A Game Theoretic Approach to North South Collaboration Ekko van Ierland Wageningen University based on joint work with Michael Finus, University of Hagen, Rob Dellink, Hans- Peter Weikard, Wageningen University and members of the STACO team by

Need for sustainable development Globe exists for about 5-7 billion years Human interaction with the environment needs to continue in a sustainable manner for several billions of years Sustainable development: non-declining per capita welfare Required: well balanced stocks of capital Human made capital (Savings and investment; new technologies) Natural capital (Efficient use of natural resources; new technologies) Human capital (Education! Education! inventions) Brundtland report; Mäler; Pearce; …..

Global problems: Climate change For global problems no legal entities exist that can enforce: we need voluntary international environmental agreements How to reach agreement?? Which countries will participate? How much emission reduction in each country? How to establish stable international coalition, e.g. Post-Kyoto protocol? It is not in our national interest to join the Kyoto protocol Barrett, Carraro, Finus, Ulph, Nordhaus, Dellink, Weikard,..

Structure of the presentation 1. Introduction 2. Collaboration in Cartel formation Game 3. Empirical context 4. Analysis & Results: without and with transfers; renegotiations 5. Conclusions

Some warning at the start: Highly stylized analysis Reality differs from model analysis Setting of standard cost benefits analysis;discount rate 3% Focus on mitigation, not adaptation Impossible to explain all details in about 20 minutes; full documentation in papers: See: But…. valuable insights can be gained!

2. Cartel Formation Game for Climate Protocol Coalition formation for 12 regions of the world non-cooperative approach: voluntary agreement cartel formation: one coalition and singletons test for internal and external stability of coalition Pay-off Pay-offDiscountingBenefitsAbatement costs q is emission reduction of greenhouse gases

Theoretical background (cont.) Regions/countries indicate yes or no for a coalition Regions/countries choose abatement strategies: playing Nash against each other and the coalition Signatories maximize sum of pay-offs of coalition members; Signatories maximize sum of pay-offs of coalition members; Singletons maximize their own pay off Singletons maximize their own pay off All consider the strategies of the other players All consider the strategies of the other players

Theoretical background (cont.) Testing for stability of coalition Internal stability: no country wants to leave the coalition External stability: no singleton wants to join the coalition We test stability for 4084 possible coalitions; in case of multiple coalitions 4 million!

3. Empirical Modeling of global warming Total stock of greenhouse gases in atmosphere according to Nordhaus DICE model Total benefits Total abatement costs

Benefits per region : base case

Marginal abatement costs EU Source: Ellerman and Decaux (1998)

Schematic representation of emission reduction Time Emissions (Gtons of CO 2 ) Simple setting Dynamic optimzed setting

4. Analysis & Results We calculate what will happen for all coalitions, but we report on the following: Singleton coalition structure: no agreement at all Grand coalition structure: if all would participate! Industrialized countries structure: industrialised countries No transfers: Stable coalition structure (Japan and EU), but only if damage are 20% more than in base case. Transfers by permit trading Renegotiations

Singleton coalition structure (Nash equilibrium)

Grand coalition structure

Industrialized countries (as intended) Note: * Coalition member

No transfers: Results for stable coalition (EU and Japan) Notes: * Coalition member Level of damages increased in 20%

Global emissions reduction (% of base year) SingletonIndustrialized countries Grand coalitionStable coalition (Japan and EU) avg. annual emissions reduction (%) Damages increased by 20%

Modify payoff function Introducing transfers in the coalition: Permit trading Emission permits thus

Initial allocation of permits (pragmatic criteria)

Initial allocation of permits (equitable criteria)

Coalition EU-15 and CHN* * This coalition is internally and externally stable under permit trading-quota BAU scenario. (1) ICM: Incentive to change membership.

Coalition EU-15 and CHN* * This coalition is internally and externally stable under permit trading-quota BAU scenario. (1) ICM: Incentive to change membership.

Stable coalitions, if transfers are used

Renegotiations What will happen if renegotiations occur? For instance after 50 years… Or every 20 years ….. Which coalitions will be stable in early commitment periods and in later periods?

Results: more often renegotiations

An optimal transfer scheme Optimal transfer scheme: any scheme that fully uses the gains from cooperation to enhance stability Based on surplus sharing not some exogenous rule, such as emissions (as above) the surplus is shared according to outside option payoffs, i.e. how much a region would get if it were to deviate Maximises internal stability if coalitional surplus exceeds outside option payoffs, internal stability is guaranteed external stability of course not guaranteed

Renegotiations and an optimal transfer scheme Renegotiations after 50 years ( years) Optimal transfers generate multiple equilibria (626) in second stage, and large number (35671) of stable coalitions in 1 st stage Best performing: USA, EU-15, EET, EEX, CHN, IND in first stage and EU-15, EET, EEX, CHN, IND in second stage (providing 57% of potential gains from cooperation) Renegotiations after 20 years ( years) Best performing: Grand coalition (!) in first stage and EU-15, EET, EEX, CHN, IND in second stage (59% of potential gains)

Conclusions (I of IV) How to reach agreement? Highly stylized model; it assists in explaining international negotiations: strong free rider incentives!; but gains from cooperation can be large! Empirical analysis for non-symmetric regions without transfers provides only 1 internally and externally stable coalition: EU and Japan at 1.2 time benchmark damages Industrialised countries reduce 8.9%; Singletons 4.8%; EU-Japan 5.6%, as compared to 2010 level. Grand coalition in our setting would reduce emissions by 21%, but restricted time horizon and low damages.

Conclusions (II of IV) How to reach agreement? In cartel setting without transfers, coalition formation will be very difficult in practice, because free rider incentives dominate! With transfers, and no renegotiations, only a few small coalitions are stable and they reach relatively little as compared to the singleton case.

Conclusions (III of IV) How to reach agreement? With renegotiations, larger coalitions can be stable, even the grand coalition in the first period. Substantial results can be reached. If countries only act on the basis of self-interest not all gains can be obtained Responsible governments should go for a grand coalition and will share benefits on equity principles. This requires willingness to cooperate and to accept sanctions if free riding would occur.

Conclusions (IV of IV) How to reach agreement? Further climate related catastrophes, unless in international politics adequate policy measures are agreed upon. In Grand coalition global welfare is optimized: we need to search for such arrangement with USA and others If a grand coalition is impossible, multiple coalitions can be helpful, as long as all major players make a substantial contribution. Special note: Climate change will be irreversible and very harmful: no scope for discounting future damages! Without international cooperation on climate change no sustainable development.

STACO PROJECT Environmental Economics and Natural Resources Group Wageningen University Thanks!

Free Rider Incentive Index

Sensitivity analysis for calibration I

Sensitivity analysis for calibration I (cont.)

Future research Test for open and exclusive membership Test for transfer schemes Test for multiple coalition structures e.g. {1,1,2,2,3,3,3,} Analyze technology spillover Anlyze impacts if lobby groups Test for uncertainty on parameter values Allow for more periods Test for multiple deviations Improve regional damage estimates!

Advantage of model: simplicity of specification allows for huge number of coalition structures to be calculated