Does trade liberalization make the environment dirtier or cleaner? Theory suggests the possibility of both. Copeland and Taylor’s (2003) composition effect changes the mix of goods produced either according to comparative advantage, or due to foreign factor inflows, particularly capital. The composition effect may or may not cause degradation of the environment in the country that has a comparative advantage in the production of pollution intensive goods. Ederington et al. 2004, that trade liberalization does not exacerbate the building up of pollution havens in less developed partner countries, a prime example being Mexico. Kahn and Yuchino (2004) find that NAFTA did not produce pollutions havens in Mexico. Why that is so is the working hypothesis that motivates our study.
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