Sunk Capital and Negotiated Resolutions of Environmental Conflicts

Two nations seek a cooperative agreement to control bilateral flows of an industrial pollutant. From previous noncooperative production choices, the nations hold a certain amount of sunk capital. If production requires relatively large investments in sunk capital, the nations may find that they cannot negotiate production quotas that improve on their noncooperative choices. When the nations find cooperation worthwhile, negotiated levels of production will be higher than in the absence of sunk capital. Furthermore, both nations are motivated to attempt to manipulate the terms of the agreement by making strategic investments in sunk capital prior to its completion.