Environmental Taxation and Trade Policy: The Role of International Coordination in the Presence of Local Pollutants

We examine a three-country trade model where two producer countries export a homogeneous good to a third country, and production results only in local pollution. Our contribution is at the intersection of trade and environment and we show how the trade and environmental policies interact to determine the efficacy of multilateral environmental agreements (MEA). In this context, we allow the exporting countries to cooperate either on a broad objective of improving welfare or on a narrow target of reducing pollution. We show that if the exporting countries coordinate on welfare, the net emissions and the environmental damage would be the lowest, resulting in the highest gain for the exporting countries. Interestingly, if countries coordinate only to reduce environmental damage, then the net emissions are higher than the levels when the exporting countries do not cooperate at all. Our results hold under various policy scenarios, i.e. when exporting countries utilize only a single instrument of either environmental or trade policy or both the trade and environmental policies. We also examine the implications on global welfare.