Transboundary Pollution, Industry Location and Productivity Growth

This paper studies how environmental policy designed to reduce transboundary pollution affects long-run productivity growth through shifts in the geographic location of industry. We construct a two-country endogenous growth and endogenous market structure framework in which there is a positive link between the geographic concentration of industry and the strength of knowledge spillovers from production to innovation. Emissions are generated as a byproduct of production. We show that an increase in the emissions tax of the country with a larger (smaller) share of industry lowers the concentration of industry leading to weaker (stronger) knowledge spillovers and a slower (faster) rate of productivity growth. In addition, we identify cases where a rise in the emissions tax of the country with a smaller share of industry lowers emissions while increasing productivity growth. With endogenous emissions taxes, a numerical analysis shows that stronger knowledge diffusion leads to higher tax rates, faster productivity growth, and lower global emissions. In contrast, trade liberalization leads to lower tax rates and eventually raises global emissions despite faster productivity growth. Our results highlight that the relationship between productivity growth and global emissions depends critically on the form of economic integration.