Sources of Comparative advantage in Polluting Industries

Abstract

We analyze the effects of environmental regulation on international trade flows. To guide empirical work we extend a standard model of international trade to incorporate pollution and environmental regulation. The model implies a simple cross-country, cross-industry empirical framework to study how environmental regulation and factor endowments combine to determine comparative advantage. We find that countries with weaker environmental regulation export relatively more in polluting industries, consistent with a pollution haven effect. Furthermore, this effect is quantitatively important and comparable in magnitude to traditional sources of comparative advantage such as skill and capital abundance.