Are trade integration and the environment in conflict? The decisive role of countries’ strategic interactions

Are trade integration and the environment in conflict? I address this controversial issue in a framework of intra-industry trade of a differentiated good produced by firms in monopolistic competition who choose to enter into a market and whose activity pollutes. Two mechanisms are at work in the model: first, unilaterally strengthening a national environmental policy leads to firm relocations. Second, trade integration makes firms more sensitive to any difference in environmental policy between countries. The model then predicts that the non-cooperative environmental regulation is too strict with regard to local pollution and too lax with regard to global pollution and that trade integration reinforces the incentives to strategically use this instrument. As a result, trade integration, which has no direct effect on the environment, generates less local pollution but more global pollution through the environmental policy response it triggers. These effects can be decomposed into a technique effect and a scale effect operating both at the extensive and the intensive margins, highlighting the decisive role of strategic interactions between countries and of firms' decisions.