A theory of mutual migration of polluting firms

Suppose that governments care about their tax revenue and local firms have some say in environmental regulations. Then, the level of employment and environmental compliance may be negotiated. We find that firms located in different countries can improve their threat-point payoffs by mutual migration. This in turn affects the negotiated output-employment and environmental regulations, which causes profits to increase if the firm's threat-point payoff is higher than that of the local government. The model predicts that pollution-intensive firms or firms with highly inelastic demands are more likely to move out. Increases in the government's valuation of the environment, or in the degree of globalization also cause mutual migration of dirty firms. The effect of a government caring about consumer surplus leads to a lower pollution tax, reducing firms' incentives to move out.