ENVIRONMENTAL POLICY AND TRADE LIBERALIZATION: THE CASE OF TRANSBOUNDARY POLLUTION FROM CONSUMPTION

Abstract This paper develops a reciprocal market model of international duopoly with transboundary pollution from consumption to examine the effects of bilateral tariff reductions on the equilibrium pollution tax and welfare. I show that tariff reductions induce each country to raise an emission tax and that trade liberalization is welfare improving if the parameter of pollution damages is sufficiently large. These results are in contrast to the case of production‐generated pollution, and I seek the reason for this contrast.