Trade, Capital Accumulation, and the Environment

To highlight endogenous capital accumulation in shaping the interaction between trade and the environment, I develop a two-sector Ramsey model featuring agriculture impaired by pollution from production. Trade raises capital rental and encourages investment. Under laissez faire, this scale effect leads to environmental degradation in the long run, even if the economy specializes in the relatively clean sector. Specialization pattern in the long run depends upon pre-trade comparative advantage. Welfare gains from trade is ambiguous. The social optimum can be achieved through a dynamic version of the Pigouvian tax, with a lump-sum transfer to households. Under optimal policy, trade does not necessarily harm the environment. The long-run specialization pattern may depend upon the initial condition as well.