Production Externalities, Environmental Taxes, and the Gains from Trade

Soham Baksi () and Michael Benarroch

Departmental Working Papers from The University of Winnipeg, Department of Economics

Abstract: We analyze the effects of environmental taxation on the pattern of and gains from trade in a two-country Ricardian framework, where production in a polluting sector (e.g. manufacturing) adversely affects productivity in an environmentally sensitive sector (e.g. agriculture). The two countries differ in terms of their production technology so that the productivity loss suffered by the environmentally sensitive sector is higher in the dirtier country. When the countries do not pursue any environmental policy, the dirtier country has a comparative advantage in the polluting good and exports that good in the trading equilibrium. If preference for the polluting good is low, the dirtier country loses from trade while its trading partner gains. Global gains from trade are also negative as the market determined pattern of trade is inefficient. Introduction of a unilateral pollution tax by the dirtier country can enable it to reverse the pattern of trade and the distribution of the gains from trade, such that international trade becomes welfare-improving for that country as well as globally. The conventional pollution haven result may get reversed in the presence of cross-sectoral externalities, as each country has an incentive to set the tax such that it exports the good that is more preferred by consumers.

Keywords: Ricardian model; Production externality; Pollution tax (search for similar items in EconPapers)
JEL-codes: F18 Q56 (search for similar items in EconPapers)
Pages: 25 pages
Date: 2015-10
New Economics Papers: this item is included in nep-ene, nep-env and nep-int
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