Location choice under trade and environmental policies

In this paper, we use a game theoretic model to analyze the trade-off between the attractiveness of FDI and the environmental damage caused by production under asymmetric information. In the first stage, the domestic developing country reveals the level of import tariff and pollution tax under information uncertainty about the environmental damage that the foreign firm can cause. The foreign firm from a developed country decides where to locate afterwards with complete information about its own damage. Results show that the developing country can be better off encouraging FDI if and only if the marginal damage of pollution is sufficiently low. The optimal level of pollution taxes attracting FDI is higher than the marginal damage of pollution. However, the optimal pollution tax without FDI can be lower than the marginal damage of pollution with sufficiently high demand in the developing country.     

Information Exchange and Transnational Environmental Problems

This paper analyzes information exchange in a model of transnational pollution control in which countries use private information in independently determining their domestic environmental policies. We show that countries may not always have an incentive to exchange their private information. However, for a sufficiently high degree of predictability of domestic environmental policy processes, the expected welfare from sharing information is greater than the expected welfare from keeping it private. The minimum degree of policy predictability for which information sharing occurs increases with the level of environmental risk. Intuitively, information exchange can help mitigate the perception of global uncertainty (both political and scientific) that surrounds transnational environmental problems and potentially improve welfare if policymaking processes are sufficiently aligned with evidence-based approaches (predictable).     

Strategic competition and optimal parallel import policy

Abstract In a two‐country Hotelling type duopoly model of price competition, we show that parallel import (PI) policy can act as an instrument of strategic trade policy. The home firm’s profit is higher when it cannot price discriminate internationally if and only if the foreign market is sufficiently bigger than the domestic one. The key mechanism in the model is that the home firm’s incentive to keep its domestic price close to the optimal monopoly price affects its behavior during price competition abroad. We also analyze the welfare implications of PI policies and show that our key insights extend to quantity competition.     

Welfare‐reducing Domestic Cost Reduction*

We show that cost reduction by a domestic firm may reduce domestic welfare if it changes a foreign firm’s production strategy from foreign direct investment to export. Domestic cost reduction can be welfare reducing when the domestic market is sufficiently small and domestic firm’s marginal cost of production is higher than the foreign firm’s marginal cost of production under foreign direct investment, which is a usual feature of trade between developed and developing countries. So, developing countries with small domestic markets need competent competition policies when encouraging domestic innovation and also trying to attract foreign direct investment.     

Intertemporal Emission Permits Trading Under Uncertainty and Irreversibility

This paper analyzes the effect of emission permit banking on clean technology investment and abatement under conditions where the stringency of the future cap is uncertain. We examine the problem of heterogeneous firms minimizing the cost of intertemporal emission control in the presence of stochastic future pollution standards and emission permits that are tradable across firms and through time. A firm can invest in clean capital (an improved pollution abatement technology) to reduce its abatement cost. We consider two possibilities: that investment is reversible or irreversible. Uncertainty is captured within a two period model: only the current period cap is known. We show that if banking is positive and marginal abatement costs are sufficiently convex, there will be more abatement and investment in clean technology under uncertainty than there would be under certainty and no banking. These results are at odds with the common belief that uncertainty on future environmental policy is a barrier to investment in clean capital. Moreover, under uncertainty and irreversibility, we find that there are cases where banking enables firms to invest more in clean capital.     

Foreign competition and social efficiency of entry

We consider social efficiency of firm-entry in the presence of foreign competition. If the labour markets are competitive, entry is insufficient for the domestic country if the transportation cost is low and the marginal costs of the domestic firms are sufficiently higher than the marginal cost of the foreign firm. In the presence of a domestic labour union, entry is always socially insufficient for the domestic country. Hence, the anti-competitive entry-regulation policy may not be justified in an industry facing foreign competition, and it may depend on the transportation cost, the marginal cost difference between the firms and the domestic labour market structure.     

Environmental Policy with Endogenous Plant Locations

In a game between the governments of two countries, each chooses its own environmental policy. The Nash equilibria of the game are generally not Pareto optimal. On the one hand, each country may want to attract industry, giving it an incentive to choose low environmental taxes or standards. On the other hand, if disutility from pollution is sufficiently high, each country might prefer that a firm locates only in other countries. This effect tends to make the environmental policy under non-cooperation stricter than it would be with cooperation.     

Asymmetric Demand Information and Foreign Direct Investment*

We examine the FDI versus exports decision of firms competing in an oligopolistic (quantity‐setting) market under demand uncertainty and asymmetric information. Compared to a firm that chooses to export, a firm that chooses to set up a plant in the host market has superior information about local market demand. In addition to the well‐known tension between the fixed set‐up costs of investment, the additional variable costs of exports and oligopoly sizes, the incentive to invest abroad is explained by the strategic learning effect. FDI may be observed even if trade costs are zero. The analysis is robust to price competition and to the possibility that a foreign firm can engage in both FDI and exports.     

Cost Uncertainty and Unilateral Abatement

Unilateral abatement is sometimes advocated in order to set a good example that will make other countries follow. The aim of this paper is to investigate whether existence of correlated cost uncertainty provides an incentive for a country to undertake unilateral abatement. The theoretical model is driven by two main mechanisms; first, a learning effect, as the follower country might reduce its risk premium as it can observe the cost level in the leader country. Second, there is the public good effect, i.e., the marginal benefit of abatement declines when abatement is a public good and other countries contribute to pollution reductions. Results shows that unilateral abatement would be efficient in reducing uncertainty about the unit costs of abatement if a country with low cost uncertainty would undertake abatement first, while a country with initially high cost uncertainty would follow. However, countries may prefer to act simultaneously because of the larger uncertainties that are inherent in a sequential game.      

Technology choice,relative performance pay,and worker heterogeneity

We identify a new problem that may arise when heterogeneous workers are motivated by relative performance pay: if workers’ abilities and the production technology are complements, the firm may prefer not to adopt a more advanced technology even though this technology would costlessly increase each worker’s productivity. Due to the complementarity between ability and technology, under technology adoption the productivity of a more able worker increases more strongly than the productivity of a less able colleague. As a consequence, both workers’ motivation to exert effort is reduced. We show that this adverse incentive effect is dominant and, consequently, keeps the firm from introducing a better production technology if talent uncertainty is sufficiently high and/or monitoring of workers is sufficiently precise.     

Regret theory and the competitive firm

This paper examines the production decision of the competitive firm under uncertainty when the firm is not only risk averse but also regret averse. Regret-averse preferences are characterized by a modified utility function that includes disutility from having chosen ex-post suboptimal alternatives. The extent of regret depends on the difference between the actual profit and the maximum profit attained by making the optimal production decision had the firm observed the true realization of the random output price. If the firm is not too regret averse, we show that the conventional result that the optimal output level under uncertainty is less than that under certainty holds. Using a simple binary model wherein the random output price can take on either a low value or a high value with positive probability, we show the possibility that the firm may optimally produce more, not less, under uncertainty than under certainty, particularly when the firm is sufficiently regret averse and the low output price is very likely to prevail.     

Environmental Regulation: An Incentive for Foreign Direct Investment

Empirical evidence has so far failed to confirm that lenient environmental regulation attracts investment from polluting firms. In a Cournot duopoly with a foreign firm and a domestic firm, we show that the foreign firm may want to relocate to the domestic country with stricter environmental regulation, when the move raises its rival domestic firm's cost by sufficiently more than its own. The domestic (foreign) country's welfare is (usually) lower with foreign direct investment.     

Centralized versus decentralized taxation of mobile polluting firms

We consider a world in which a mobile polluting firm must locate in one of two regions. The regions differ in two dimensions: their marginal cost of pollution and the production cost of the firm. It is shown that under incomplete information on regional marginal costs of pollution, fiscal competition may lead to the sub-optimal location of the firm. We also show that under incomplete information, a sub-optimal location is less likely under centralized than under decentralized taxation.     

Human Capital and Growth: New Evidences from African Data

Assuming that all firms have rising marginal costs, merger between a dominant firm and one of the firms in the competitive fringe is considered. The effects on market price and output, profits and market power are shown when the dominant firm operates as a two-plant firm after merger and output arises from both plants. It is proved that if merger offers no efficiency gain, then market price always rises; and if merger results in efficiency gain, then market price falls if and only if there are sufficiently large number of firms in the fringe. In any case, there is profit incentive for merger to take place. [611]     

Pollution standards, technology investment and fines for non-compliance

In this paper, we analyze whether it is socially desirable that fines for exceeding pollution standards depend not only on the degree of non-compliance but also on technology investment efforts by the polluting firms. For that purpose, we consider a partial equilibrium framework where a representative firm chooses the investment effort and the pollution level in response to an environmental policy composed of a pollution standard, an inspection probability and a fine for non-compliance. We find that the fine should strictly decrease with the investment effort when (i) there are administrative costs of sanctioning; (ii) the optimal policy induces non-compliance; and (iii) either the fine is sufficiently convex in the degree of non-compliance or the investment effort decreases marginal abatement costs significantly.     

Domestic R&D,Foreign Direct Investment and Welfare

This paper provides a new rationale to examine the two‐way relationship between domestic research and development (R&D) and foreign direct investment (FDI), as well as their impacts on domestic welfare. Our analysis is based on the strategic interaction in cost‐reducing investment decisions between domestic firms and a foreign firm, which is different from the common factors that are discussed in the literature such as spillovers and technology sourcing. Our results are as follows. We show that domestic R&D investment may either increase or decrease the foreign firm's FDI incentives. Further, depending on the marginal cost of domestic firms, domestic R&D incentives can always increase regardless of the effects of domestic R&D investment on the foreign firm's FDI decision. Finally, we find that domestic welfare improves under domestic cost reduction if the slope of the marginal cost of domestic R&D investment is sufficiently small.     

How does the design of international environmental agreements affect investment in environmentally-friendly technology?

In this paper, we investigate how the design of international environmental agreements (IEAs) affects the incentives for the private sector to invest in environmentally-friendly technology. The givens are a transboundary pollution problem involving two asymmetric countries in terms of benefits arising from global abatement. There is a single polluting firm in each country. We account for two types of IEAs: an agreement based on a uniform standard with transfers and an agreement based on differentiated standards without transfers. To carry out this study, we use a two-stage game where the private sector anticipates its irreversible investment given the expected level of abatement standards resulting from future negotiations. Our findings indicate that the implementation of the agreement based on a uniform standard with transfers may be preferable for the two countries, as it creates greater incentives for firms to invest in costly abatement technology. This result arises when this technology’s level of the sunk cost of investment is low. If this level is sufficiently high, the implementation of the same agreement is not beneficial to countries, because it takes away the incentive of each firm to invest in new abatement technology. Moreover, this agreement is not able to generate any positive gains for either country through cooperation, thus no country is motivated to cooperate.     

A Note on Emissions Taxes and Incomplete Information

In contrast with what we perceive is the conventional wisdom about setting a second-best emissions tax to control a uniformly mixed pollutant under uncertainty, we demonstrate that setting a uniform tax equal to expected marginal damage is not generally efficient under incomplete information about firms’ abatement costs and damages from pollution. We show that efficient taxes will deviate from expected marginal damage if marginal damage is increasing and there is uncertainty about the slopes of the marginal abatement costs of regulated firms. Moreover, tax rates will vary across firms if a regulator can use observable firm-level characteristics to gain some information about how the firms’ marginal abatement costs vary.     

STAY OR LEAVE? CHOICE OF PLANT LOCATION WITH COST HETEROGENEITY

Using a two-country model, we examine location choices by two domestic firms when they serve only the domestic market and their cost structures differ. The findings indicate that whether the firm that has a greater incentive for foreign direct investment is more or less efficient depends on the differences in domestic and foreign marginal costs, trade costs, and the presence of fixed costs. Plant locations may not be uniquely determined. In particular, a small change in trade costs may reverse plant location. Moreover, a decrease in transport costs in the presence of foreign direct investment may deteriorate domestic welfare.     

The effects of abandonment options on operating leverage and forward hedging

This paper examines the behavior of the competitive firm under output price uncertainty when the firm is endowed with an abandonment option and has access to a forward market for its output. When the realized output price is less than its marginal cost, the firm optimally exercises its abandonment option and ceases production. The firm lets its abandonment option extinguish, thereby producing up to its capacity, only when the realized output price exceeds its marginal cost. The ex post exercising of the abandonment option as such convexifies the firm's ex ante profit with respect to the random output price. We show that neither the separation theorem nor the full-hedging theorem holds in the presence of the abandonment option. The firm under-hedges its output price risk exposure in the forward market wherein the forward price contains a nonpositive risk premium. When the set of hedging instruments is expanded to include options, we show that both the separation and full-hedging theorems are restored. We further show that the firm prefers options to forwards for hedging purposes when both types of contracts are fairly priced.