Optimal Control of Acid Rain in a Federation with Decentralized Leadership and Information

We examine some aspects of the acid rain problem in the European Union. Acid rain is a by-product of electricity production, and the EU is a federal system characterized by decentralized leadership; that is, regional governments are leaders and the center is a common follower. Regional governments design environmental policies and the center designs an interregional income redistribution policy in a setting with decentralized information. Information is decentralized in that an upwind regional power plant is privately informed about its technology. We show that the subgame perfect equilibrium of a game with decentralized leadership and information is constrained socially optimal.