Optimal control of upstream pollution under asymmetric information

This paper derives optimal bribes to reduce upstream transfrontier emission s in the presence of asymmetric information on the polluter's concern for t he environment. In a model in which the starting point for the negotiations on emission reduction is a Cournot-Nash equilibrium, it is shown that tran sfers from the victim induce the polluting country to exaggerate its concer n for the environment. As a consequence, in the second best solution, abate ment of all but the least caring type is distorted downward and optimal bri bes may be such that more caring types turn them down. These results are in sharp contrast to earlier policy proposals derived for a non-equilibrium s tarting point. They indicate that under asymmetric information the binding incentive problem is to prevent the polluting country from claiming not to care about the environment and that optimal bribes from the victim should b e restricted to sufficiently environmentally concerned polluters.