Transboundary Pollution and the Gains from Trade

We analyse the effects of transboundary pollution on trade patterns and welfare in a general equilibrium trade model. Production in a dirty industry generates pollution that negatively effects productivity, both at home and abroad, in a clean industry. Trade may lead to the spatial separation of production but the existence of transboundary pollution can offset the benefits from specialization. We present a general model in which the effects of a country’s pollution is country specific. We analyse particular cases that correspond to an acid rain problem and a problem in which one country has a cleaner technology than the other. We also present some results for small, open economies to examine the effects of transboundary pollution in the absence of terms of trade effects. We acknowledge useful comments from Brian Copeland, Scott Taylor, participants at the Midwest International Economics Conference, and seminar participants at the University of Calgary, and University of British Columbia.