Endogenous Technical Change and Pollution Havens A Two-Country Dynamic Framework Corrado Di Maria ∗ Tilburg University The Netherlands Sjak Smulders † Tilburg University The Netherlands This version May 30, 2004 Abstract Our paper focuses on the role of endogenous technology and technology spillovers in explaining cross country differences in pollution and in influenc- ing the pollution haven effect of international trade. We present a North-South trade model, in which technology is endogenously developed in the North and adopted in the South. The model features environmental regulators who choose national environmental policies by trading off the income gains from a rise in pollution against the disutility from additional pollution. We rule out both differences in environmental stringency through income effects and from differ- ences in factor-endowments which traditionally give raise to pollution havens. We show that without goods trade and in the absence of technology subsidies the North imposes more stringent environmental regulation than the South. Moving to the trading equilibrium, we show that with exogenous technology the standard results arise in our model: trade makes the South specialise in pollution-intensive goods. We furthermore show that when technological change is endogenous this pollution haven effect can be reversed, depending on how well polluting inputs can be substituted by other inputs. JEL Classification: F18, O13, O33, Q21. Keywords: Pollution Havens, Endogenous Technical Change, International Trade. 1 Introduction In the debate about the international aspects of environmental policy, two main issues are important. On the one hand, the studies that go under the general head- ing of the Environmental Kuznets Curve (EKC) point out a specific relationship between income levels and environmental policy. According to this literature, when income grows, pollution increases at first but it tends to decrease at higher income levels. On the other hand, the literature on the so called pollution haven hypothesis * CentER and Department of Economics, Tilburg University, Warandelaan 2, P.O. Box 90153, 5000 LE Tilburg, The Netherlands. E-mail: C.DiMaria@uvt.nl † CentER and Department of Economics, Tilburg University, Warandelaan 2, P.O. Box 90153, 5000 LE Tilburg, The Netherlands. E-mail: J.A.Smulders@uvt.nl 1