Transboundary Natural Resources, Externalities, and Firm Preferences for Regulation

Abstract

This paper analyzes a common property resource shared by two countries in the presence of two forms of bilateral externalities: the tragedy of the commons and the environmental damage resulting from the exploitation of the resource. We demonstrate that both cooperative and non-cooperative forms of regulation produce a negative effect on firms’ profits, as they increase firms’ unit production costs. However, regulation can also entail a positive effect on profits by mitigating industry overproduction. We show that the magnitude of these two effects depends not only on the type of regulatory instrument, but also on the rate of resource extraction and the environmental damage in each country. We identify conditions under which the positive effect of regulation dominates its negative effect, thus increasing firms’ profits and ultimately incentivizing them to support the introduction of regulation, either at the national or international level.

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Notes

  1. 1.

    In the case of the Upper Paraná Atlantic Forest expansion of land use, owing to agriculture, cattle ranching, and extraction of timber for construction, furniture, and biofuel, led to severe forest fragmentation and degradation, with only 7.4% of the original forest cover remaining (Di Bitetti et al. 2003). In the case of the Aral Sea, heavy irrigation for water-intensive crops such as cotton and rice, and construction of hydroelectric dams severely reduced the amount of water flowing into the sea. This ultimately caused the sea to shrink, thereby creating one of the worst ecological disasters in Central Asia. Specifically, the decline of the Aral Sea drastically changed regional climate, landscape, river flow, water level and salinity, fish population dynamics, soil fertility and public health (Glantz 1999; O’Hara et al. 2000; Whish-Wilson 2002; Philip and Aladin 2008).

  2. 2.

    For instance, Iran and Iraq share the Al-Fakkah oil field; Iraq and Kuwait share the Rumaila oil field; and Kuwait and Saudi Arabia share the Khafji oil field; and all four countries are OPEC members.

  3. 3.

    As part of its effort to support the environment and sustainable development, OPEC requires from its member countries full, effective and sustained implementation of the United Nations Framework Convention on Climate Change (UNFCCC) and the Kyoto Protocol, which represent coordinated international environmental agreements. For further details, visit http://www.opec.org/opec_web/en/press_room/315.htm.

  4. 4.

    See, for example, Ostrom (1992), Ostrom et al. (1994), Bromley (1992), Baland and Platteau (1996) and Berkes and Folke (1998). In particular, this line of literature contends that the lack of cooperation between agents is often associated with over-exploitation of natural resources, whereas cooperative management would lead to an efficient consumption of the resource.

  5. 5.

    See Heyes (2009) for a review of this literature.

  6. 6.

    The two countries under consideration are, for instance, in political dispute or underdeveloped, and hence no significant amount of trade takes place between them. For example, in the context of the Aral Sea, products whose production requires river water (a tributary of the sea) are primarily for self-sufficiency or for trade with non-basin countries. For instance, Tajikistan, where the major part of Central Asia’s water resources originates, produces hydroelectricity exclusively for domestic consumption, with hydropower contributing to about 98% of total electricity production in 2009 (Liu et al. 2013). Similarly, Uzbekistan obtained 12% of its total electricity generation from hydropower in 2010, which it consumed domestically (Kochnakyan et al. 2013). In addition, Uzbekistan produces cotton using the river water and exports it mainly to China, Bangladesh, Korea and Russia (International Cotton Advisory Committee 2011)—countries that are not located in the Aral Sea drainage basin.

  7. 7.

    Players in the CPR game may collect precise information on payoff functions with repeated interaction, communication, signaling, or inspection. Therefore, the agents may know the mapping between decisions and payoffs. See, for example, Hackett et al. (1994), Ostrom et al. (1994), Gardner et al. (1997), Herr et al. (1997), Keser and Gardner (1999), Walker et al. (2000), and Casari and Plott (2003).

  8. 8.

    Note that when countries coordinate their policies in expression (6), each enjoys the residual stock of the CPR, i.e., Y can be enjoyed by both countries, since it is non-rival in consumption.

  9. 9.

    As a consequence, pollution is above the optimum (as well as the exploitation of the resource) ultimately yielding a lower welfare level when countries do not coordinate their policies than when they do. This result is relatively standard, and analogous to that in oligopoly games, where firms are better off coordinating their output choices than independently choosing their individual output.

  10. 10.

    The relative position of the cutoffs and their intersection points are discussed in the proofs of Corollary 2 and Propositions 34 and 5. For profit ranking and firm preferences towards regulation in different regions of the \((d^i,z^i)\) quadrant, see the discussions following the aforementioned propositions.

  11. 11.

    In a special case, when \(z^i = z^l = 0\), no environmental externalities (i.e., neither tragedy of the commons nor environmental damage) will be generated.

  12. 12.

    In a special case, when \(d^i = d^l = 0\), the consumption of the CPR generates neither internal nor transboundary pollution in two countries, but can still lead to the tragedy of the commons.

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Acknowledgements

A previous version of this paper was circulated under the title “Multicountry Appropriation of the Commons, Externalities, and Firm Preferences for Regulation.” We thank the co-editor, two anonymous reviewers, and the participants of the 11th Econometric Society World Congress, the 91th Western Economic Association International conference, and Agricultural and Applied Economics Association meeting for valuable comments and suggestions. This research is supported by the Utah Agricultural Experiment Station, Utah State University, and approved as journal paper number 9066. See the online appendix for supplementary materials and proofs.

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Correspondence to Sherzod B. Akhundjanov.

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Akhundjanov, S.B., Muñoz-García, F. Transboundary Natural Resources, Externalities, and Firm Preferences for Regulation. Environ Resource Econ 73, 333–352 (2019). https://doi.org/10.1007/s10640-018-0265-5

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Keywords

  • Common property resource
  • Bilateral externalities
  • Transboundary externalities

JEL Classification

  • H23
  • Q38
  • C71
  • C72