Welfare Effects of International Income Transfers under Transboundary Pollution

This paper examines the welfare effects of international income transfers in a two-country, two-good model with transboundary pollution. Most existing studies have assumed that pollution negatively affects the consumer's utility function instead of influencing production. In our model, there is interindustry interaction caused by pollution. First, we show the effects of aid on each country's welfare. Second, we show that untied aid improves world welfare if the marginal propensity to consume the polluting good in the donor country is larger than in the recipient country. We also derive the condition for Pareto-improving untied aid. The source of welfare improvement is productivity gains induced by a reduction in pollution