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And lastly, our approach forces us to distinguish between the pollution consequences of income changes brought about by changes in openness from those created by capital accumulation or technological progress. We find that income gains brought about by further trade or neutral technological progress tend to lower pollution, but income gains brought about by capital accumulation raise pollution. The key difference is that capital accumulation favors the production of pollution intensive goods whereas neutral technological progress and further trade do not. One immediate implication of this finding is that the pollution consequences of economic growth are dependent on the underlying source of growth. Another more speculative implication is that pollution concentrations should at first rise and then fall with increases in income per capita, if capital accumulation becomes a less important source of growth as development proceeds.

The theoretical literature on trade and the environment contains many papers where either income differences or policy differences across countries drive pollution intensive industries to the lax regulation or low-income country. For example, Pethig (1976), Siebert et al. (1980), and McGuire (1982) all present models where the costs of pollution intensive goods are lower in the region with no environmental policy. One criticism of these papers is that while they are successful in predicting trade patterns in a world where policy is fixed and unresponsive, their results may be a highly misleading guide to policy in a world where environmental protection responds endogenously to changing conditions. Empirical work by Grossman and Krueger (1993) suggests that it is important to allow policy to change endogenously with income levels and in our earlier work (Copeland and Taylor (1994, 1995)) we incorporated the Grossman-Krueger finding to investigate how income-induced differences in pollution policy determine trade patterns.