Trade and the Environment: The Role of Firm Heterogeneity

In this paper, we derive a new effect of trade liberalization on the quality of the environment. We show that in the presence of heterogeneous firms, the aggregate volume of emissions is influenced by a reallocation effect resulting from an increase in the relative size of more productive firms. The relative importance of this reallocation effect and the scale effect well-known from the literature is affected by the emission intensity at the firm level. Domestic emissions decrease as a result of a unilateral tariff reduction if and only if firm-specific emission intensity decreases strongly with increasing firm productivity. As a result of the induced change in foreign emissions, domestic pollution can increase even if domestic emissions decrease.