Abstract
The creation of the internal market in Europe has raised the question of how the relocation of factors and the distribution of welfare gains are affected by the institutional competition among the countries involved. This paper is particularly concerned with environmental regulation. A two-country model is considered in which each country chooses its environmental policy in response to foreign policies which the country considers to be given. There are two types of externalities, a transboundary pollution spill-over and an effect on the rate of return on the mobile factor. The process of economic integration is modelled by lowering the costs of factor mobility. The impact on the environmental policies chosen by the countries and the welfare effects are analysed. The results are used to derive policy implications concerning the issues of institutional competition and the potential gains from cooperation.
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