Munich Personal RePEc Archive

Trade and the environment in a two-country model with endogenous capital accumulation

Li, Gang (2020): Trade and the environment in a two-country model with endogenous capital accumulation.

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Abstract

This paper examines the role of endogenous capital accumulation in the interaction between trade and the environment in a two-country, two-sector model. Atomic households follow a simple rule of saving: higher the real interest rate, higher the saving rate is. In autarky, the real interest rate depends only on the quality of the environment, and investment provides a channel allowing for the trade-off between the amount of factor of production and the quality of the environment. In free trade, the real interest rate depends on i) terms of trade if the environmentally sensitive sector (agriculture) is shut down, or ii) both terms of trade and the quality of the environment if agriculture is still active. In either case, the real interest rate jumps right after trade liberalization due to terms of trade improvement, which boosts investment and causes capital accumulation. This scale effect dominates in the long run, causing environmental degradation even if the economy specializes in the relatively clean sector. Trade improves the total world consumption and the country preserving agriculture has relatively better environment in the long run.

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