The Environment and Welfare Implications of Trade and Tax Policy

Abstract

Developing countries with comparative advantage in dirty industries face the risk of environmental degradation unless appropriate policy is implemented to curtail industrial emission. Using applied general equilibrium analysis, we examine how trade influences the transfer of environmental effects and assess the welfare and environmental implications of alternative pollution abatement policies for Indonesia. Our results indicate that unilateral trade liberalization by Indonesia would increase the ratio of emission levels to real output for almost all major pollution categories. More importantly, when tariff removal is combined with a cost-effective tax policy, the twin objectives of welfare enhancement and environmental quality improvement may be achieved. This sheds new light on the positive role of trade for sustainable development.

Keywords: trade and environment, pollution, Indonesia, applied general equilibrium model

JEL Classification: F13, O53, Q28