Environmental standards in a large open economy revisited

Abstract

Oates and Schwab (J Public Econ 35:333–354, 1988) consider an economy with mobil capital and jurisdictions that suffer from local pollution. They show that welfare-maximizing jurisdictions implement the first-best, if they take prices as given and have at their disposal a capital tax and an environmental standard. Petchey (J Public Econ Theory 17:461–467, 2015) claims that the efficiency result of Oates and Schwab can be extended to a large price-influencing jurisdiction. To enable efficiency comparisons, we expand his model by a second jurisdiction with price-elastic excess supply of capital and prove that his large price-influencing jurisdiction sets an environmental standard and a capital tax that fail to be (Pareto) efficient. Thereby we clarify that and why the allocation of emissions is inefficient, in general, although the allocation rule for emissions is not.