Trade Liberalization, Pollution and Welfare:Theoretical Analysis with Reference to Informal Manufacturing Sector

Abstract

This paper examines the impacts of foreign capital inflow and reduction of import duty on environmental pollution and social welfare with reference to an informal sector. The informal sector produces a non-traded intermediate good for the formal sector and generates pollution. Owing to environmental regulations, the formal sector pays the pollution tax as it shifts the burden of production to the informal manufacturing sector. Under certain restrictive conditions, an inflow of foreign capital increases pollution but at the same time increases social welfare. In addition to a reduction of import duty, it reduces pollution and under some reasonable conditions increases social welfare.