Trade and the Environment with Heterogeneous Firms

As the world is becoming more globalized and international trade agreements proliferate, there is a rising concern that trade liberalization may be detrimental to the environment. In a seminal paper Antweiler, Copeland, and Taylor (2001) identify three channels through which may trade affect the environment: Reducing trade barriers increases output (scale effect), abatement expenditures (technique effect), and changes the composition of goods produced (composition effect). All these channels operate at the country level and/or the industry levels. In this paper we focus on the effect that trade liberalization has on the pollution behavior of individual firms. We develop a theoretical framework that is able to account for differences in pollution behavior across firms within the same industry by embedding a model of trade with heterogeneous firms into the classical literature of trade and the environment following Antweiler, Copeland and Taylor (2001). The model shows that firm heterogeneity is important in determining the economy’s aggregate behavior. In particular, more productive firms are less pollution intensive and are more likely to be exporters than less productive firms. The model identifies a new channel through which trade affects the environment: a “selection effect”. International trade causes the less productive firms within an industry to exit. Since less productive firms are more pollution intensive, through this channel international trade reduces pollution intensity by “selecting” these firms out of the industry.