The environment and welfare implications of trade and tax policy

Developing countries with comparative advantage in dirty industries face the risk of environmental degradation unless appropriate policies are implemented. Using applied general equilibrium analysis, we examine how trade influences the environment and assess the welfare and environmental implications of alternative pollution abatement policies for Indonesia. Our results indicate that unilateral trade liberalization by Indonesia would increase the ratio of emission levels to real output for almost all major pollution categories. More importantly, when tariff removal is combined with a cost-effective tax policy, the twin objectives of welfare enhancement and environmental quality improvement appear to be feasible. This sheds new and positive light on the role of trade in sustainable development.