederived, suchthat there is a

full

cooperativestrategyprofile of the interconnected game that isaParetoimprovement of all dominantNashequilibria. It

will

beshown

that

there exist_rangesof_{parameters of thegames, such}thatinterconnection betweenaninitial game andgames

with

parametersfrom

within

the predeterminedranges

ofparameters, results inan_{interconnected game with a full} cooperative strategyprofile that is astrict Pareto improvement ofall dominantNash equilibria.

Finally, chapter7_providesa_{summary and conclusions of the thesis. I summarize the}

results from _{chapters 2 to}6. These results are then related tothe _{applicability of}issue

Chapter 2

International Environmental

Problems and Multilateral

Environmental Agreements

Within

_{the larger context} ofsolvinginternational environmental problems (IEPs) using

issue _linkage, this _{chapter explores IEPs. What line of argumentation call be used to}

justify

issue linkage as a tool to solve IEPs? Sections 2.1 and 2.2 review the

characte-ristics of IEPs,the_{properties of}amultilateralenvironmental_{agreement (MEA), and the} existing principles for MEAs. Section 2.3 first discusses three different _{approaches for}

solving IEPs: the market approach, the non-cooperative approach anda_cooperative ap-proach. Section 2.3then_explainsthereasons_{why countries}areinvolved in MEAs. These

reasons lead to a discussion on the _(full) cooperative approach, including its obstacles

and instruments to overcomethe obstacles. Section 2.4 then focusses on issue linkage

as an instrument to overcomethe obstacles to the full cooperative approach. Reasons,

drawbacks and _{the applicability of}issue _linkage are discussed. _Finally, section 2.5 uses the examples ofsomeexisting_{MEAs, including the MEAs}associated withthe cities that

started chapter 1 to illustrate theissues thatwere discussedinsections 2.1 to 2.4. Some

'smaller' MEAs arealsodescribed-smaller in_{the sense that the agreements concern only}

some countries. _Finally, a _EuropeanUnion_agreement is_{included, relating to} the

title of

this thesis.

2.1

Characteristics

of

International

Environmental

Problems

As explained in chapter 1, IEPs are _{environmental problems that have} an international

10 2. International

EnvironmentalProblems

externalityis_generated.

A

_{country can be}a_{pollutingcountry, suffer from pollution, or,}

more commonly, beboth pollutingand _suffering. This_{aspect of IEPs}is discussed below.

IEPs occurin situationswhere there are no _{property rights and} no institutions with

the authority

to

initiate

and enforce environmental policy internationally The latter

aspect, the lack

of

_{institutions, will}beexplained belowin furtherdetail.

Sources and

victims

For _{analytical purposes, a} distinction is made between countries that pollute and

countries that suffer from pollution. These countries are _{referred to, respectively, as} sourceand

victim

countries. Two kinds

of

relations betweensource andvictimcountries

are _{distinguished, expressed in two cases of IEPs: 1) the unidirectional IEP; and 2) the}

reciprocal IEP.

With

regard to reciprocal IEPs, a further distinction is made between

regional reciprocal IEPs and global reciprocal IEPs.

In a unidirectional IEP, a_{country involved inthe problem}iseitherasource_{country or} a_{victim country, but not both. Anexample isthe pollution of}a_{border-crossingriver by} a_{singleupstream country, suffered only by}a _{single downstreamcountry.} Unidirectional

IEPs canbedivided on the source side intoonesource and manysources; thevictim side

includes onevictim and many victims. The most general (but in practice almost

non-existent) form ofaunidirectional IEP is the _{many sources/many}victimscase. Generally,

asource_{country has no} interest in a _policymeasure_{for reducingpollution,} whereas the measure is in thefull interest ofthe

victim

country.

In a reciprocal IEP, a _{country is both} the source and

victim of

an _{externality. The}

externality affects either a group of countries in a specific region (regional reciprocal IEP), or most or all countries of the earth (global reciprocal IEP). A classic example

of a _{regional reciprocal IEP is} the _{problem of acid rain in Europe (See, for example}

Mailer (1989), EMEP (2003) and EEA (2002)). Throughout Europe, the wind direction

is _{generally westerly or southwesterly Consequently, much of}the _{pollution emitted in} theUnitedKingdom travelsacrosstheNorth Sea andisdepositedinScandinavia. While

the_{United Kingdom}emits muchmore_{pollution than}

it

receives_throughacid deposition, Norway and Sweden both receive more than 90% of their sulphur pollution from other countries (primarily the United Kingdom, Germany and_{Poland) and from international}

shipping. It mustbe_{noted that, from} 1980until 1999, theUnited Kingdom significantly

reducedits emissionsl.

Examplesof global reciprocal IEPs include the threat of extinction ofrare species,

global warming and thepollution ofinternational seas.

1

Some_{remarkable figures are (from EMEP (2003)):} 76%reductionofsulphuremissions, 38%reduction

2.1 Characteristics of IEPs 11

Related to thedistinctionbetweensource andvictimcountries are the characteristics of the pollutant itself.

A

pollutant can beuniformly mixing or non-uniformlymixing (see Tietenberg (1985)).

Some pollutants contribute to the accumulation

of

_{pollution, independent} ofwhere

theyaregenerated.

An

example canbefound inthe globalwarmingproblem,where each

unit of

C02 contributes tothegreenhousegases in the sameway, regardlessofwhere it is produced. Itisclear that in the case

of

theseuniformly mixing pollutants,thedistinction

betweensourceand

victim

_country isirrelevant.

In the case

of

non-uniformly mixing pollutants, the place _{of origin determines the} accumulation ofthe pollutant. Anexample canbefound in the acid rainproblem, where the winds overEurope disperse the sulphuremissionsof different countriesintodifferent directions, thereby spreading the acid substances over _{Europe differently. In this case,} the_{source/victim}country distinctionisrelevant.

Absence of

an

international institution

Absence ofan international

institution with

the

authority

to

initiate

andenforce

en-vironmental policy internationally is _{typical for an IEP,} and _{distinguishes it from} do-mestic _{environmental problems (see} Folmer and de _{Zeeuw (2002) and} Folmer and van

Mouche (2000/2001)). Anyenvironmental_{policyproposed on an}internationallevel must

be_{initiated, adopted, implemented} and_{enforced bythe participating} countries

volunta-rily. Sovereigncountries cannot intervene ineachother's_{policies. For instance,} a_country

downstream of aninternational riverwantsthe upstream country toreduceits pollution of_{the river,} but cannot enforcethe_{necessary measures,} since they have to be taken by

theupstream country. An evenmore extreme example canbe foundininternational ge-ographical space - suchas international seas and space -where no_{authority exists at all}

with

_{controllingjurisdiction.} Thisabsence of aninternational

institution

isrevealed both bynon-participating behavior and by non-compliance behavior, asdescribedbelow.

First, countriescanrefuse_{to participate inthe development of}a_{common policy, either} because_{they disagree with the goal ofthe agreement, or because they want}to free-ride (enjoying the benefits ofan agreement without bearing any ofthe costs from measures that have to be_{taken, according to the agreement).}

Second, participatingcountries can fail tocomply with an agreement bydeciding not to implement thepolicy, orbypulling outcompletely fromtheagreement. Anexample of

failing to comply with (part of) an agreement is theEuropeanUnionadding reservations upon approval of aninternationalenvironmental agreement (IEA). In 1985, the EUsigned

12 2. International Environmental Problems

On behalf of the European Community, itis herebydectand that the said

Com-munitycan acceptarbitration asameans

_of

dispute settlement within the tenns

of

the Vienna _{Convention for}the _{Protection of}the Ozone Layer.

It

cannot

acceptsubmission of any dispute to the International Court of Justice.

A reservation was also added upon approval ofthe Helsinki Convention on the

Trans-boundaryEffectsofIndustrial Accidents in 1998 _{(UNECE (2003)).} The reservation

con-cerned_{higher threshold quantities}for_{bromine, methanol and oxygen, and for}substances

consideredtoxic and very toxicto aquaticorganisms.

Anotherexample is thefailureof compliance with the 1987MontrealProtocol, which bannedtrade inanumberofozone-depletingchemicals, includingCFCs. Despite the ban on trade,customs officersthroughout the worldregularly intercept deliveries

of

chloroflu-orocarbons (CFCs).

2.2 Properties of a

Multilateral Environmental

Agree-ment

Assuming thatthe countriesare _actingrationally,the foregoingimplies that all MEA has to be signed voluntarily, must be agreed upon by consensus and must be self-enfoming

(see also Finus (2002)). Although these three aspects of an MEA are _{interdependent,}

they are discussed_{separately below, for sake}ofclarity.

Voluntarism

Countries will only signan _{agreement voluntarily if they find}an agreement beneficial

(in thesense that the benefits from the agreement exceedthe costs of pollution reduc-tion). Voluntarism is also referred to as individual rationality. Generally, although an

internationalenvironmental agreement raises_globalwelfare, individualcountries may be worse off. For_{instance, in the case}

of

non-uniformly mixing pollutants, ifacountryemits

relativelymanypollutants but suffersrelatively

little from

theeffects, thecostsof

abate-ment may exceedthe benefits.

In

_{Maler (1989), for example, it} was argued that (with

respect totheproblem of acid rain in Europe) thecosts ofreducingemissions exceeded

the benefits fromthereduction fortheUnited Kingdom.

Consensus

An MEA must alsobereached by consensus; that is, by the countries together.

Con-sensus has beenreferred to_{in Barrett (1998)}ascollectiverationality: an_{agreement is not}

vulnerabletorenegotiation and there isno alternativeagreement that allcountriesprefer.

Of

course, consensus can bereached only ifthe countriesparticipate voluntarily.

2.2 Properties of MEAs 13

can_{relativelyeasily agree} on declarations

of

intentions. But _agreeing on_{protocols with}

explicit emission reductions is far more difficult. The difficulties in _reaching consensus

are evident, for example, from the time elapsed from recognition of the environmental problem

until

the signature ofan agreement. The timethat elapses _{from recognition to}

treatyratification _{and enforcement,}throughnegotiations on the design of thetreaty and

agreement onprotocols

with

explicitmeasures, may takea_{period of more that 40 years.}

For example, the needforenvironmental _{protection of the Antarctic areawas recognized} in 1961. Thesignature ofthe Protocol to the Antarctic Treaty onEnvironmental Pro-tection _{took place in 1991 - more than} 30 _years later. TheProtocol has not even been ratified yet, more thantenyearslater.

Self-enforcement

Even when countries _{agree on an MEA by consensus, the agreement must be}

setf-enforcing. That is,

the agreement must be designed in such a way

that

countries

vol-untarily sign the agreement and carry out

its

terms without interference ofan outside

Part;y2.

Self-enforcing agreements havebeendescribed

in

_{Barrett (1994)} and_{Barrett (1998).}

Barrettdevelopsa_{theory of internationalcooperation, assumingindividualand collective}

rationality, therebymodellinga'credible' strategy fordeterring free-riding and enforcing

compliance. He does this by analyzing an _{infinitely repeated linear prisoners' dilemma} game, with symmetriccountries. _{Linearity implies that the payoffs to the countries are} linearfunctions ofthe

total

numberofcountries

that

cooperate.

_{Specifically: if z (z N,}

N 2 2) is

thenumberofcountries

that

cooperate (with Nthe

total

numberof_countries),

then the payoff to each country from cooperation

equals 71-c(z) = -c + dz, and the

payofffromdefection equals 7rD(z) -_bz, where b, c, and d are parameters3, such that the prisoners'dilemma_{game satisfies}three features: ₁₎defection isadominant_{strategy in the}

one-shot game4; 2) eachcountry's payoffisincreasing with the number

of

othercountries

that

cooperates, irrespectiveof whether or notthe countryitselfcooperates5; and 3) the aggregatepayoffis

strictly

increasing withthenumberofcountries

that

cooperates6. The

main conclusions

that

Barrett drawson self-enforcement areasfollows:

1. The number

of

countries that can sustain

full

_{cooperation by} means of a

self-enforcing agreement must be lower or equal to 9 . For example, if b = d = 3

and c = 4, then the full cooperative outcome can be _{sustained by at most two}

2Indeed, there exists nointernationalinstitution that hasthe power toinitiateandenforcean

agree-ment.

3Where b, c, d>0andassuming that d k b.

4_{This implies bz >}

-c+d(z+1),

O S Z S N-1. Furthermore, upon settingz=O,i tholds that c>d.

5This implies d, b > 0.

14 2. International

EnvironmentalProblems

countries. And if b=d=1 and c= 149, then the full cooperative outcome can be sustained by at most 150 countries.

2. Global cooperation under self-enforcement call be sustained only when the gains from cooperation aresmall: there isan inverse relationship betweenthe maximum

number of countries that can sustain full cooperation and the aggregate gains to

cooperation. Theaggregate gains equal N· (1Tc(N) - 71'D(0)) =N· (-c + dN). The

aggregategains

to

cooperation are thus decreasing in cand increasing in d. But the inequality N 5

₄₂

implies thatthe maximalnumberof countries N thatcansustain cooperation isincreasing in c and decreasing in d. Thusinternational cooperation

betweenallcountries canbe_{sustained only when the}gainstocooperationaresmall.

Thislast resultisexemplified by theMontrealProtocol. TheUnitedStatesEnvironmental Protection_{Agency calculated the differences}incostsandbenefitsbetween the case of the

United States carrying outthe terms ofthe MontrealProtocol unilaterally and the case of the United States acceding the treaty (see EPA (1987)). Under unilateral action,

the United States would bear the costs of $21 billion and would receive a benefit of

$1.373 billion. _{Under the treaty, the} United States would bear the same costs of $21

billionand would receive a_higher benefit of$3.575 billion. The difference between

non-participation _(andtaking theactions unilaterally)and participationarerelativelysmall.

With

the_strongbelief

that

costsand_{benefits estimates for the other countries would give}

relativelycomparable results, the small number

of

signatories to theMontreal Protocol is not surprising, sincethe_gainsfromcooperationaresmall.

Ftorn the above it is clear _{that voluntarism,} consensus and self-enforcement generally

weaken thecommitments embodied in an agreement. An agreement frequentlyreflects

thelowestcommondenominator betweenthecountries. Thislowestcommon denominator

is_{negatively influenced by}countries that havelittleinterest inreaching an agreement.

Environmental principles

To complete thediscussion above _{regarding the properties of MEAs, it} is _important

to refer to someprinciples thatserve as abasis forsomeexistingMEAs . They are very

general, however, and do notstate specific measures or standards. The principles have been adoptedfrom either the Rio DeclarationonEnvironment and Development or from theInternational Union forConservationof NatureandNatural Resources_{(IUCN) Draft}

CovenantonEnvironmentand_Development (seeHunter et al. (2001),ENTRI (2003) and

IUCN (2003)):

• Principle of Common Concern: the global environment is a common concern of humanity (IUCNCovenant, Principle 13);

2.2 Properties of MEAs 15

• Duty Not to Cause Envimnmental Harm: states have the responsibility toensure

that

activities

within

their

jurisdiction

orcontrol donot causedamage to the envi-ronment of other states or

of

areas _{beyond the limits of national jurisdiction (Rio}

Declaration, Principle 2);

• Principle of Integmtion: inordertoachievesustainable development, environmental

protectionshall constitutean _{integral part of thedevelopment process and cannot}

be considered_{in isolation from it (RioDeclaration, Principle 4);}

• Principle of

Global_{Partnership: states shall cooperate in} a

_spirit

of_global

partner-ship

to

conserve,protectand restorethe healthand_{integrity of}the earth's_ecosystem (Rio Declaration, Principle 7);

• Principle of Common but Diferentiated Responsibilities: in view of the different

contributions _{to global environmental degradation, states have commonbut} diffe-rentiatedresponsibilities _{(Rio Declaration, Principle 7);}

• Principle of

Public Participation: environmental issues are best handled with the participation of all concerned _{citizens, at the relevant level (RioDeclaration,} Prin-ciple 10);

• Precautionary Principle: where therearethreats ofseriousor irreversibledamage,

lack of

full

scientific certainty shall not be used as a reason for _postponing cost-effectivemeasurestopreventenvironmental_{degradation (Rio Declaration,}Principle

15);

• Pottuter Pays

Principle: national authorities should promote the internalization ofenvironmental costs and the use of_{economic instruments, taking into} account

the approach that the polluter _should,

in

principle, bear the cost of pollution (Rio

Declaration, Principle 16); and

16 2. International

EnvironmentalProblems

2.3

_Approaches,

Obstacles

and

Instruments for

Solving IEPs

2.3.1

_{Market, Non-Cooperative and Cooperative Approach}

There are in general three approaches to solve IEPs: the market approach, the

non-cooperative approach and the non-cooperative approach.

In

general, each country's welfare

equals itsbenefitsminusits damagesfrom pollution. Benefitsdepend on production and

consumption (and thereforeonemissions associated with them). Emissions contribute to

a_country'sbenefits _(throughproduction), but also to thedamages (through the

environ-ment). In the case ofaninternationalenvironmental problem, acountry suffers not only

from itsown emissions, but also from foreignemissions.

The sectionbelowdiscusses themarket approach, the non-cooperative approach and

a _{cooperative approach (see} also Folmer and de _{Zeeuw (2000) and} Folmer and van

Mouche (2000/2001)).

The market approach

Underthemarket approach,countries maximizetheirown benefits, ignoring

environ-mental _damages. Hence, there are no limitations on emissions. It is obvious that this

approach israrely seenin countries that care for the environment.

The non-cooperative approach

Under the non-cooperative approach, countries maximizetheirown welfare,including

damages, but take only their own damages into account and ignore theeffects oftheir emissions on _{other countries. Furthermore, damage causedby other countries'}emissions

are taken as given. This results in the optimal non-cooperative level of emissions for each country, suchthatmarginalcostsequal marginaldamage in thehomecountry. The

most commonlyusednon-cooperative equilibrium is theNashequilibrium8. In the Nash equilibrium, each_countrytakesthe others'choices asgiven andchooses hisown strategy;

equilibrium is where all these choices are _{mutually consistent. The} Nash_{equilibrium is} often referred to as a _{threat-point:}

if

cooperation is not possible, the Nashequilibrium

will result9.

8_{Othernon-cooperative equilibria are the subgame-perfect equilibrium and the expectations} equilib-rium. See_{Osborne and Rubinstein (1994) for}acomprehensive overview on non-cooperativegametheory.

'In general,anydisagreementpoint isathreat-point, butathreat-point has to beacrediblepoint in

2.3 Approaches, Obstacles and Instruments 17

The cooperative approach

In

_{the cooperative approach, countries maximize welfare whiletaking all}effectsof their

emissionsintoaccount, includingtheeffectsonother countries.

An

_agreementisreached

after _{negotiations between}the countries on several possibleoutcomes. It is natural to

assume that anoutcomeisselected thatisPareto-efficient.

An

outcomeisPareto-eflicient

if there is no other outcome that is better for one country and is at least as good for all other countries. Thejustification for choosing aPareto-efficient outcome is that an

inefEcient outcome leaves room_{for renegotiation}

that

makesallcountriesatleastbetter off

and one (orrnore) country

strictly

betteroff. ThereareseveralPareto-efficient outcomes possible, one of which is the

full

cooperative outcome. In the

full

cooperative outcome, the sum of theindividualcountries' benefitsis_{maximized, assuming transferable benefits}

in some way.

The aboveis_{illustrated by the followingsimpleexample with two countries that each} havetwopolicy options. Note that thisexample does not present any generalresults. It

is_{merely meant}to illustrate theconceptsofParetoefficiency, Nashequilibrium and the full_{cooperative outcome.}

Supposetwocountries A and B have two _{policyoptions:} to cooperate (denoted by C)

or not to _{cooperate (denoted byD). Cooperation} is associated

with

reduction of a unit

pollution and _{non-cooperation with} no _{reduction. Cooperation involves} costs of 2 for

country A and 4for country B. Thebenefits

of

_cooperationare_{enjoyed by}both_countries,

regardless ofwhich country cooperates. The benefits equal 5 for

country A and 3 for

country B. If

both_{countries cooperate,} each _{countryenjoys double benefits and}suffers

the costs onlyonce. Non-cooperation bybothcountriesleadstoneitherbenefitsnorcosts,

so that the netbenefits are 0 for eachcountry. The netbenefits of the two countries in

the _{four possible outcomes,} resulting from the combinations of policyoptions, aregiven

in aso-called bi-matrixstage gamerepresentation:

Country B

Policy C Policy D Country A Policy C (8,2) (3,3)

Policy D

(5,-1)

(0,0)

For example,

if

country A optsfor cooperation (C)and_{country B optsfor non-cooperation}

(D), then_{country A} enjoys thebenefits _{from cooperation (5), but} also suffers the costs

(2), resulting in net benefits of 3. _Country

B

_enjoys the benefits _{from cooperation by}

country A,withoutsuffering any costs,resulting innet benefits of 3. The

full

_cooperative

outcome of this game is the outcomein which bothcountries cooperate (outcome (C, C)),

18 2. International Environmental Problems

other outcome, where all countries areat least aswell-off as in_{outcome (C, C), and one} country is_strictlybetter-off.

However, the Nash equilibrium of this game is outcome (C,D), where country A cooperates and_{country B does not cooperate. The}rationalebehindthisoutcome is that, whatever action _country

B

chooses, it is _{always best} for

_{country A to opt}

for_{policy C,}

sincethisleaves_{country A}

with

_{higher netbenefits (if}

B

chooses_{policy C, then 8}is_larger

than 5, and if Bchoosespolicy D, then 3is larger than 0). Thesame reasoningholds for

country B with policy D, resulting in outcome (C, D). Thisoutcome is Pareto-eflicient. So, even if the countries can agree onreaching the full cooperative outcome, country B

hasanincentive

to

deter from_{the agreement by changing}

to

policy D. These _{aspects will} be further dealt withinsection 2.3.3.

The cooperative approach, and in particular the

full

_{cooperative outcome,} has received

most attention intheliterature on IEPs. It is also theapproach I focus on inthisthesis.

The argumentsforusingthecooperative approach arise fromthereasons countries have

to be involved in_{MEAs, which are the focus of the next section.}

2.3.2 Reasons to Cooperate

Why do countries want to be involved in MEAs? Besides the common concern on global environment, thereareother_importantreasonsforcountriesto_{cooperate on IEPs}

(sources: Folmer and van Mouche (2000/2001) and ENTRI (2003)):

Effectiveness

An MEA

is_{usually superior} interms

of

effectiveness

if

thosecountriesthat contribute most to the problem agreeon measures to solvethe problem. Furthermore, by sharing

their experience and exchanging information on environmental policies, countries can improve theindividualandcombinedeffectiveness

of

their_policiesand measures,thereby raising global welfare.

An example of increasing effectiveness is the involvement of developing countries. Developing countries are _{largecontributors to IEPs, for example to the global warming}

problem. They are expected toproduce more C02 than the developed countries before

2010. It

is therefore essential to involve developing countries in MEAs. In order to

encourage cooperation among developingcountries, an MEA may provide incentives in

the formof financial aidandtransferof environmentally soundtechnologies.

Cost-efficiency

2.3 Approaches, Obstacles and

Instruments 19

cheaper_{thancleaning theriver in thedownstream country,oneshould opt forthe former}

option. For this purpose, countries may include mechanisms in an MEA to transfer or

acquirepollution reduction units fromother countries orfromprojectsinother countries. Examples are the mechanisms

of

emission trading,joint implementation and the clean

development mechanism (see theKyoto Protocol insection 2.5.1).

2.3.3 The Full Cooperative Approach

In spite of

the attractiveness of the

full

_{cooperative outcome, it} has proved

difficult in

practicetoachieve a_{Pareto-efficient outcome (and}particularly, the

full

cooperative

out-come).

A situationinwhichaPareto-efficient outcomeisdimcult to achieve, is when the

pre-ferencesonenvironmental_{quality of the}countriesinvolved in anMEA _{differ widely. This}

is especially truefor industrialized and developing countries. In industrialized countries,

demands on environmental_qualityare_{generallyincorporated in all} kindsof_{policies. In} addition, awareness has_grown

that

international_cooperationis neededfor_{solving IEPs.}

In

developingcountries, environmentalpolicyis_restricted,

first of

allbecausepriority lies in policy on the provision ofbasic necessities andonstimulationof_{economic development.}

Secondly, developing countries feel that it is _{mainly in the interest of}the industrialized countriestoreachan agreement, since they are themainusersofcommonresources and

have generated the most pollution.

Twomain obstacles to adopt the

full

cooperative outcome appear to be asymmetric

gainsfrom agreement and free-riding behavior.

First, although the

full

cooperative outcome maximizes

total

welfare, it does notimply

that

allcountries experience a net welfare gain compared tothenon-cooperative outcome.

Some countries _{may indeed incur a net welfare loss. This} results in different levels of

willingness towards solving environmental problems.

An

example is the unidirectional

pollution of

a river. An _{upstream country has} no direct benefits from _{cooperating on}

solvingriver pollution.

It

would thereforebe difficult to convince the upstream country

to join

aninternational agreement

that

advocates areduction

of

_pollution.

Thesecondobstacle

to

adopt the

full

cooperativeoutcome is that even if allcountries

incur a _{net welfare gain,} a _{country has} an incentiveto free-ride.

A

_country call choose

to stay out ofan agreement completely, or take on lessabatement effort, thereby

incur-ring fewer costs, but

still

benefit from the abatement efforts

of

other countries. This is especially the case

in

global environmental problems, whereeachcountry hasasmall

con-tribution

in pollutionreduction. Another form offree-riding behavior is when acountry

20 2. International Environmental Problems

2.3.4 Instruments

to

Overcome

Obstacles

To overcometheobstaclestoadoption of the

full

cooperative outcome, three instruments

can be considered: side-payments, retaliationand issue linkage.

Side-payments

Side-payments havebeen proposed(byamong others, Maler (1989)) as a way to

over-comethefirstobstacle to thefull_{cooperative approach: net welfare loss to}somecountries. Side-paymentsaremoney transfers made by thecountries that gain from fullcooperation

to those countries that have no direct net welfare gain from cooperation. Since

total

net benefitsaremaximized in the

full

cooperative outcome, the countries that gain from

cooperationhave _'enough'tocover_{the losses. This way, net}losses can be compensated,

inducingthe losersto cooperate. Forexample, in the bi-matrix game

of

section 2.3.1, if

country

A

transfers anamounttocountry B in the

full

cooperativeoutcome of at least 2

and at most 4, then bothcountriesarebetter-off than in theNashequilibrium.

Side-payments could also be used as an instrument to overcomethesecondobstacle

to the

full

cooperative approach: free-ridingbehavior. Thegeneral idea is that the more

countries joina_{coalition, the more}thecoalitiongains _(seeamongothers_{Barrett (1994)).} Thus, countries inside the coalition may offer side-payments to countries outside the

coalition

to

_{bribe them to join}thecoalition. Side_{payments may take the form}offinancial transfers or of technology transfers.

Side-payments are _{illustrated by}the _{Montreal Protocol (see UNEP (2003)).} Article

10 of the Protocol providesafinancial mechanism

for the purposes of providing jinanciat and technical cooperation, including the

tmnsfer of technologies, to developing parties to enable theircompliance with the controt measures of the Protocol. The mechanism, contributions to which

shall be additional to otherjinancial transfers todevelopingparties shall meet alt agr'eed incmmental costs ofsuchpartiesin onier toenabletheircompliance with the control measums ofthe Protocol.

The mechanism includesaMultilateralFund, financed by the developedcountries in the Protocol. TheMultilateral Fundisintended to: _1)identifytheneedsfor_{cooperation of the}

developing countries; 2)facilitatetechnical cooperationtomeetthese needs; 3)distribute

information and relevant materials for the _developing countries; and 4) facilitate and

monitor other _{multilateral, regional and} bilateral cooperation available

to

Parties that are availableto_{developing countries.}

Under the Montreal Protocol, the developed countries mustalsotransfer the best available,environmentallysafesubstitutesand_{related technologies to}thedeveloped

2.3Approaches, Obstacles and

Instruments 21

There_{are, however,} many disadvantages to using side-payments. _First, there is the

pos-sibility that the

net losers may even want to gainfrom cooperation. Thenet losers may

demand not only

that

their net loss becompensated, but even that theyacquire net be-nefitsafter the allocation ofthe

total

_{net benefits among theparticipating}countries. This incurs a new allocation problem ofthetotal net benefitsin _{itself, raising}newquestions: howmuch shouldthelosers gain,_{after reallocation of}

_total

_{net benefits? And how much} shouldeachwinningcountrycontribute tothe side-payments?

Second,anticipation ofside-payments may induce countries to act strategically. Prior to the agreement, the netlosersmay lowertheirenvironmental abatementevenbelow the non-cooperative level, thereby extractinglarger side-payments. The net winners on the

other side havean incentive

to

lowertheirnet gains,thereby inducinglower side-payments.

The risk_{of strategic}behavioris_particularlyrelevant for IEPs. In IEPs the countries have imperfect information onthe other countries' preferences forenvironmental _{quality and} abatementcosts _{(Folmer et al. (1993)).}

Side-payments may also leadtostrategic behavior in the caseofbribing.

If

countries

know they will

be bribed, they have an incentive to stay out ofan

initial

coalition, in

orderto obtain side-payments upon_{joining later (Hoel and Schneider (1997)).}

Third, countries

that

_{offer side-payments may} incur a loss _{of reputation and may}

weakentheir negotiation_{positions (Mbler (1990)). Compensating countries may be}

cha-racterized as 'weak _{negotiators'. This will} undermine _{their position - not only during}

future negotiations on thesameproblem, but also duringnegotiations on otherissues.

Finally,side-payments areanapplication ofthe

"victim

pays" principle. Thisprinciple

has been _{banned for the most part by} international _{guidelines on} international environ-mental agreements, as in the case of the EuropeanUnion.

Side-paymentsare _{indeed rarely seen in practice, although}secret _{side-payments may}

occur. Countries that have an incentive to defect are mostly driven to cooperate for

reasons of_{expected punishments or} in _{exchange for cooperation by other countries on}

otherissues. These instrumentsarediscussed below.

Retaliation

Another instrument toinduceadoption of the

full

cooperative outcomeisretaliation. Retaliation reflects the idea that each country's interest is thatthe agreement does not break _{down prematurely,} sincethis would_{imply a}net welfare loss relativeto continued

cooperation. This net welfareloss forms aninstrument to_{prevent defection: as soon as}

a country defects from an agreement, the other countries retaliate by changing to the

non-cooperative outcome, thereby imposing a net welfare loss on the defecting country. Two problemsarise with this kind of retaliationonenvironmentalissues. _{First, retaliation}