Cross-country heterogeneity in production–environment nexus and international trade

Abstract

This study examines the interplay between international trade and the environment using a dynamic two-country, two-sector model that captures the impact of economic activities on environmental quality and the subsequent feedback on resource-good sector productivity. We focus on the scenario in which two countries differ in sectoral ranking of environmental impacts and export their respective “dirtier” goods under trade. We show that in this context, trade harms long-term environmental quality in both countries, and the welfare effects of trade depend on the magnitude of productivity and terms-of-trade changes. Smaller pre-trade comparative advantages and greater trade-induced environmental deterioration increase the likelihood of welfare loss. The presence of such cross-country differences can result in multiple equilibria under trade, with contrasting welfare implications. We calibrate the model using data from China and Ghana to demonstrate its real-world relevance. These findings highlight the importance of considering country-specific characteristics of production–environment relationships in assessing trade impacts and designing policies.