Scandinavian Working Papers in Economics

Research Papers in Economics,
Stockholm University, Department of Economics

No 2017:4: Trade Liberalization, Transboundary Pollution and Market Size

Rikard Forslid (), Toshihiro Okubo () and Mark Sanctuary ()
Additional contact information
Rikard Forslid: Dept. of Economics, Stockholm University, Postal: Department of Economics, Stockholm University, S-106 91 Stockholm, Sweden
Toshihiro Okubo: Keio University, Postal: Keio University, 2-15-45 Mita Minato-ku Tokyo,108-8345 Japan
Mark Sanctuary: Stockholm School of Economics, Royal Swedish Academy of Sciences, Postal: Department of Economics, Stockholm School of Economics, S-113 83 Stockholm, Sweden

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.

Keywords: Market size; emission tax; trade liberalisation; pollution haven effect

JEL-codes: D21; F12; F15

30 pages, June 26, 2017

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