Trade and the Environment: Spatial Separation under Product Differentiation

Abstract

This paper presents a two-country model of monopolistic competition in which production of differentiated products in the manufacturing sector lowers productivity in the agricultural sector through a cross-sector pollution externality. We show that free trade raises the spatial separation of the incompatible industries and is possibly harmful to the country that becomes a net exporter of the manufacturing products. Also, we reveal that with product differentiation, trade only in the manufacturing products can be the most beneficial trade regime for the country holding a comparative advantage in those products.