The Environmental Industry, Environmental Policies, and International Trade

Abstract

  In this paper we construct a two country model with a final good and an environmental good such as a pollution abatement equipment to examine the formation of comparative advantage based on the international differences of environmental policies and the effects of the emission tax under free trade. The main results of our paper are as follows. First, the subsidy on the environmental good purchase can be a substitute for the emission tax. That is, the government can impose the lower emission tax by raising the subsidy in order to achieve the first best allocation. Second, a raise in the emission tax decreases the relative price of the environmental good while a raise in the subsidy increases the relative price. Hence, ceteris paribus, the country with a higher emission tax or a lower subsidy on the use of the environmental good has a comparative advantage in this good. Third, the effects of the emission tax in one country on the amount of pollution and welfare depends on the specialization pattern under free trade.