Who Pay for the Cleaner Air? Distributional Impact of Environmental Policy in a Dualistic Economy

Using a technology where pollution is regarded as by-product of industry's activity and applied in a simple setup of Heckscher-Ohlin-Copeland-Taylor model, this paper analyses the possible distributional impacts of stricter environmental policy in a developing country characterized by the presence of labor-intensive informal sector which may not be a subject to the environmental regulation, and capital intensive formal sector which may face minimum wage policy. The comparative static analysis illustrates that stricter environmental regulation if enforced uniformly accross industries in undistorted labor market, hurts both labor and capital owner, leaving income ditribution unchanged. On the contrary, when economy is dualistic, income distribution may change due to labor reallocation. When the stricter regulation can only be enforced in formal sector, capital owner will be worse-off while labor are better-off. If initially capital reward is higher, the environmental policy will improve income distribution in favor of labor. The change in income distribution is greater when economy is dualistic.