Proposition 1. Consider two economies which are identical, except with respect to openness (that is, they have the same scale, per capita income, population, tastes, technology, and relative factor abundance). (a) Suppose that both countries export the polluting good. Then pollution is higher in the country that has lower trade frictions. (b) Suppose that both countries import the polluting good. Then pollution is lower in the country that has lower trade frictions.
Proof: Suppose country 1 has lower trade frictions than country 2. In case (a), we have b1 < b2. In case (b) we have b2 < bb Now apply (2.22).
The means by which a country is made cleaner or dirtier works through its impact on domestic relative prices. When b > 0 (or when p w > 0) the relative price of the pollution intensive good rises. Holding the abatement intensity constant, an increase in the relative price of X stimulates the output of X, and hence increases pollution via this composition effect. Second, for given levels of the pollution tax, an increase in the price of X increases the cost of abatement activity and this also increases pollution. When b < 0 (or when p w < 0) just the opposite occurs. While all countries in our sample will respond similarly to a change in world prices, their response to a change in trade frictions depends on their comparative advantage. This feature of our theory provides a method for identifying the composition effect created by freer trade. It suggests that some of the variation in our pollution data could be explained by a country’s openness, but only after we have conditioned on those country characteristics that determine comparative advantage.