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This paper bridges the gap between two‐country Ricardian trade models where differences in environmental policies create pollution havens in a poorer region with weaker pollution regulations, and 2 × 2 Heckscher–Ohlin models that predict under certain conditions that pollution havens may occur in a richer region with tighter regulations. By relaxing the Heckscher–Ohlin assumptions of factor price equalization and no specialization, we show how creation of pollution havens in either region is possible, due to the interplay of policy and factor‐endowment motives. We also analyze the conditions for creating pollution havens in the cases of exogenous and endogenous environmental policy.

We investigate the interaction between a developed country that imports a carbon-intensive product, such as electricity, and a transitioning economy that exports the product. Production of the good generates a transboundary externality related to climate change; if this externality is priced improperly, the application of a feed-in tariff or border tax adjustment can provide an indirect policy instrument. We analyze the application of such a measure in a stark model where the importing country cares about climate-related damages while the exporting country does not; this can be viewed as reflecting a scenario where the (developed) importing country is more concerned about climate change than is the (transitioning) exporting economy. Because climate change will occur over a long time frame, the problem is dynamic. In this modeling context, we describe the manner in which the (second-best) tariff-cum-border tax adjustment relates to the carbon stock.

Recent events have fueled the discussion of the susceptibility of government policies to lobbying by foreigners. In this paper, we consider the role of foreign lobbying in determining trade and environmental regulations. In particular, we develop a differential game to examine the effects of foreign lobbying on the solutions for transboundary pollution stock control involving two trading countries linked by trade flows. Our analysis suggests that the success of trade policy as an instrument for enforcing cooperation and internalizing externalities depends critically on the degree of governments' corruptibility and susceptibility to international political influence. The model explores optimal pollution regulation strategies, the evolution and equilibrium level of pollution stock, and welfare implications under two different scenarios: in the presence and in the absence of foreign lobbying. Comparison of the outcomes of these scenarios shows that foreign lobbying may lead to a less stringent regulation of the transboundary pollution externality and to degradation of environmental quality.2

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