Taxing the invisible: Unobservable pollution and green transition in a multi-sector framework

The rising demand for green products has encouraged firms to adopt sustainable practices, but it has also intensified the phenomenon of greenwashing. We develop a partial-equilibrium model of a multi-sector economy in which firms undertake both observable and unobservable abatement activities, creating incentives for greenwashing. The model incorporates the threat of nonpoint-source pollution taxes or taxes on individual emissions. Transition risk may induce some industries to sharply reduce, or even discontinue, production when expected environmental damages are high, yielding piecewise-smooth production dynamics of environmental degradation. We show that: (1) the threat of taxing observable pollution mitigates pollution stock; (2) very high expected tax may generate endogenous oscillations; (3) unobservable pollution amplifies this risk; and (4) when pollution is unobservable, consumer extra willingness to pay for green products does not eliminate zero-degradation equilibria.