Free trade is believed to impact the environment in two conflicting ways: (i) as trade leads to increased income it can cause increased concern for the environment, motivating a reduction in pollution; and (ii) as trade shifts the international location of production and consumption it can mean polluting processes move to countries with lower environmental standards, causing an increase in world pollution. In our analysis of the trade-environment-development system we develop and use a simulation model that considers sustainable development on three levels: economic (by determining production, consumption, investment, trade, and natural resource use); social (by calculating population growth); and environmental (by calculating the environmental pollution less remedial investment and net transboundary pollution flows). Our model represents a system that is both complete (i.e., environment, economic development, and population are simultaneously considered) and closed (i.e., all important parameters change endogenously).

We find that the benefits of trade depend on country endowments, and that the pollution effects of trade are closely tied to the benefits of trade.

Our model generally shows higher pollution levels under free trade than autarky; however, our results do not support the pollution haven hypothesis (i.e., trade causes a shift in the location of polluting activities leading to less pollution in developed countries and more pollution in developing ones). Some developing countries produce more of the pollution intensive good, but ultimately consume less pollution under autarky, because they have higher per capita GDPs and, thus, invest more heavily in environmental remediation under autarky. The rejection of the pollution haven hypothesis as well as the idea that trade is always welfare enhancing depends on (a) three model characteristics: (1) production welfare, (2) traded intermediate goods are among the product factors of (traded) final goods, and (3) pollution is lowered through remedial investments (which have higher returns as countries increase in wealth); and (b) two empirically justifiable assumptions: (1) pollution intensive processes may not migrate because they are important to developed countries or because developed countries maintain a competitive advantage in their production even with a hightened concern for the environment, and (2) much pollution is associated with consumption, and, thus, such pollution is less likely to decline as income rises and is not at all subject to international trade.