The effects of environmental policy on trade and welfare are analyzed in a modified Heckscher-Ohlin (H-O) general equilibrium model. Modifications include the specification of a health production function with good and pollution as arguments, quasi-homothetic preferences are assumed to account for the observed differences in countries' expenditure shares on health, and pollution is modeled as a by-product of input use in production. Three types of pollution are modeled: local-disembodied, global-disembodied and embodied. The Walrasian, Pareto optimal and the regulator's problem are analyzed for each case. The optimal tax structure is shown to improve a country's welfare if it is small in the world market. Otherwise, changes in the terms of trade may cause one country to be made better off at the expense of the other. Interdependencies among countries are explored using a one-shot Nash game, and situations requiring cooperation, and compensatory payments are identified. A counterintuitive finding is that taxing the polluting input only can cause concentration of contaminants in a traded good to rise when the polluting input is used intensively in production. Instead, a tax must be accompanied with a subsidy to the non-polluting input. Contrary to other approaches, an abatement policy does not necessarily decrease a country's comparative advantage in world markets.; A sample economy was developed to clarify the analytical results that were indeterminate, and to further illustrate the implications of the model. A more detailed and realistic, although more complicated, three-region, five-sector applied general equilibrium model is calibrated to world data. Simulations of policy alternatives for the case of global disembodied pollution are performed. The Pigouvian tax rate derived from the optimal analysis found to be much lower than the tax rates used in previous environmental AGE models.
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