A model of trade agreements and cross-border externalities:

Abstract: This thesis examines a second-best trade agreement between the governments of two countries that tries to remedy the distortions arising from non-coordinated environmental policy. In a reciprocal-markets model with bidirectional cross-border pollution, it is found that if the cross-border pollution is sufficiently strong, a second-best trade agreement requires that both governments impose import tariffs on the goods whose production gives rise to pollution. Also, it is found that if governments cooperate both in trade and environmental policies, they will engage in free trade.