Intra-industry trade and heterogeneity in pollution emission

This paper develops a model of intermediate goods firms heterogeneity with respect to a pollution parameter to analyze the effects of intra-industry trade on final good output, pollution and welfare. By focusing on intra-industry trade we consider trade between similar countries. We analyze both trade between developed countries, and trade between developing countries. In our model, final good producers pay an environmental tax on the total pollution emitted in their country. Therefore, final good producers determine the overall level of pollution by demanding ‘cleaner’ or ‘dirtier’ intermediate goods. To focus on intra-industry trade we consider only intermediate goods firms trade. We analyze three scenarios: closed economy; open economy with no impediments to trade; and open economy with transportation cost. Our main findings are: i. a developing country closed to trade faces lower final good output and higher total pollution and is thus worse off than a developed country; ii. countries are better off under trade than under autarky, regardless of their development level; and iii. an open economy with low transportation costs are better off than an open economy with no impediments to trade.