Climate Policies with Private Information: The Case for Unilateral Action

Countries often have private information about their willingness to pay for protecting the climate system. We use a principal-agent model to reexamine the economic case for unilateral action by individual countries, in our case of the principal. We find that the incentive structure that arises in an incomplete information framework may lead to a more positive assessment of unilateral action than in papers that neglect private information. First, we find that a unilateral commitment to emission reductions that is made before contract negotiations always reduces aggregate emissions, in contrast to the results in the seminal contribution by Hoel. Second, we show that the principal often has an interest to unilaterally reduce emissions below the level to which she would be obliged under the standard contract solution. Hence we provide an economic rationale for overcompliance. Multilateral externalities and type-dependent outside options, which are characteristic for climate policies, play a crucial role to explain these results.