Designing Collusion-Proof International Environmental Agreements: Developing Countries and Polluting Firms

We analyze the design of international environmental agreements (IEA) for developing countries (DCs) by a supranational governmental authority (SNGA). We focus on the interaction between an asymmetrically informed SNGA, national governments, and polluting firms in DCs. Two scenarios are compared. In the first, the DC government and the SNGA negotiate a ceiling on pollution abatement and then the SNGA offers an incentive-compatible and collusion-proof IEA to the two DC parties. In the second, the DC government manipulates its monitoring device and the SNGA takes this into account when designing the IEA. Our principal conclusions are as follows. First, the contractually specified levels of pollution abatement and the pattern of the weighted marginal costs of abatement differ depending on the form of the DC government's representation. Second, for the most part, the SNGA is able to extract the informational rents from the government and the firm. Third, as compared with contracting with monitoring device manipulation, the SNGA will prefer contracting with a ceiling constraint. Fourth, the pollution ceiling and the budget constraints limit the magnitude of the monetary transfers that the SNGA can offer and the extent of pollution abatement that the SNGA can require. Finally, by explicitly modeling the effects of sovereignty, that is, by disallowing the possibility of monitoring and enforcement and by allowing the possibility of collusion, we show that the SNGA's lack of monitoring and enforcement powers do not preclude it from designing effective collusion-proof IEAs.