Strategic environmental taxation in the presence of involuntary unemployment and endogeneous location choice

We analyze strategic environmental taxation in a two-country model with local environmental pollution. Two firms decide whether to serve the foreign market either by exports from the domestic plant or by operating a subsidiary in the foreign country. When involuntary unemployment prevails, a conflict in two policy goals arises: One the one hand countries want to internalize the negative externalities due to pollution in production. On the other hand they try to fight unemployment by inducing the foreign firm to immigrate by means of low environmental taxes. We identify two non cooperative equilibria depending on the magnitude of the marginal disutility of pollution and of the firms' mobility: Either countries are content with one plant within their bounderies or, alternatively, interjurisdictional competition results in two plants in each country. Whether the latter equilibrium induces welfare losses for both countries, depends again on the parameter values. This result is in contrast to previous studies, which neglected labour market effects.