International Rivalry of Polluting Firms Under Flexible Regulation^*

We construct a model of strategic environmental policy with flexible regulation in an international duopoly context. Firms can affect future environmental regulation through a prior investment in abatement. We demonstrate that the strategic use of environmental policy leads to lower welfare and higher pollution. We further illustrate that when the policy instrument in use is emission standards, then pollution, profits and welfare are higher compared to the case where pollution taxes are implemented. Finally, we claim that flexibility in environmental policy is superior in terms of profits and welfare relative to a prior commitment to a certain emission standard.