Environmental Protection and Trade Liberalization in a Small Open Dual Economy

The author investigates the conditions under which environmental protection and trade liberalization might improve urban unemployment and welfare in a small open Harris-Todaro model with polluting urban manufacturing. While a tariff reduction decreases manufacturing employment, a rise in the pollution tax rate may increase it when a dirty input is complementary to capital. Environmental protection and trade liberalization are consistent in reducing the level of urban unemployment because they lower it under the same condition. They are consistent in increasing GDP if a rise in the pollution tax rate decreases manufacturing employment. Otherwise, trade liberalization will mitigate a decrease in GDP because of environmental protection if the degree of urbanization is low and if rural technology exhibits weak diminishing returns to labor. This GDP effect plays a central role in welfare improvement.