Compliance Technology and Self-Enforcing Agreements

We analyze a repeated game in which countries are polluting and investing in technologies. While folk theorems point out that the first best can be sustained as a subgame-perfect equilibrium when the players are sufficiently patient, we derive the second-best equilibrium when they are not. This equilibrium is distorted in that countries over-invest in technologies that are “green” (i.e., strategic substitutes for polluting) but under-invest in adaptation and “brown” technologies (i.e., strategic complements to polluting). Particularly countries that are small or benefit little from cooperation will be required to invest in this way. With uncertainty, such strategic investments reduce the need for a long, costly punishment phase and the probability that it will be triggered. The framework is consistent with the evolution from the 1997 Kyoto Protocol to the 2015 Paris Agreement