Trade and Environmental Policies With Special Interest Politics: A Case of Asymmetric Information

This paper presents a model on the political economy of trade and environmental policies in the presence of asymmetric information. Information asymmetries stem from the preference of the incumbent government towards welfare of the general voter and political contributions made by special interest groups. Special interest groups are owners of sector‐specific factors of production used to produce traded final goods and there exist negative production externalities. The incumbent uses trade and environmental policies to regulate trade flows and environmental quality, respectively. Results show that: (i) information asymmetries work in favour of special interest groups as they guarantee laxer environmental policy in comparison to the baseline scenario of complete information; (ii) trade policy in the domestic country is invariant of the information on the incumbent's preference over aggregate social welfare and reflect terms‐of‐trade effects and addresses production externalities generated abroad; (iii) including intermediate goods along with final goods in the model creates an additional layer of distortion in the environmental policy through cross‐sectoral effects on returns to the sector‐specific factors of production. The downward distortion in environmental policy worsens environmental quality, which adversely affects the general voters.