Transboundary Natural Resources, Externalities, and Firm Preferences for Regulation

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.