Taxes and subsidies for pollution-intensive industries as trade policy

Abstract This paper constructs a model of international oligopoly with negative externalities in production, in which optimal environmental policy responses to foreign emission tax and subsidy programs can be calculated. It is shown that by granting subsidies for abatement efforts or for a heavily taxed polluting input, domestic net welfare is improved by capturing a greater share of the world market. Since the subsidy programs are supposed to improve the quality of the global environment, they can be justified on environmental grounds. In addition, we show that a Pigouvion emission tax restores efficiency in natural resource allocation, whereas subsidy programs are in principle used as instruments in imperfectly competitive international markets.