Nova workboard

a blog from young economists at Nova SBE

Playing the Future

Climate change is one of the biggest challenges faced by every society nowadays. In order to address this issue in an effective way, the world’s nations are required to cooperate between them. This, however, has been proven difficult largely because of free-rider incentives, that is, some countries expect others to reduce greenhouse gas emissions and so they do not reduce emissions themselves.

The reason why some countries adopt this non-cooperative behavior has to do with the fact that global warming mitigation can be considered as a public good, meaning that no one can be excluded from receiving its benefits.

In order to understand the mechanics of international behavior regarding the environment consider the following simple model.

Two countries have to choose simultaneously between polluting or abating pollution (one of the countries may be a big polluter like USA or China, and we might consider the other one as the “rest of the world”).

Also, assume that the socially best possible outcome is climate change mitigation, which requires both countries to abate pollution. Now, if one country chooses to pollute and the other engages in abating, the latter one will incur in a high loss, since its government will have to adopt measures such as green taxing which may decrease its popularity relative to the first country’s government and therefore its chances of being re-elected. We assume that if both governments choose to abate pollution, then the abating government’s popularity will decrease by less than what it would decrease if that country chose to abate but the other didn’t, while climate change mitigation is achieved yielding overcompensating benefits. This is summarized in the payoff matrix below, where the numbers are only representative and do not have any cardinal interpretation; only ordinal.

Country 2
Country 1 Abate Pollute
Abate 5 ; 5 1 ; 8
Pollute 8; 1 2 ; 2

In the end, and assuming both governments act rationally, due to the uncertainty regarding the other country’s actions, both will end up choosing to continue polluting. This situation is known as a Prisoner’s Dilemma. Although both countries would be better off if they cooperated by choosing to abate pollution, they end up choosing to pollute and no one will have the initiative to abate. The two countries have achieved what is called a Nash equilibrium which in this case is clearly not optimal in terms of welfare (since both would be better off if they abated).

We conclude that future sustainability depends on how countries strategically interact with each other at the present time. It is often the case that individuals are not very good in making decisions where there is a trade-off between uncertain future benefits and certain immediate costs. So, how to solve this Prisoner’s Dilemma?

One way would be to have negotiations occur between smaller groups of countries, rather than having every nation sit at a parliament and try to reach an agreement. It stands to reason that the smaller the group of countries present in a negotiation, the more likely it is to achieve a successful outcome.

However, when seen as public good climate change mitigation should receive contribution from all nations, so in order to efficiently and equally tackle climate change, every nation should take some measure towards that goal.

Another way is to reduce the cost of adopting non-polluting production processes and lifestyles. This can be done either through research and development aimed at improving or inventing environment-friendly technology or through economic incentives such as subsidies for using renewable and clean sources of energy, for instance.

If measures to promote a green economy are taken, countries that choose to abate need not become less competitive than polluting ones and hence more and more countries will contribute to climate change mitigation, which might turn out to be what we call a dominant strategy.

Needless to say, how governments act towards climate change depends explicitly on how they value the future. Although there is consensus1 in the scientific community that human activity is contributing to global warming, myopic behavior still lurks in many decision making processes.

Personally, given that what is at stake is future generations’ well-being and that the transition to a sustainable green economy is becoming more and more feasible from both economic and technological perspectives, it stands to reason that governments should adopt a prudent behaviour and hence cooperate.

Daniel Baeta

1 http://climate.nasa.gov/scientific-consensus/

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Author: studentnovasbe

Master student in Nova Sbe

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