Indeterminacy and Pollution Haven Hypothesis in a Dynamic General Equilibrium Model

This paper develops a two-sector dynamic general equilibrium model of a small open economy in which production activities are accompanied by emission of pollution that has a negative welfare effect. It is shown that the dynamic equilibrium may display indeterminacy, i.e., continuum of dynamic equilibrium paths converging to a common steady state, depending on (i) the relationship between capital intensity and pollution intensity, (ii) the property of households' discount rate as a function of total pollution, and (iii) the pollution-consumption relationship in instantaneous utility. In addition, the effect of environmental policy on the economy's comparative advantage and its relation to indeterminacy are examined