Environmental policy, intra-industry trade and transfrontier pollution

The paper discusses effects of domestic environmental policy on foreign emissions and on transboundary pollution. We use a Dixit-Stiglitz type model of monopolistic competition with an endogenous number of firms. Production generates environmental externalities which spill over to the other country. It is shown that environmental policy has an impact on market structure at home and abroad. These market structure effects induce changes in emissions abroad. In contrast to what has been derived in earlier contributions, it turns out to be possible that tighter environmental standards at home lead to less emissions abroad. The paper derives these results and provides the economic intuition behind them. Finally, conditions for optimal environmental policies are derived.