The Effects of Exchange Rates and Labor Intensity on Environmental Policies and Location Choice

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1 Th Ects o Exchang Rats an Labor Intnsty on Envronmntal Polcs an Locaton Choc Hakan Orbay 1 an Bnan Zk Orbay 2 Abstract Thr s a branch o ltratur arssng th concrns o usng nvronmntal polcs to attract orgn nvstmnt, an rms shtng proucton abroa to scap strct nvronmntal rgulatons. Ths papr as to ths ltratur by nvstgatng th cts o xchang rats, labor ntnsty an wag rntal on nvronmntal polcs as wll as locaton choc. mlar to othrs, w mploy a two-country (orth an outh), two-rm mol o ntra-nustry tra. Both rms pollut th local nvronmnt an mport som o thr nputs at worl prcs. orth Frm cs whr to locat rst, among th chocs o stayng at hom, movng th proucton ntrly to th outh country an srvng ach markt locally through splttng th proucton. outh an orth Countrs rval th lvl o polluton taxs atrwars. Frms c thr country spcc proucton lvls a la Cournot n th thr stag. W show that polluton taxs ar ruc as labor ntnsty ncrass. I th orth rm kps all or som o ts proucton n orth, polluton tax n outh crass wth valuaton o outh currncy. In th othr cas, whr orth rm movs all proucton to outh, tax ncrass wth valuaton. Du to th ths hghr polluton taxs whn all proucton taks plac n outh, splttng th proucton appars to b th omnant outcom or orth. JEL Cos: F18, L13 Kywors: Envronmntal polcs, orgn rct nvstmnt. Exchang rats. 1. Introucton Dvlopng countrs try to attract orgn rct nvstmnt (FDI) or a astr conomc growth an lowr unmploymnt. Ralzng th ct o FDI on vlopmnt rsarchrs put mor ort to trmn whch stat attrbuts ar mor ctv on locaton choc csons. Most o ths stus hav show that, markt sz, nrastructur, local polcs (nclung nvronmntal polcs) nput costs an xchang rats ar closly rlat to locaton choc csons. Th othr mportant ssu hr whch attracts ntrst o conomsts s th nvronmntal cts o ths locaton chocs. It s not uncommon to s rms rom vlop 1 abanc Unvrsty, Orhanl, 34956, Istanbul, -mal: horbay@sabancunv.u. Hakan Orbay pass away on ptmbr 15, Corrponng Author: E-mal arss: borbay@ogus.u.tr. Doguş Unvrsty, Faculty o Economcs an Amnstratv cncs, Acbam Zamt ok. o:23, Kaıköy - Istanbul, TURKEY; Tl.: xt 1541; ax:

2 countrs wth strct nvronmntal stanars locat thr proucton aclts abroa, spcally whn thr proucton has svr nvronmntal mpact. Thr s a consrabl numbr o stus analyzng th rlatonshp btwn nvronmntal polcy an locaton choc both mprcally an thortcally. Lst an Co (2000) an Xng an Kolsta (2002) an Dan t al. (2009) ar among th mprcal stus nng sgncant ngatv rlatonshp btwn nvronmntal strngncy an attractvnss o locaton. On th thortcal s, thr ar svral paprs analyzng th ssu o locaton choc an nvronmntal polcs. Markusn t al. (1993) nvstgat th rms locaton choc unr ntrnatonal olgopoly an monstrat that nvronmntal polcs ar ctv on rms locaton chocs an markt structur an can altr polluton an wlar lvls n th concrn countrs. Markusn (1997) looks at th ssu rom th vwpont o tra lbralzaton an shows that proucton snstvty o multnatonal rms to nvronmntal polcs proucton snstvty o multnatonal rms to nvronmntal polcs ncrass wth lbralzaton. Ulp an Valntn (1997) analyz th smlar ssu by allowng ntr-sctoral lnkags btwn nustrs an monstrat that n crtan cass rms rallocats btwn countrs u to th nvronmntal rgulatons. Mor rcntly, Ab an Zhao (2005) analyz th rlatonshp btwn nvronmntal polcs an th typ o abatmnt tchnology o th local rm or th cas whr th choc o nvstmnt typ or th orgn rm s nognously trmn. Thy hav show that outh owns a poor abatmnt tchnology, t shoul mpos a hgh polluton tax to attract FDI; convrsly, t owns a goo abatmnt tchnology, thn attractng jont vnturs wth a low polluton tax s a bttr altrnatv. Kayalıca an Lahr (2005) xamn th cts o FDI on th nvronmntal polcs o a host country comptng wth anothr country or a thr country markt. Thy show that r ntry motvats lss svr polcs or th host country. Çlk an Orbay (2011) analyz th ntracton btwn nvronmntal an tra polcs an locaton choc n a two-country. Thy show that whn FDI s prrr by th host country only or sucntly low lvls o margnal amag o polluton an optmal taxs or ths cas s hghr than th margnal amag. Exclung th locaton choc, Barrtt (1994) an Knny (1994) ocus on th optmal nvronmntal polcs unr olgopolstc sttngs an monstrat that pnng on th mo o comptton optmal polluton taxs rs rom th tratonal Pgouvan tax. 2

3 Our ramwork analyz nvronmntal polcs not only ocusng on thr cts on th locaton cson o a orgn rm, but also consrng how ths polcs chang pnng on som attrbuts o th conomc nvronmnt such as labor ntnsty o th proucton an th valu o th local currncy (xchang rat) n th host country. Ths attrbuts hav varous cts through varous channls on both nvronmntal polcs an on locaton cson. Ects o xchang rat luctuatons appar to b vry sgncant on FDI n varous mprcal stus ocusng on ths ssus. Howvr, ths stus n no clar rlatonshp btwn xchang rat volatlty an FDI. om o thm n postv (s Golbrg an Kolsta (1995), Cushman (1988) an Campa (2002) an th othrs n ngatv rlatonshp (s Chakrabat an cholnck (2002)). Exchang rat has sgncant cts on th rlatv cost o labor an on th rlatv proucton cost o th local rm, thus, nvronmntal polcs clarly shoul b mo wth xchang rat movmnts. Ths crtanly crats anothr nlunc on locaton choc whch has not bn consr n any o th prvous stus w hav look at. On th othr han, wth mor labor ntnsty th mploymnt ct o proucton s mor substantal, thus, host country s nvronmntal polcs chang accorngly, bss, labor ntnsty act locaton cson bcaus wth lowr wag rat n th host country proucton bcoms chapr wth mor labor ntnsty. To th bst o our knowlg, no thortcal stuy has bn carr out to analyz th cts o xchang rats an labor ntnsty on nvronmntal polcs an on locaton cson n th sam ramwork. In orr to ll ths gap, w construct a two-country thortcal mol wth two rms locat n ach o ths countrs. W ncat th vlop country as orth an th vlopng country as outh ; w urthr assum that th rm locat n outh has a lss cnt proucton tchnology than th rm locat n orth. Each o ths rms polluts th local nvronmnt an thr s no cross-borr polluton. Th nvronmntal amags caus by th rms ar assum to b publcly known. Both rms mport som o thr nputs at worl prcs an labor s assum to b chapr n outh. In th rst stag o th gam, orth Frm cs whr to locat. Its chocs ar to stay at hom, mov th proucton aclty to th outh country an splt th proucton btwn two countrs pnng on th sals locaton. In th scon stag outh an orth Countrs rvals th lvl o polluton tax. Dpnng on th locaton choc o th orth rm, rms cs thr country spcc proucton lvls a la Cournot n th 3

4 thr stag. Our rsults show that wth mor labor ntnsty (hghr mploymnt ct) polluton taxs bcom lowr an thus, nvronmntal stanars wakns n most cass o th orth s locaton choc. Bss, polluton tax lvls ncrass wth orgn rm s cncy lvl an crass wth omstc rm s cncy lvl as long as th mploymnt ct o th omstc proucton s sucntly low. Ths rsult s n accoranc wth th convntonal rsult o th stratgc tra ltratur whch says that wnnrs shoul b gvn mor support. Hr, whn th omstc rms bcom rlatvly mor cnt govrnmnts lowr th polluton taxs to support thm mor. Howvr, or sucntly hgh lvls o omstc mploymnt ct, govrnmnts prr to cras th polluton taxs vn though th omstc rm s rlatv cncy crass. Rsults rlat to th cts o xchang rats show that orth prouc n ts country o orgn valuaton o th outh s currncy (u to th comptton avantag crat or th outh rm) gvs ncntv to th outh govrnmnt to lowr th polluton taxs. Howvr, whn th orth rm proucs n outh (partly or totally) w obsrv a rvrs rlatonshp. nc both rms ar proucng n outh, spt th valuaton, outh prrs to ras th polluton tax nsta o lowrng. Atonally, smlar to Barrtt (1994), w obsrv that whn orth prouc n ts country o orgn polluton taxs n both countrs ar always blow th margnal amag o polluton. Howvr, th orth rm locats only n outh, th polluton taxs ar abov th margnal amag o polluton (hghr than Pgovan taxs). In th cas o splttng th proucton, pnng on th mploymnt ct an th valu o xchang rat t s possbl to obsrv both strct (hghr than Pgovan taxs) an wak taxs (lowr than Pgovan taxs). Th analyss o th locaton choc o th orth rm shows that th most lkly cas or th orth rm s splttng th proucton. Th hgh polluton taxs vanshs th avantag o movng th whol proucton to th outh. Whn th outh s margnal amag o polluton s rlatvly low, valuaton may gv ncntv to th orth rm to splt ts proucton btwn orth an outh. Ths papr s organz as ollows: In cton 2, th basc mol an th solutons o th last two stags ar gvn. cton 3 scusss th soluton o th locaton choc stag. Fnally, cton 4 provs a summary an som conclung rmarks. 4

5 2. Th Mol In ths scton, w construct a two-country mol wth a omstc vlopng country (th outh) an a orgn vlop country (th orth). Each country has on rm proucng a homognous goo an gnratng local polluton urng th proucton procss. outh Frm s proucton an abatmnt tchnology s lss cnt compar to th orth Frm. Th nvronmntal amag caus by th rms ar publcly known. Margnal amags o polluton ar constant an th orth Frm s margnal amag s lowr than th outh Frm ( > ). In th rst stag o th gam th orth rm cs on ts locaton or proucton. Th optons ar proucng th total output n th outh (FDI), proucng th total output at hom an splttng th proucton btwn orth an outh. In th scon stag, both outh an orth Countrs trmn th polluton tax lvls. In th last stag, rms choos thr output lvls obsrvng th polluton tax lvls mpos by outh an orth govrnmnts. Fgur 1 rprsnts ths gam. orth Frm chooss ts locaton orth an outh Countrs trmn polluton tax lvls Frms play Cournot Gam FIGURE 1 For smplcty, w assum that thr ar no x costs n our mol. Th margnal costs o both orth an outh Frms ar assum to b compos o x proporton amount o labor ( L an L ) an othr mport nputs ( X an X ) that must b procur at worl prcs. uppos that ntal xchang rat s 1, wthout loss o gnralty. Thus, ntal margnal costs can b wrttn as ollows: c c w w L L p p w w X X (1a) (1b) 5

6 whr w an w ar wag rats n two countrs, an pw rprsnts worl prc o othr nputs. Both costs ar wrttn n rms own currncs. Wth ths nton, c rprsnts ntal margnal cost, hnc bcoms a unamntal paramtr nsnstv to xchang rat. ot that, orth currncy s assum to rprsnt worl currncy (n othr wors, p s x n orth currncy), margnal cost o orth rm s w nsnstv to xchang rat by nton. uppos that rprsnts wags pa by compans as a racton o margnal costs. Usng abov, s ar n to b, w L (2a) c w L (2b) c At th comptton stag, margnal cost o th outh rm wll b c ( 1 ) c / an wags pa by outh s stll gvn by c rgarlss o xchang rat. rprsnts th xchang rat o outh s currncy pr unt o orth s currncy. I w consr th cas whr th orth rm proucs n outh, th orth rm s margnal cost c can b wrttn as s c s w L p w X. (3) w s Dnng, (3) can b wrttn as c c ( 1 ) c an wags pa w by orth rm n outh s orth Frm or proucton n outh can b xprss as c s whr c n outh s currncy. Fnally, margnal cost o c (4) (1 ). Hr rprsnts th xtnt o th proucton cost avantag o orth Frm whn t proucs n outh. Consumpton taks plac n both outh an orth an nvrs man unctons ar: P a b Q,, (5) whr Q j {, j} {, }, j, th total output an an ar th amounts prouc by th outh rm an orth rm an P s th prc n ach country s own currncy, rspctvly. outh rm acs th ollowng prot maxmzaton problm: 6

7 max (, ) [( a b ( )) ( a b ( )) / C ( C (6a) ) / ] whr C s th total unt cost o sllng at hom (n outh s currncy) c whch s th sum o polluton tax rat mpos by th outh pr unt o proucton an th margnal cost o proucton, smlarly, C ( c t) s th total unt cost o sllng n orth (n orth s currncy) whch s th sum o margnal cost o proucton, polluton tax an th transportaton cost t. maxmzaton problm o th orth rm can b ormulat as: Th prot max ( a b ( )) ( a b ( )) C C (6b) (, ) whr s th total unt cost o sllng n orth ( n orth s currncy) an s th total unt cost o sllng n outh (n outh s currncy) or th orth rm. Clarly, ths unt costs wll r pnng on th proucton locaton choc o th orth Frm latr n th ollowng sctons. olvng th racton unctons obtan rom (6a) an (6b) smultanously yls th markt stag ulbrum outputs as ollows: 1 ( a C 2C) (7a) 1 ( a C 2C ) (7b) 1 ( a C 2C) (7c) 1 ( a C 2C ) (7) ubsttutng ths ulbrum outputs w obtan th ollowng Cournot-ash ulbrum prot lvls. 7

8 2 b ( a C C ) b ( a C 2C ) (8a) 9b b b ( a 2C C ) b ( a 2C C) (8b) 9b b 2.1 Markt tag Gam 1: orth Frm prouc n ts Country o Orgn In ths scton, w consr th cas whr th orth Frm stays at hom an xport to th outh. orth rm s total unt cost whn t slls n orth s (n orth s currncy) C c (9a) an whn t slls n outh s (n outh s currncy) C ( c ) / t (9b) Hr rprsnts th polluton tax mpos by th orth govrnmnt. ubsttutng ths cost lvls nto th abov ulbrum output an prot lvls ((gvn n (E 7) an (E 8)) an notng thm as j, an ({, j} {, }, j ), w can rv th ollowng socal wlar unctons or outh an orth rspctvly: W C ( c )( ) (10a) W C ( c )( ) (10b) C s th consumr surplus n ach country or th markt stag gam 1. Th optmal polluton taxs or th outh an orth Countrs unr th markt stag gam 1 can b comput by solvng th.o.c. s W / 0an W / 0 smultanously. Dnotng ths ulbrum taxs as an, w can analyz how ths taxs chang wth som crtcal paramtrs o th mol. Proposton 1: Eulbrum polluton taxs o both countrs or th markt stag gam 1 cras as th mploymnt ct o proucton ncrass. 8

9 c b Proo: ( 4). Clarly th trm n parantss s ngatv, thus, 2 b b c 4b 0. mlarly, ( ) 0. 2 b b From ths rsult w can say that whn th mploymnt ct o proucton bcoms mor substantal, countrs crass thr polluton taxs rgarlss o margnal amag o polluton. Whn xchang rat s sucntly low an outh rm has rlatv comptton avantag, outh country prrs not to mpos any polluton tax (or any lvl o ) to captur mor rnt or ts rm n worl markt an to crat mor wag gan. W also analyz how optmal polluton taxs chang wth margnal proucton costs o th rms. Th ollowng Propoposton summarz th rsults. Proposton 2: Eulbrum polluton taxs o both countrs or th markt stag gam 1 ) cras wth th orgn rm s ntal cost lvl ) ncras wth thr own rms ntal cost lvl th mploymnt ct o proucton s sucntly low. Proo: ) c b ( 1) b ( 1). nc, 1, 0. mlarly,. 2( b b ) c c 2( b b ) nc, 1, 0. c ) c ( b 2b ( 2( b 4b b ) ) ). Clarly, 0 c b 2b. 4b mlarly, c (2b b (4b 2( b b ) ) ) an 0 c 2b 4b b. For th low lvls o, ths rsult s n accoranc wth th convntonal rsult o stratgc tra ltratur whch stats that govrnmnts shoul subsz th wnnrs mor. Howvr, whn th mploymnt ct o proucton bcoms sucntly hgh, thn w obsrv a rvrs ct. It s possbl to say that or hgh lvls o, mploymnt ct omnats savantag o th crasng rlatv cncy o 9

10 th omstc rm, thus, govrnmnts prrs to support thr rms mor by lowrng taxs. Du to th complxty o th rvatvs, th cts o xchang rats on polluton taxs ar prorm numrcally. W analyz th snstvty o optmal taxs to xchang rats or rnt lvls o margnal amag o pollutons. Our numrcal analyss 3 show that whn outh currncy valuats crass an ncrass or all lvls o an. Ths can b xplan by th ncntv to subsz th wnnrs (loosrs) mor (lss). Clarly, whn local margnal amag o polluton s hghr th local polluton tax also bcoms hghr (or all lvls o ). It shoul also b not that (n all th numrcal analyss prorm) both taxs ar blow th an or a w rang o paramtrs. Ths rsult s paralll wth Knny (1994) an Barrtt (1994) who show that unr mprct comptton th govrnmnts may hav an ncntv to mpos nvronmntal polcs wakr than th Pgouvan tax 4 to support thr own rms n ntrnatonal comptton nvronmnt. Mor spccally, Barrtt (1994) monstrat that th mo o comptton s mportant, whn rms compt a la Cournot govrnmnts prr wakr nvronmntal polcs, howvr, whn th comptton s a la Brtran govrnmnts choos strongr nvronmntal polcs. It s ntrstng to not that, although th orm o comptton s always Cournot n our mol, or sucntly hgh lvls o, t bcoms hghr than. At hgh lvls o, orth rm has comptton savantag an hghr tax lvls bcoms mor prrabl or th orth Country. 2.2 Markt tag Gam 2: Both Frms Prouc n outh In ths scton, w consr th cas whr th orth rm ngags n a FDI an prouc total output n outh playng a Cournot-ash gam wth th outh rm. In ths cas, th total unt cost o th orth rm whn t slls n outh s (n outh s currncy) 3 umrcal analyss can b obtan rom corrsponng author upon rust. 4 Th Pgouvan tax s known as th optmal nvronmntal tax polcy n prctly compttv markts an s ual to th margnal amag o polluton. 10

11 C c / (11a) whch s th sum o polluton tax rat an margnal cost o proucton. mlarly total unt cost o orth Frm whn t slls n orth (n orth s currncy) s C c t (11b) Dnotng j, an ({, j} {, }, j ) as th Cournot ulbrum output an prot lvls comput at C an C, w can wrt own th socal wlar uncton or orth an outh Countrs, rspctvly, as ollows: W C ( / c )( ) ( c )( ) (12a) W C (12b) C s agan th consumr surplus n ach country or th markt stag gam 2, s th margnal amag o polluton or ach rm. Th trms c ( ) an c ( ) n (12a) rprsnt th mploymnt ct o th proucton by outh an orth Frms rspctvly. By solvng th.o.c., W / 0, w obtan th optmal polluton tax or th outh Country. For ths cas, w not ulbrum polluton tax or outh as. Th ollowng propostons analyz how ths tax changs wth th crtcal paramtrs o our mol. Proposton 3: Whn both rms prouc n outh, ulbrum polluton tax o th outh country crass as th mploymnt ct o proucton o both rms ncrass. 3c ( b b ) Proo: 0 6b 10b 3c ( b b ) an smlarly, 0. 6b 10b 11

12 mlar to th markt stag gam 1, whn th mploymnt ct o proucton s hghr, outh govrnmnt prrs to mpos a lowr polluton tax an th rnc n xtnts o ths cts s rlat to th rato o c / c. Proposton 4: Whn both rms prouc n outh, ulbrum polluton tax o th outh country ) crass wth c, ) ncrass wth c th mploymnt ct s sucntly low. 3( b b) Proo: 0. b 3( b b) 0 c (6b 10b ) 2 c (6b 10b ) 3( b b. b ) Intrstngly, rgarlss o how hgh s th mploymnt ct o th orth rm, polluton tax o outh always cras wth ncrasng c, howvr, smlar to th abov, polluton tax ncrass wth c only or sucntly low lvls o mploymnt ct. Obvously, ncrasng c crats a comptton avantag or th local rm n trms o rnt shtng, thus, local govrnmnt supports ths avantag lowrng th tax, bss, thr s an atonal postv mploymnt ct rom th orgn rm, ths tax ructon bcoms vn hghr. Agan, u to th complxts o algbrac uatons, w rsort to numrcal analyss to ncat th rlatonshp btwn an th xchang rat. Our rsults show that, whn outh currncy valuats, crass wth ncrasng or all lvls o an. Ths rsult s contractory wth th ncntv to subsz th wnnrs mor. But, snc both rms ar proucng n outh an lowrng tax crats atonal avantag to th orgn rval rm, outh prrs to ras th tax nsta. Anothr mportant obsrvaton n ths cas s that, n contrary wth Barrtt (1994) rsult, polluton taxs ar always hghr than th margnal amag o polluton (strctr than th Pgovan tax). Obvously, whn both rms ar proucng n outh an th orth rm s prots gos to th orth Country, outh can not tolrat mor aggrgat polluton by lowrng taxs blow th margnal amag o polluton. 12

13 2.3 Markt tag Gam 3: orth Frm plt n ts Proucton btwn Countrs In ths last markt stag gam, orth rm splts ts proucton btwn orth an outh pnng on th locaton o sals. Thus, orth Frm s total unt cost s th sam wth (9a) whn t slls n orth ( C C c ), an s th sam wth (11a) whn t slls n outh ( C C c / ). ubsttutng ths cost lvls nto th abov ulbrum output an prot lvls ((E 7) an (E 8)) an notng thm as j, an ({, j} {, }, j ) or th markt stag gam 3, w can comput th socal wlar unctons or outh an orth rspctvly as ollows: W C ( c )( ) ( / c ) (12a) W C ( c ) (12b) C s th consumr surplus n ach country or th markt stag gam 3. mlar to th prvous two markt stag gams, w comput th optmal polluton taxs or th outh an orth Countrs by solvng th.o.c. s W / 0 an W / 0 smultanously. W not th ulbrum polluton taxs as an. Analyzng th cts o som crtcal paramtrs w obtan th ollowng propostons. Proposton 5: Whn orth rm splts ts proucton btwn outh an orth, ulbrum polluton tax o th outh country always crass wth th mploymnt ct o proucton o ts own rm but may ncras wth th mploymnt ct o proucton o th orth rm. 3c ( b 2b ) Proo: 0 6b 4b c (2b ) but, 0 6b 4b 2b. It s ntrstng to s that whn th orth rm proucs ts total output n outh, th polluton tax o outh always crass wth hghr mploymnt ct, but hr, ths kn o ct s obsrv only or sucntly hgh valus o rlatv wags ( w / w pronounc. ) whch maks th mploymnt ct o th orth rm mor 13

14 Proposton 6: Whn orth rm splt ts proucton btwn orth an outh, ulbrum polluton tax o th outh country ) crass wth c, ) ncrass wth c th mploymnt ct s sucntly low. 2b (1 ) ( ) Proo: 0. 2 c (6b 4b ) c (1 ) 2b (1 2 ) 0 (6b 4b ) 2b. 4b Ths rsult s smlar wth th prvous two cass. It s ntutvly clar that agan hgh mploymnt ct gv ncntv to th govrnmnt to cras th tax burn on ts local rm vn though t bcoms lss compttv aganst th rval. Clarly, th thrshol valus o r among thr cass. Proposton 7: Whn orth rm splt ts proucton btwn orth an outh ulbrum polluton tax o th orth country ) crass wth, ) ncrass wth c th mploymnt ct o th orth rm s sucntly low. Proo: ) 2 c (1 2 ) a an thus, 2c 0. ) c 1 2. Th rsults gvn n Proposton 7 ar paralll wth our prvous nngs. Our numrcal analyss wth rspct to xchang rat shows that whn outh currncy valuats, crass smlar to th rst cas. Howvr, ths rlatonshp can chang pnng on markt paramtrs, urthr analyss s n to not any pattrns. 14

15 Mor ntrstngly, w obsrv that or most o th valus orth govrnmnt prr to st zro taxs (unlss s vry hgh). Morovr, n contrast wth cas whr orth rm proucs th total output n outh, outh may choos a polluton tax blow margnal amag o polluton. For nstanc, whn s low ( ) polluton tax ( ) can b lowr than but hghr than. I thn t s possbl to obsrv that polluton tax s blow th margnal amag o polluton or hgh valus o xchang rats, but abov th margnal amag o polluton or low valus o t. 3. Th Locaton Choc In ths scton, w analyz th rst stag gam whr orth rm cs whr to locat. For ths purpos w substtut ulbrum polluton taxs an costs or ach locaton choc nto th prot uncton gvn n E (8b) an compar or ach rnt locaton choc. Unortunatly, algbrac comparson o ths prots ar ut complx, thus, w prr to prorm som numrcal analyss to prsnt th rsults. Our analyss shows that or a ut w rang o paramtrs, splttng th proucton btwn orth an outh s th prrr choc or th orth rm. W also obsrv that whn margnal amag o polluton s rlatvly low n outh a valuaton o outh s currncy may gv ncntv to th orth rm to mov ts proucton partly to th outh. Ths can b xplan mor by th rlatvly lowr polluton taxs (u to low ) an lowr proucton cost opportunty. nc movng th whol proucton aclty to th outh wll ras th polluton taxs substantally, ths stuaton os not appar to b an ulbrum n non o our numrcal analyss. ummary an Conclusons Ths stuy ocus on how nvronmntal polcs an locaton choc o th rms ar rlat wth xchang rats an labor ntnsty o proucton. In a smpl two-country ntra nustry tra mol, whr thr s a sngl rm n ach o th vlop country orth an th vlopng country outh an ach o ths rms polluts th local nvronmnt. W assum that n th rst stag o th gam, 15

16 orth Frm cs whr to locat. Its chocs ar to stay at hom, mov th proucton aclty to th outh country an splt th proucton btwn two countrs pnng on th sals locaton. In th scon stag outh an orth Countrs rvals th lvl o polluton tax. Dpnng on th locaton choc o th orth rm, rms cs thr country spcc proucton lvls a la Cournot n th thr stag, Accorng to th rsults wth mor labor ntnsty (hghr mploymnt ct) polluton taxs bcom lowr an thus, nvronmntal stanars wakns n most cass o th orth s locaton choc. On th othr han, w obsrv that orth prouc n ts country o orgn outh govrnmnt lowrs th polluton taxs wth a valuaton n ts currncy. Ths tax ructon s to nhanc th comptton avantag o th omstc rm rsult rom th valuaton to hlp capturng mor rnt n th ntrnatonal markt. Whn th orth rm proucs n outh (partly or totally) w obsrv that outh govrnmnt ras th taxs wth valuaton bcaus lowrng tax crats an unsr avantag to th orgn mor cnt rval rm. Mor ntrstngly whn orth prouc n ts country o orgn, polluton taxs n both countrs ar blow th margnal amag o polluton n most cass. Howvr, th orth rm locats only n outh, th polluton taxs ar abov th margnal amag o polluton (hghr than Pgovan taxs). Fnally, splttng th proucton s th most lkly choc or th orth rm. Movng th whol proucton aclty to th outh s not obsrv u to th hgh polluton taxs or any valus o xchang rat an labor ntnsty. Ths stuy s th rst attmpt to xamn th cts o xchang rat an labor ntnsty on nvronmntal polcs an locaton choc. A possbl xtnson o ths analyss s to look at how th rsults chang th govrnmnts clar thr nvronmntal polcs bor th orth rm choos ts locaton. Rrncs Ab K., Zhao L. (2005) Enognous Intrnatonal Jont Vnturs an th Envronmnt. Journal o Intrnatonal Economcs 67: Barrtt,. (1994) tratgc Envronmntal Polcy an Intrnatonal Tra. Journal o Publc Economcs 54:

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