Environmental Standards in a Large Open Economy

• DOI: http://doi.org/10.1111/jpet.12098
• Date: 01 June 2015
• Published date: 01 June 2015
• Author: JEFFREY PETCHEY

ENVIRONMENTAL STANDARDS IN A LARGE OPEN

ECONOMY

JEFFREY PETCHEY

Curtin University

Abstract

The small-country price-taking assumption of Oates and

Schwab is relaxed to consider a large open economy that

can influence its net capital return. This creates an incen-

tive for the country to distort its policies. The key question

asked is whether this induces inefficient outcomes. The re-

sult is that if the country has a dedicated tax on capital and

uses this tax optimally, the Oates and Schwab first-best re-

sult still holds. However, efficiency in a large open economy

requires that the tax on capital be nonzero, unlike Oates

and Schwab where the capital tax must be zero for first-best

efficiency.

1. Introduction

The 1988 paper by Oates and Schwab develops a model of a region with a

large number of small open-economy jurisdictions.1The region has a given

stock of capital that migrates between jurisdictions without restriction. Due

to the large number assumption, jurisdictions are price-takers with respect

to the net return they pay for mobile capital. Each jurisdiction has two policy

variables, a dedicated tax on mobile capital and the choice of environmental

standards. The main result, which has endured in the recent economics liter-

ature, is that each jurisdiction chooses a first-best efficient policy mix where

1See also Oates (2002) and Cumberland (1979, 1981).

Jeffrey Petchey, School of Economics and Finance, Curtin University, GPO Box U1987,

Perth 6845, Western Australia (J.Petchey@curtin.edu.au).

I am very grateful to the editor, subeditor,and an anonymous referee for many helpful

and improving comments and suggestions. The final version is much improved because of

their valuable assistance.

Received April 24, 2013; Accepted April 25, 2013.

C2013 Wiley Periodicals, Inc.

Journal of Public Economic Theory, 17 (3), 2015, pp. 461–467.

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