We consider a symmetric three-stage game played by a pair of regulator-firm hierarchies to capture the scale and technology effects. Each firm produces one good sold on the market. The production process generates pollution characterized by a fixed emission/output ratio, and cross-borders. Firms can invest in R&D in order to lower their emission/output ratio, and this activity is characterized by positive R&D spillovers. We show that R&D spillovers and the competition of firms on the common market help non-cooperating countries to internalize transboundary pollution more efficiently. Consequently, in most cases, when the positive externality increases, the levels of R&D and production increase while pollution decreases, implying an increase of the social welfare. However, in some other cases, pollution under common market increases with the R&D externality implying a decrease of the social welfare. Opening markets to the international trade leads to more investment in R&D and more production. In most cases, pollution under common market is lower than under autarky, implying a greater social welfare. Nevertheless, in some other cases, pollution under common market is higher than under autarky implying that opening markets deteriorates social welfare.
Transboundary pollution R&D spillovers common market social welfare