In recent years, many nations have formed regional free trade pacts in order to take advantage of locational benefits as well as gains from freer trade. While regional integration and tariff elimination will most likely increase welfare for the participating nations, it is quite possible that those gains will be eroded by secondary negative environmental considerations. First and foremost, a shift in the production of a pollutive good to a country with lower environmental standards could lead to increase transnational pollution that affect neighboring countries. Secondly, a nation could find itself facing a comparative disadvantage with a trading partner that has lower environmental standards. If so, domestic producers of the pollutive good in the high-standard nation will lobby to obtain lower standards to offset this disadvantage. Lobbying will remove productive resources from the economy, while the resulting change in standards will have welfare effects on economic agents.; Each of these environmental considerations must be addressed within a general equilibrium framework in order to study the full impact of regional free trade agreements. A locational model utilizing the specific factors approach will be developed in this paper which will seek to explain an industry's choice of location when negative externalities are present, under conditions of both autarky and free trade. A general equilibrium framework will be used so that welfare comparisons for various states of the economy will be possible. Taxation of the polluting good will be shown to be the optimal policy response to the externality.; The domestic industry's response to competition from nations with lower environmental standards will also be addressed within a general equilibrium, specific factors model. Under this formulation, government environmental policy will be dependent on lobbying activity by each industry. As a result, the final position of the economy on its Production Possibilities Frontier will be determined by both the lobbying-induced level of the pollution tax as well as the amount of resources used by lobbying activity. Various zones of welfare will be derived for different exogenous shocks, including removal of a prohibitive tariff. Within this context, it will become evident why certain interest groups would oppose a move to freer trade in spite of the likelihood of attaining a higher level of welfare for the economy as a whole. The theoretical findings of this paper can be applied to recent regional free trade agreements such as Nafta in order to gain an understanding of the behavior of different interest groups.
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