Southern Export of Dirty "Variety" and Optimality of Environmental Standards: Case of Consumption Pollution

This paper examines the optimality of environmental standards that are often observed to be imposed by the importing North on exporting South. In the context of goods differentiated in terms of environmental quality and the degree of consumption pollution they generate, consumers' willingness-to-pay varying with such quality and being different across income groups, we show that: (1) competitive environmental qualities are sub-optimal; (2) environmental-quality dependent consumption tax is the first best policy; and (3) when South has a cost advantage in dirty varities, the second-best policy for North is to lower minimum environmental standard from the autarchic level of minimum standard.