Environmental Benefits from International Trade * Beatriz Gaitan † Oliver Schenker ‡§ Economics Department University of Bern April 19th, 2008 Short abstract: We analyze the impact of international trade with transboundary pollution and endogenous-environmental policy on welfare and emissions in a general equilibrium model. Pollution in one industry affects another industry’s output domestically and abroad. With international trade in final goods emission levels and emission-permit prices are the same regardless of whether emission rights are tradable or not. Even without internationally tradable- emission rights countries account for foreign marginal damages from emissions. In autarchy, environmental policy does not account for all marginal damages. Still, sometimes a country’s consumer may be better off in autarchy even if she received all emission-permit revenues under trade. Long abstract: We analyze the impact of international trade with transboundary pollution and endogenous-environmental policy on welfare and emissions in a general equilibrium model. Pollution in one industry affects the output of another industry domestically and abroad. With international trade in final goods we first analyze a centralized framework with internationally tradable-emission permits where environmental policy satisfies Pareto optimality. Second, a decentralized scenario where countries choose the environmental policy that maximizes domestic welfare. We compare the trade cases with autarchy. With international trade in final goods i) emission levels and emission-permit prices of the decentralized and centralized frameworks are equal and ii) the decentralized formulation takes into account also foreign marginal damages from emissions. Despite that environmental policy with international trade accounts for all the marginal damages from emissions, and in autarchy does not, we find that in some instances under free international trade-even if the entire emission- permit revenues are passed to a single country's representative consumer-this consumer may be better off in autarchy than in trade. Key words: Pollution, International Trade, Autarchy, Optimal environmental policy. JEL Classification: F10, Q20 * We would like to thank Seraina Buob and Gunter Stephan for their helpful comments. †Corresponding author: Department of Economics VWI, Schanzeneckstrasse 1, CH-3012 Bern, Switzerland. Tel: +41 31 631 4508, email: beatriz.gaitan@vwi.unibe.ch ‡ Email: oliver schenker@vwi.unibe.ch § The authors gratefully acknowledges the support of the Swiss National Center of Competence in Research on Climate (NCCR Climate), funded by the Swiss National Science Foundation (SNF).