Bargaining and Coalition Formation Dr James Tremewan (james.tremewan@univie.ac.at) International Environmental Agreements
International Environmental Agreements Overview • International Environmental Agreements (IEAs) typically involve negotiations between a large number of countries so are an interesting application of coalition-formation theory. • The global environment is a public good, and IEAs are vulnerable to two types of free-riding: • Choosing not to sign an agreement. • Signing an agreement but failing to comply with its terms. • We will focus on the first, assuming that all signatories comply with an agreement. • We will look at four specific issues: uniform emission reduction quotas, transfer schemes, single vs multiple agreements, and far-sighted vs myopic agents. • The first three issues will be analyzed using the same computable general equilibrium (CGE) model: STACO. 1 1 See ”Stability of climate coalitions in a cartel formation game”, Finus, van Ierland, and Dellink (2006). 2/27
International Environmental Agreements Analytical vs Numerical Analysis • Economic models can be solved analytically (finding a ”closed form” solution, possibly involving various parameters) or numerically (as in CGE models). • Closed form solutions: • Allow us to find general (especially qualitative) results that are independent of specific functional forms or precise parameter values. • But to find closed form solutions we must often make extreme symplifying assumptions (e.g. identical agents, linear costs...), and if results depend on parameter values, what range of values is ”realistic”? 3/27
International Environmental Agreements Analytical vs Numerical Analysis continued • Numerical models: • Allow analysis of more complex environments and can be ”calibrated” to be close to the real world and give specific policy advice. • But require estimates of parameters which may be hard to evaluate, and different estimates may give different results (ameliorated by ”sensitivity analysis”: testing a range of parameter values). • Note that both types of analysis will mostly use similar assumptions in the underlying models, such as optimizing behaviour by individuals, Nash equilibrium, etc. so both are equally sensitive to modelling errors in this regard. 4/27
STACO STAblility of COalitions model (STACO) • Two-stage game (baseline model): • Regions decide whether or not to sign agreement. • Coalitions (and singletons) choose abatement strategies. • Abatement strategies are chosen based on the following payoff function: T � (1 + r i ) − t ( B it ( q t ) − AC it ( q it )) , π i ( q ) = t =1 • T is the time horizon, • r i is the discount factor of region i, N • q t = � q it , the sum of individual abatement. i =1 • B it ( q t ) is a country’s benifit from global abatement. • AC it ( q it ) is a region’s cost from individual abatement. • Note incentive to free-ride: private cost to abatement, but global benefit. 5/27
STACO STACO: Solution Concepts • In the baseline model, coalitions are assumed to choose strategies to maximise the sum of their members’ payoffs (singletons maximise their own payoff), taking the strategies of others as given. • A coalition structure is considered stable if no country has an incentive to change its membership strategy, taking the decisions of others as given. Requires: 2 • Internal stability: no coalition member wants to leave. • External stability: no non-member wants to join. • With no agreement (Singleton coalition structure) we have the classical Nash equilibrium. • If everyone signs an agreement (Grand Coalition) we have the social optimum. 2 This is just a Nash equilibrium: coalitional deviations are not considered. 6/27
STACO STACO: Callibration • Analysis looks at the 100-year period from 2011-2110. • World divided into 12 regions: USA, Japan, European Union (EU-15), Other OECD Countries, Central and Eastern European Countries, Former Soviet Union, Energy Exporting Countries, China, India, Dynamic Asian Economies, Brasil, and ”Rest of the World.” • Abatement costs and benefits callibrated using pre-existing estimates (from mid-90’s so probably now out of date). • Discount factor assumed to be 2%. • Clearly heroic assumptions, but: • Authors primarily interested in stability of coalition structures, so precision not so important. • Alternative specifications are tested and qualitative results are robust. • What is the alternative? 7/27
STACO Preliminary notes • In the Singleton coalition structure, individual rationality implies each country equating its marginal abatement cost (MAC) to its marginal abatement benifit (MAB). • In a coalition, efficiency implies that the marginal cost of abatement will be equal for each coalition member: Countries with shallower marginal cost curves will take a larger share of a coalition’s abatement. • The attractiveness of a coalitions depends upon: • the country’s MAC relative to other coalition members (the share of additional abatement it must take). • the country’s MAB (how much it benefits from the additional abatement). 8/27
STACO 9/27
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STACO Summary of Basic Results • Even without cooperation (i.e. in the Singleton coalition structure) it is in every country’s interest to unilaterally reduce emmisions (a total of 4.6% of global emmisions). • With global cooperation, abatement is significantly higher (21.4%). • The total net benefit of abatement for the Grand coaltion is $6,031 billion compared with $1,960 in the Singleton coalition structure: large potential gains from cooperation. • All regions except Japan and the EU have an incentive to leave the Grand Coalition (high MAC so small share of abatement costs, and high MAB so remaining coalition members would reduce abatement a lot): it is not stable. • EET and China are worse off under the Grand Coaltion than the Singleton coalition structure (because of low MAB for EET; and low MAC for China implying they bear much of the abatement costs). 13/27
STACO STACO: Sensitivity analysis • Under the baseline calibration, NO coalition is stable. • Raising the ”global benefit of abatement” parameter: 3 • lower emmisions in all coalition structures. • by 20% results in a stable coalition between EU and Japan (but little extra abatement compared to the new non-cooperative NE because of their high MACs). • no other major changes (tested up to 300% of original callibration). • An alternative calibration for regional shares of benifits finds only one stable coalition: Japan, Brasil, and ROW (again with only minor improvement over non-cooperation). • Conclusion: in the baseline model, useful cooperation appears unlikely. 3 Altering benefits from abatement can also be viewed as altering discount factors as they work in a similar way in this model. 14/27
STACO Uniform Emmision Reduction Quotas 4 • The baseline model assumes that coalitions maximise their total payoff which implies abatement is allocated efficiently (and probably asymmetrically) across members. • However, many IEAs specify UERQs: • Helsinki Protocol (30% reduction in sulphur emmisions). • Sofia agreement to freeze N 2 O at 1987 levels. • ”Protocol Concerning the Control of Emissions of Volatile Organic Compounds or Their Fluxes” (30% reduction). • Clearly inefficient: for a given level of abatement, abatement will not be distributed across countries in a cost-effective way (unless MACs identical across coalition members)... why so attractive? 4 See Altamirano-Cabrera et al (2008). 15/27
STACO UERQs: Alternative Models • Common Quota : coalition maximises total welfare under the constraint that all regions reduce emissions by the same percentage. • Median Quota Proposal : each member proposes a coalition abatement reduction that is individually optimal, and the median reduction is chosen (corresponds to majority voting). • Lowest Quota Proposal : each member proposes a coalition abatement reduction that is individually optimal, and the lowest reduction is chosen (corresponds to unanimity voting). • For the grand coalition, these imply global welfare of: • Common Quota: $4,589 bln • Median Quota Proposal: $4,565 bln • Lowest Quota Proposal: $3,212 bln • Much worse than social optimum ($6,021 bln)... but need to consider stability. 16/27
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STACO UERQs • UERQs are clearly inefficient, but enable stable coalitions to form. • All UERQ models result in non-trivial coalitions which improve global welfare relative to the Singleton coaltion structure. • The best is the Lowest Quota Proposal (the worst when stability is not taken into consideration): lower abatement targets are made up for by wider participation. • Also, abatement costs (i.e. gains from cooperation) spread more evenly. 18/27
STACO UERQs with trading • Allowing trading of emission quotas should reduce inefficiency by shifting abatement to regions with lowest MAC. • Potential information problems: pay a country to abate, but how can abatement be verified? • For now, assume trading is efficient: price of quota equal to equilibrium MAC (which will be the same in every country). 19/27
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