Carrots, sticks, and international externalities

doi:10.1016/S0144-8188(97)00019-7

International Review of Law and Economics

Volume 17, Issue 3, September 1997, Pages 309-324

https://doi.org/10.1016/S0144-8188(97)00019-7 Get rights and content

Abstract

Dispute-settlement panels of the General Agreement on Tariffs and Trade (GATT), as well as the GATT Secretariat, have condemned the use of trade restrictions by some countries to induce other countries to protect the global environment. The GATT Secretariat has recommended that countries rely on “carrots’ rather than “sticks” to induce the participation of other countries in multilateral environmental agreements. This article presents a formal of a signaling game that indicates that the type of “carrots-only” regime suggested by the GATT Secretariat would create perverse incentives. Under conditions of asymmetric information, countries may seek to convince others that they bear large costs from pollution abatement by engaging in a great deal of pollution, so that other countries will offer larger “carrots” to induce abatement. In both pooling a separating equilibria, “carrots” encourage greater environmental harm pending a multilateral agreement.

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For instance, Baumol (Baumol and Oates, 1988) investigated the cost-effectiveness of taxes and subsidies for pollution control. Chang (Chang, 1997) argued that the recommended carrot policy encourages greater environmental harm. Researchers have also found that the combination of emission taxes and subsidy abatement was a more effective measure (Fullerton and West, 2000; David and Sinclair-Desgagné, 2010).
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^∗: I wish to thank Lucian Bebchuk, Jagdeep Bhandari, Michael Knoll, Thomas Merrill, A. Mitchell Polinsky, Hilary Sigman, and two anonymous referees, as well as seminar participants at Stanford Law School, for helpful discussions and comments on earlier drafts. I also gratefully acknowledge financial support from the James H. Zumberge Faculty Research and Innovation Fund.

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