Abstract Chinese sulfur dioxide emissions cause acid rain in China and in Japan. This is an interesting case oftransboundary pollution to which economists have paid little attention. We examine simultaneous andsequential noncooperative games to illustrate the shortcomings of decentralized policy making.Sequentiality seems to be important, since one may interpret China's disposition against limiting itssulfur dioxide emissions as signaling policy leadership vis-à-vis Japan. Motivated by the inefficiency ofdecentralized behavior, we design an efficient and potentially implementable international scheme underwhich a benevolent international agency, mirrored after the Global Environment Facility, makes incometransfers from Japan to China.
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