Dynamic Environmental Policy in Developing Countries in the Presence of a Balance of Trade Deficit and a Tariff

Abstract

We first review the literature relating to the protection of the modern sector in developing countries (DCs). We then discuss the connections between protection, economic dualism, and optimal environmental policy in DCs. Next, we construct an intertemporal model of the environmental policy formulation process in a stylized DC in which there is a balance of trade deficit, and a tariff that protects the modern --- also the import competing and the polluting --- sector. The employment and output effects of three different pollution taxes are examined. These taxes incorporate alternate assumptions about the DC government's ability to commit to its announced course of action. The taxes are described, the dependence of these taxes on the extant tariff is analyzed, and the conditions that call for an activist policy are specified. Our analysis shows that the time inconsistency of some optimal programs and the existence of the tariff can prevent the DC government from attaining its employment and environmental goals.