Trade and Environmental Policies under Incomplete Information

The damage caused by the economic activities is one of the major problems of the world. On the one hand, countries try to support their own firms and motivate FDI by protectionist trade policies, and on the other hand, they try to protect environment via environmental policies. In this paper, we aim to analyze optimal trade and environmental policies using a two-stage game theoretic model where domestic developing country reveals the level of import tariff and emission tax in the first stage and the foreign firm from a developed country decides where to locate in the second stage. The foreign firm can either stay in its own country and exports to developing country or invest and produce in developing country (FDI). Domestic firm’s marginal cost is publicly known however, foreign firm can either have low cost or a high cost technology. Analyzing this model, we observe how trade and environmental policies and the location choice of the foreign firm are related and how these decisions affect the environmental pollution of the domestic country under uncertainty on foreign firm’s technology