Foreign investment and environment in a North-South model with cross-border pollution

We develop a North-South model with cross-border pollution. In the South, pollution is abated by both private producers and the public sector. The North suffers from cross-border pollution from the South. The policy instruments are foreign aid for the North, and funds for public abatement, emission tax rate, and a tax on foreign capital, for the South. We characterize the Nash equilibrium under two scenarios: foreign investment is (i) exogenous, and (ii) endogenous. Under (i), we examine the effect of a reform where both foreign investment and aid are changed in an income-neutral way. In the latter case, we analyze the effect of a tax-induced change in foreign investment on pollution. In both scenarios, an inflow of foreign investment unambiguously reduces the net emission of pollution.