Regulatory Competition, Transboundary Pollution and International Trade

Abstract

We consider a model of strategic trade and environmental policies with transboundary pollution. In each country a domestic market is served by a regulated monopoly that emits pollution to reduce its cost of production. We study the impact of opening borders and of delegating environmental policies at a supra-national level. Under complete information, opening borders leads to a reallocation of the production from the large country (with a high marginal cost) to the small country (with a low marginal cost). Total production increases leading, by technological complementarity, to an increase in the total level of pollution. Because each regulator does not completely internalize the social cost of pollution, the creation of a common market sometimes leads to a deterioration of total welfare. Centralization of environmental policies reduces, but does not remove entirely, this loss. Under asymmetric information, international competition generated by the common market enables to decrease the informational rents given up to the firms, thereby reinforcing the gain to open markets to international competition.

We thank an anonymous referee for helpful comments. A mathematical appendix is available form the authors on request.