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The debate over the role international trade plays in determining environmental outcomes has at times generated more heat than light. Theoretical work has been successful in identifying a series of hypotheses linking openness to trade and environmental quality, but the empirical verification of these hypotheses has seriously lagged. Foremost among these is the pollution haven hypothesis that suggests relatively low-income developing countries will be made dirtier with trade. Its natural alternative, the simple factor endowment hypothesis, suggests that dirty capital intensive processes should relocate to the relatively capital abundant developed countries with trade. Empirical work by Grossman and Krueger (1993), Jaffe et al. (1995) and Tobey (1990) cast serious doubt on the strength of the simple pollution haven hypothesis because they find trade flows are primarily responsive to factor endowment considerations and apparently not responsive to differences in pollution abatement costs. Does this mean that trade has no effect on the environment?

This paper sets out a theory of how “openness” to international goods markets affects pollution levels to assess the environmental consequences of international trade. We develop a theoretical model to divide trade’s impact on pollution into scale, technique and composition effects and then examine this theory using data on sulfur dioxide concentrations from the Global Environment Monitoring Project. The decomposition of trade’s effect into scale, technique and composition effects has proven useful in other contexts [see Grossman and Krueger (1993), Copeland and Taylor (1994,1995)] and here we move one step forward to provide estimates of their magnitude. We find that international trade creates relatively small changes in pollution concentrations when it alters the composition, and hence the pollution intensity, of national output. Combining this result with our estimates of scale and technique effects yields a somewhat surprising conclusion: if trade liberalization raises GDP per person by 1%, then pollution concentrations fall by about 1%. In the case of sulfur dioxide concentrations, free trade is good for the environment.