The Income and Production Effects of Leakage∗

In general equilibrium, Home’s stricter environmental policy can either increase or decrease trading partners’ pollution levels, resulting in positive or negative leakage, respectively. This experiment holds fixed partners’ policies. Home’s stricter policy leads to a reallocation of its factors of production, creating an income and a production effect. These combined effects determine the sign of leakage. The production effect is related to a technical feature of production, “separability”. A partial equilibrium analog to a general equilibrium model does not take into account endogenous income and factor prices. Under plausible conditions this partial equilibrium model overstates the magnitude of leakage.