The Political Economy Linkage between Trade Liberalization and Domestic Environmental Regulations

Abstract

This paper considers the political economy linkage between trade liberalization and domestic environmental regulations in a duopolistic product market. We investigate the environmental consequences and welfare implications of a home country`s unilateral tariff reduction on a polluting good. In a framework where the domestic environmental tax is subject to the influence of the home firm, we find that a tariff reduction on a good producing a consumption-type externality will improve the home country`s environmental quality. Moreover, we find that the home country`s tariff reduction will unambiguously enhance the home country`s welfare; and it will damage the foreign firm`s profits and thus the foreign country`s welfare, provided that the weight that the home government attaches to its social welfare is sufficiently small. This result also suggests the possibility that a unilateral tariff reduction will achieve a Pareto improvement.