International Positive Production Externalities and Capital Movement

I attempt to establish whether positive international externalities generate an incentive for cooperation between governments and how that incentive depends on the degree of capital mobility between economies. I adopt a simple economic model incorporating the international linkage of national economies. Allowing for capital mobility does not destroy the incentive to cooperate, since it does not affect optimal policies in the symmetric long run equilibrium. In the short run, capital mobility triggers a 'race to the bottom' effect, which comes in addition to the 'free riding' effect existing because of positive international production spillovers. Thus, allowing for capital mobility intensifies the need to cooperate.