Harmonisation, minimum standards and optimal international environmental policy under asymmetric information

This paper is concerned with the role of a supra-national agency, such as the European Commission, say in influencing environmental policies set by national governments. One rationale for such intervention is the need to overcome incentives for national governments to engage in "environmental dumping", that is that national governments acting non-cooperatively may set environmental policies which are laxer than they would set if they acted cooperatively, the reason being that they seek to confer a competitive advantage on their domestic producers. It is sometimes proposed that to overcome such incentives a supra-national agency should harmonise environmental policies or set minimum standards for environmental policies. However, it is well known that harmonisation will not be efficient if countries differ, say with respect to environmental damage costs. In this paper I set out the simplest model in which environmental dumping occurs and show, not surprisingly, that harmonisation will not produce a Pareto improvement on the non-cooperative outcome if countries are sufficiently different with respect to environmental damage costs. I also show that minimum standards may not produce a Pareto improvement either if environmental policy instruments are strategic substitutes, and there may be limited scope for improvement on the non-cooperative outcome if they are strategic complements. This leaves the question why a supra-national agency does not just impose a cooperative solution which Pareto dominates the non-cooperative outcome. The reason explored in this paper is that the supra-national agency may be less well informed about national environmental damage costs than national governments. I derive the non-cooperative and cooperative equilibria with asymmetric information, and show that the cooperative equilibrium with asymmetric information sets environmental policies for countries with different environmental damage costs which are more similar than would be the case with full information. However this narrowing of the differences in environmental policies across countries with different damage costs falls well short of harmonisation, so asymmetries of information provide no basis for policies such as harmonisation.