We would be the first to admit that our simple theoretical model carries a heavy burden in providing us with the structure needed to isolate and identify the implications of international trade. We suggest however that earlier empirical investigations failed to find a strong link between environmental outcomes and freer trade precisely because they lacked a strong theoretical underpinning. With a more coherent theoretical framework we are able to look in the “right directions” for trade’s effect.
The remainder of the paper is organized as follows. In section 2 we outline our theory and in section 3 we describe our empirical strategy. In section 4 we present our empirical results estimating trade’s effect on pollution. Section 5 concludes. Appendix A contains summary statistics for data, plus additional notes on data sources and methods. Appendix B contains some additional supporting materials. In Appendix C we report results from a series of sensitivity tests of our specification.
A population of N agents lives in a small open economy that produces two final goods, X and Y, with two primary factors, labor, L, and capital, K. Industry Y is labor intensive and does not pollute. Industry X is capital intensive and generates pollution as a by-product. We assume constant returns to scale, and hence the production technology for X and Y can be described by unit cost functions cX(w,r) and cY(w,r). We let Y be the numeraire, set py = 1, and denote the relative price of X by p.