International positive production externalities under a transfer payment scheme – the case for cooperation

Abstract

In the present work we try to find out whether the existence of positive international externalities generates an incentive for cooperation between governments and if the adoption of a transfer payments scheme moderates that intensive. We adopt a simple economic model incorporating the international linkage of national economies. Utility proves always to be higher when countries cooperate than when they play Nash to each other. We then add a transfer payment scheme and prove it intensifies the intensive to cooperate, since a moral hazard problem arises on the top of the free riding problem.

JEL Classification: H23; F35; F42

Keywords: Optimal Taxation, International Policy Coordination, Production Externalities, Foreign Aid, Intertemporal Choice.