Trade Liberalization, Transboundary Pollution, and Market Size

Abstract

This paper uses a monopolistic competitive framework to study the impact of trade liberalization on local and global emissions. We focus on the interplay of asymmetric emission taxes and the home market effect and show how a large-market advantage can counterbalance a high emission tax, so that trade liberalization leads firms to move to the large high-tax economy. Global emissions decrease when trade is liberalized in this case. We then simulate the model with endogenous taxes. The larger country, which has the advantage of the home market effect, will be able to set a higher Nash emission tax than its smaller trade partner, yet still maintain its manufacturing base. As a result, a pollution haven will typically not arise in this case as trade is liberalized. However, global emission increases as a result of international tax competition, which underscores that the importance of international cooperation increases as trade becomes freer.

Quality of Institutions, Technological Progress, and Pollution Havens in Latin America. An Analysis of the Environmental Kuznets Curve Hypothesis

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