Pollution, Welfare and Informal Sector : A Theoretical Analysis

We present a three-sector general equilibrium model with an informal sector, which produces an intermediary for the formal sector, to analyze the effects of different policies on the pollution level and welfare of the economy. The informal manufacturing sector creates pollution and higher the use of informal sector product, higher is the pollution created and higher the discrepancy between actual and permissible levels of pollution, so that the abatement cost payable by the formal sector is also higher. The efficiency of a representative worker is inversely related to the level of pollution. In this set-up, we show that even if the permissible pollution level is reduced, the polluting sector may expand and affect welfare adversely. On the other hand, an inflow of foreign capital may reduce the pollution level and increase welfare of the economy. These results are new in the literature of trade and environment