Unilateral Environmental Policy Choices

Abstract

This paper demonstrates that the notion of environmental policy as a secondary trade barrier needs substantial modification when production pollution and consumption pollution coexist. The paper first focuses on local pollution and unilateral tax adjustments, showing that, under certain conditions, jointly increasing production taxes and consumption taxes to neutralize terms of trade effects raises welfare by more than consumption tax hikes alone in pursuit of terms of trade gains. Relatedly, this paper shows that production tax hikes alone resulting in terms of trade deterioration can increase welfare by more than that of the above policy mix. I then extend the analysis to the case where pollution emissions are global, showing that environmental policy as a secondary trade barrier can prevent emissions leakages and is therefore mutually welfare-improving. The main message of this paper is that regardless of whether pollution emissions are local or global, unilateral environmental policy is less harmful than previously thought, and a two-pronged policy approach relying on consumption taxes and production taxes is a good candidate for both unilateral and cooperative mitigation actions.