A Game of Transboundary Pollution under Endogenous Ecological Uncertainty

We analyze a dynamic game of transboundary pollution control in discrete time in a stochastic framework in which the pollution stock affects the probability of shock realizations. We allow the likelihood of the most adverse shock realization to increase or decrease with the pollution stock to represent the different effects that climate change may induce on ecological and social dynamics. We contrast the noncooperative and cooperative scenarios to quantify the consequences of free riding on the economy's stochastic steady state, which is characterized by an invariant pollution distribution. In both the noncooperative and cooperative frameworks the invariant distribution is supported on strictly positive pollution levels, suggesting that even cooperation cannot ensure complete pollution eradication. Under cooperation though the support is leftward shifted with respect to the noncooperative case, and the size of such a leftward shift which quantifies the inefficiency induced by free riding tends to be larger when the probability function increases with pollution. Moreover, both noncooperation and cooperation nontrivially interact with the monotonicity properties of the probability function affecting the shape of the steady state pollution distribution over its support, thus making it difficult to draw general conclusions on whether on average environmental outcomes under increasing probabilities are more or less desirable than under decreasing probabilities.