Pollution havens and industrial agglomeration

This paper examines the pollution haven hypothesis using a spatial-economy model of two countries and two sectors. The manufacturing sector generates cross-border pollution which reduces cross-sectoral productivity of agricultural goods, and lowers local income. We derive a demand-reducing effect that discourages firms to move to the country with laxer environmental regulations, in the absence of any comparative advantage. Our analysis also demonstrates that manufacturing agglomeration forces can alleviate the pollution-haven effect: a pollution haven may not arise if environmental regulation is slightly more stringent in the larger country.