Soham Baksi

Regional versus Multilateral Trade Liberalization, Environmental Taxation, and Welfare

We consider strategic trade among identical countries and compare the impacts of multilateral versus regional tariff reduction on equilibrium pollution tax and social welfare. While both forms of trade liberalization increase production and consumption in the tariff-reducing countries, regional trade liberalization also reduces production in a non-participating country and may decrease its consumption. When pollution is local, regional and multilateral trade liberalization have similar impacts in the tariff-reducing countries. In contrast, when pollution is perfectly transboundary, regional (multilateral) trade liberalization (i) weakens (may strengthen) environmental protection in the tariff-reducing countries, and (ii) in the neighbourhood of free trade, may increase (decreases) welfare of the tariff-reducing countries.

Transboundary Pollution, Trade Liberalization and Environmental Taxes

In a bilateral trade framework, we examine the impact of tari¤ reduction on the op- timal pollution tax and social welfare when pollution is transboundary. Strategic considerations lead countries to distort their pollution tax in the non-cooperative equilibrium. Trade liberalization changes the distortion, and consequently the pol- lution tax and welfare, in ways that depend on the extent to which pollution is transboundary. We find that when the pollution damage parameter is sufficiently small (large), bilateral tariff reduction always decreases (increases) the pollution tax, irrespective of the value of the transboundary pollution parameter. However, when the pollution damage parameter takes intermediate values, bilateral tari¤ reduction decreases the pollution tax if and only if the transboundary pollution parameter is sufficiently large (or even sufficiently small, in certain cases). More- over, with pollution being transboundary, the impact of trade liberalization on welfare is non-monotonic and concave. The greater the extent to which pollution crosses borders, the more likely is trade liberalization to reduce welfare.