Implications of Inequality Aversion for International Climate Policy

Any solution to the problem of voluntary cooperation in international climate policy does not only have to overcome the notorious free rider incentives, but also has to comply with the notions of "equity" and "justice". Inequality aversion, i.e. the disutility of having a higher or lower payoff than others, is one important concept in this area of other-regarding preferences. In this paper, we analyse the implications of inequality aversion for international climate policy. For this purpose, we extend the Fehr and Schmidt (1999) model of inequality aversion to the context of full heterogeneity, i.e. players in our public good model are allowed to differ with respect to their initial endowments, their degrees of inequality aversion and to their marginal benefits and costs of contributions to the public good. Hence, the model developed in this paper captures all essential aspects of real world international climate policy. There, heterogeneous countries face the opportunity to contribute to the production of the global public good climate protection. The purpose of this paper is two-fold: Firstly, we derive simple analytical conditions that allow us to identify the circumstances under which perfectly heterogeneous countries are willing to contribute to the public good climate protection. Secondly, we check whether these conditions hold for important negotiating parties in the real world, e.g. China, the EU, Russia and the US. The main theoretical result is that a country’s benefit has to exceed some critical value as a necessary condition for contributing to the global public good climate protection, whereby this critical value depends on a country’s degree of inequality aversion, its position in the payoff ranking, its costs of contributing and other countries’ benefits. It is exactly this condition that is used for the empirical test. We employ data from Nordhaus’ RICE, a regionalised impact assessment model, to estimate empirical benefits and costs of climate protection for different regions. The data input for the degree of inequality aversion is taken from the experimental economics literature. We then show that for major countries involved in international climate policy such as China, the US and Russia, the necessary condition for contributing is violated – at least for the time horizon until 2055. Thus, although inequality aversion theoretically enhances the prospects for voluntary cooperation in providing public goods, it is advisable not to overestimate its potential for overcoming cooperation problems in real world climate policy.

Vogt, Carsten and Bodo Sturm (2011), Implications of Inequality Aversion for International Climate Policy, ZEW Discussion Paper No. 11-050, Mannheim.