Dynamic Environmental Policy in Developing Countries in the Presence of a Balance of Trade Deficit and a Tariff

Abstract

We first examine the literature pertaining to the protection of the modern sector in developing countries (DCs). We then discuss the nexuses between protection, economic dualism, and optimal environmental policy in DCs. Next, we build a dynamic model of the environmental policy formulation process in a stylized DC in which there exists a balance of trade deficit and a tariff that protect the modern sector. The modern sector is also the import-competing and the polluting sector. The output and employment effects of three pollution taxes are studied. These taxes incorporate different assumptions about the DC government's ability to commit to its announced course of action. We describe the taxes, we study the dependence of these taxes on the current tariff, and we analyze the conditions that call for an activist environmental policy. Our study demonstrates that, inter alia, the dynamic inconsistency of certain optimal programs and the tariff can prevent the DC government from attaining its employment and environmental objectives.

Keywords: Commitment, Developing Country, Environmental Policy, Tariff, Trade Deficit

JEL Classification: O20, Q20