Trade and the Environment

1
Chapter 10

• Trade and the Environment

2
Key Questions

• What are the classical theorems of international
  trade and the implications of extending them to
  environmental resources?
• When does trade liberalisation damage the
  environment and if so does it matter?
• Do countries competitively reduce environmental
  standards and if so for what purpose?
• Does banning trade in products made from
  endangered species necessarily augment stock
  size?
• Does adherence to the General Agreement on
  Tariffs and Trade unduly constrain attempts to
  tackle environmental problems?
• Does the empirical evidence suggest that
  differences in the stringency of environmental
  regulations are a major determinant of trade
  flows?

3
Viewpoints

• Concerns expressed by environmentalists about
  international trade
• Will gains from trade liberalisation be
  outweighed by the damage to the environment?
• Is there an incentive for countries to engage in
  ecological dumping where one country lowers its
  emissions standards to gain some competitive
  advantage?
• Will footloose industries migrate to pollution
  havens?
• Will countries competitively lower environmental
  standards to generate trade benefits resulting in
  a race to the bottom?
• What about the environmental impact of
  transporting goods internationally?
•  
• Businessmen often argue that environmental
  regulations
•  will result in the loss of jobs, and that
• the production of pollution intensive goods will
  merely be pushed offshore.
• Politicians are concerned about the resulting
  unemployment.
• Debate about the impact of international trade on
  the environment grew noisier in the early 1990s,
  mainly in response to fears about the possible
  impact of the proposed North American Free Trade
  Agreement (NAFTA) between Canada, the US and
  Mexico. Standing on a populist platform former US
  presidential candidate Ross Perot claimed that
  NAFTA would result in a giant sucking sound of
  jobs flowing to Mexico and recommended that
  Mexican goods be barred from entering the US
  unless they were produced under conditions
  meeting US standards for environmental
  protection. The exchange between Daly (1993) and
  Bhagwati (1993) is between two of the chief
  protagonists in the debate over NAFTA.
•  

4
Debate

• Debate about the impact of international trade on
  the environment grew noisier in the early 1990s
  ...
• Mainly in response to fears about the possible
  impact of the proposed North American Free Trade
  Agreement (NAFTA) between Canada, the US and
  Mexico.
• Former US presidential candidate Ross Perot
  claimed that NAFTA would result in large scale
  flow from USA to Mexico and recommended that
  Mexican goods be barred from entering the US
  unless they were produced under conditions
  meeting US standards for environmental
  protection.
• The exchange between Daly (1993) and Bhagwati
  (1993) is between two of the chief protagonists
  in the debate over NAFTA.

5
Free Trade and Welfare

• Many economists believe that free trade improves
  economic welfare.
• Some welcome the fact that industries might wish
  to relocate in countries with low standards.
• For them it just demonstrates that differing
  endowments are the basis of trade.
• Economists do not generally accept the argument
  that countries ought to share the same
  environmental standards, given the existence of
  large differences in per capita incomes and
  population densities between countries.
• Many economists therefore would see no reason for
  biophysical standards and environmental taxes to
  be harmonised.
• Many would also contend that although changes in
  environmental regulation might result in
  temporary unemployment, changes in the exchange
  rate will ultimately restore the trade balance.
• Calls for trade restrictions made on
  environmental grounds should be viewed with
  suspicion as they might be motivated by
  protectionist concerns.

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Structure of this Chapter

• Review of the traditional theory of trade
• Extension of this theory to incorporate
  environmental resources.
• Why might a country have an advantage in the
  production of environmentally intensive
  commodities.
• Partial equilibrium analysis of the effects of
  moving from a position of autarky (no trade) to a
  system of free trade with and without the
  requisite controls on the production of
  environmental externalities.
• We show that the problem is the absence of
  economically efficient environmental policy
  rather than trade liberalisation per se.
• General equilibrium model analysis of the effect
  of trade liberalisation on welfare.
• Consideration of situations in which governments
  might attempt to manipulate environmental
  standards in order to benefit national producers.
  
• Development of a model in which jurisdictions
  compete in order to attract capital.
• Is this likely to result in an erosion of
  environmental standards?
•  The role played by the World Trade Organisation
  (WTO) in policing the global trading system.
• What, according to the WTO, is the difference
  between justifiable and unjustifiable
  restrictions on trade enacted in the name of
  environmental protection?
• Brief overview and critique of attempts to test
  the proposition that environmental regulations
  explain trade flows and patterns of Foreign
  Direct Investment (FDI).

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Traditional trade theory

• Traditional trade theory characterised by a
  number of theorems. These include
• Heckscher-Olin theorem
• Stolper-Samuelson theorem
• Rybczinski theorem
• Factor price equalisation theorem.
• These are covered by any standard textbook on
  international trade e.g. Bhagwati and Srinivasan
  (1983).
• Like Rauscher (1999) and Steininger (1999) we
  wish to consider the implications of these
  theorems when environmental factors of production
  are brought into the picture alongside capital
  and labour.
•  

8
The Heckscher-Ohlin theorem

•  
• A fundamental proposition regarding the pattern
  of trade between two economies.
• The Heckscher-Ohlin theorem suggests that trade
  is determined by differences in factor
  endowments.
• A country will export those goods relatively
  intensive in its abundant factor of production
  and import those goods relatively intensive in
  its scarce factor of production.
• For example, a country having an abundant supply
  of capital will find it cheaper to manufacture
  goods whose production is capital intensive.
• The country is said to have a comparative
  advantage in the production of such goods.
• Post free trade the consumption of the labour
  intensive goods will increase because of an
  increase in national income and a positive
  substitution effect whereas the consumption of
  capital intensive goods may or may not increase.
• Taken as a whole, consumers unambiguously reach a
  higher level of welfare.

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Heckscher-Ohlin theorem assumptions

•  
• The theorem rests on a number of assumptions
• Countries have identical constant returns to
  scale technologies.
• Countries have identical tastes.
• There are no impediments to trade and no
  transport costs.
• There are two goods, two factors of production
  available in fixed quantities, and two countries
  one of which is small and the other one large
  representing the rest of the world.
• Factors of production are immobile.

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Environmental extension (1)

• How can the HO theorem be extended to include
  environmental and natural resources as factors of
  production?
• The exports of many countries reflect their
  exploitation of particular natural resource
  endowments. But the observation that countries
  with, say, deposits of bauxite should
  specialise in the production of bauxite ore is
  not especially insightful.

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Environmental extension (2)

• But environmental resources include air, soil and
  water quality, and the capacity of the
  environment to assimilate the unwanted by
  products of economic activity.
• From our perspective a country is therefore well
  endowed with environmental resources when it is
  sparsely populated and has a higher assimilative
  capacity.
• HO theorem implies that countries well endowed
  with environmental resources should specialise on
  the production of environmentally damaging goods.
  

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Endowment Regulation

• Ultimately, a countrys endowment of
  environmental resources is determined by
  environmental regulation.
• The stringency of environmental regulation should
  reflect the populations appetite for
  environmental quality.
• The stringency of environmental policy is
  endogenous so the growth in income that
  accompanies trade liberalisation might increase
  the stringency of environmental policy and
  therefore reduce the endowment of environmental
  factors of production.

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Harmonisation of standards?

• Differences in the abundance of environmental
  resources and differences in the appetite of
  populations for environmental quality make it
  fairly clear that the harmonisation of
  environmental standards is inappropriate.
• There are perfectly legitimate reasons why
  Governments should wish to set different
  environmental standards.

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Impact of Regulation on Trade

• HO theorem predicts that tighter environmental
  regulation at home leads to increased production
  of environmentally intensive products abroad.
• These environmentally intensive products are then
  imported.

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Topical Example

• A single country or a bloc of countries imposes
  restrictions on CO2 emissions.
• This should result in an increase in CO2
  emissions elsewhere, (carbon leakage).
• Economists have utilised CGE models to estimate
  the extent of carbon leakage associated with
  attempts to reduce carbon emissions by, say, OECD
  countries or the EU.
• It is easy to understand why the threat of carbon
  leakage might prompt policy makers to
• (a) think about trade restrictions to prevent the
  import of carbon intensive commodities and
• (b) reconsider the wisdom of unilateral measures
  to reduce carbon dioxide emissions.

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Other bases for trade in waste and residuals

• Differences in
• population density
• the waste assimilative capacity of countries
• national preferences for environmental quality
• also provide a basis for trade in waste and
  residuals.

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Brief comments on some other theorems
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Stolper-Samuelson theorem

• The HO theorem explains why a country is able to
  increase its income through trade.
• But this does not mean that free trade will be
  advantageous for everyone.
• The Stolper-Samuelson theorem demonstrates that
  those who supply the scarce factor of production
  can gain through protection that restricts
  imports of goods intensive in that factor.
• A tariff will increase the income of the factor
  used intensively in the good that receives
  protection.
• Intuition the resulting increase in the price
  of the good increases the derived demand and
  therefore the price of the intensively-employed
  factor.

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Applicability of Stolper-Samuelson

• Many environmental resources are not privately
  owned.
• But where environmental resources are subject to
  private property rights (perhaps because these
  have been created by the Government in the form
  of tradable permits) then the Stolper-Samuelson
  theorem may apply.

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The Rybczynski theorem

• An increase in the endowment of one factor will
  reduce the production of goods intensive in the
  other factor.
• For example, if there is an increase in labour
  the production of capital intensive goods will
  decline.
• A de facto increase in environmental resources
  caused for example by an increased allocation of
  environmental permits by an incoming Government
  that cares less for environmental quality should
  decrease the production of environmentally
  less-intensive commodities.

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The factor price equalisation theorem

• HO suggests that free trade would equalise factor
  prices since a country would export goods
  intensive in its abundant factor of production
  and import goods intensive in its scare factor of
  production. This would decrease the derived
  demand for the scarce factor of production and
  increase the demand for the abundant factor of
  production thereby reducing international
  differences in factor prices.
• Despite the fact that there is much capital
  mobility, and quite a lot of labour mobility,
  observation suggests that factor price
  equalisation does not hold. Unskilled workers in
  the developed world continue to earn far more
  than equivalent workers in Less Developed
  Countries. This could be attributed to the rather
  rigid assumptions upon which the theorem, and
  indeed the Heckscher-Ohlin theorem, is based e.g.
  the existence of free trade and the assumption
  that production technologies are the same
  everywhere.
• The factor price equalisation theorem would seem
  to suggest that international trade equalises the
  shadow price of environmental resources a
  striking result. The shadow price of
  environmental resources means environmental tax
  rates or the price of environmental permits. Note
  that this does not require tax rate harmonisation
  or trade in permits. This of course does not
  mean that environmental quality will be
  equalised.

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10.1.1 North-South models of trade and the
environment

• So-called North-South models suggest that the
  source of the poor Souths advantage is not that
  they have abundant environmental resources but
  that the use of these resources is unregulated by
  the Government.
• Such models are associated with the seminal paper
  of Chichilnisky (1994). This gives the South an
  illusory comparative advantage in the production
  of environmentally intensive goods. It is
  customary to refer to the region suffering from
  absent property rights governing access to the
  environmental resource as the South and the
  region in which property rights both exist, and
  are enforced, as the North.
• Due to the mismanagement of environmental
  resources trade may exacerbate the environmental
  problems of the South whilst the rich North
  benefits from trade.

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10.2 Does free trade harm the environment? A
partial equilibrium analysis

• The preceding section extended classical theories
  of trade to include environmental resources.
• We will now address the twin questions of (a)
  whether trade is bad for the environment and (b)
  whether it matters in a partial equilibrium
  setting in which the production of a single good
  gives rise to external costs.
• For the sake of simplicity these external costs
  are assumed to arise from the production of the
  good rather than the use of particular production
  processes.
• The country is assumed to be small such that it
  cannot affect its own terms of trade. Factors of
  production are assumed to be immobile and there
  is no transboundary pollution.

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Cases to consider

• This analysis follows closely that of Anderson
  (1992).
• Assume that the country switches from an initial
  position of autarky to one of free trade.
• Four cases to consider
• the country already imposes ,and retains, an
  (allocatively efficient) environmental tax or
  permit quantity of the correct amount and becomes
  a net importer
• the country already imposes, and retains, an
  environmental tax and becomes a net exporter
• the country does not already impose, nor
  introduces, an environmental tax and becomes net
  importer
• the country does not already impose, nor
  introduces, an environmental tax and becomes net
  exporter.
• Liberalising trade in the good whose production
  harms the environment can be welfare enhancing or
  not depending upon whether the country already
  imposes the efficient tax rate on domestic
  production.

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Cases c) and d) efficient tax not imposed

• the country does not impose an environmental tax
  and becomes net importer
• the country does not impose an environmental tax
  and becomes net exporter.
• Begin with cases where the country does not
  impose an efficient environmental tax, and trade
  is liberalised in the good whose production harms
  the environment.
• If the good ends up being imported then welfare
  is definitely improved. This is because real
  resource costs fall whilst at the same time
  domestic pollution levels fall.

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Case (d) Figure 10.2

• The horizontal line P is now higher, indicating
  that opening up to trade will result in a higher
  price for consumers and increased domestic
  production leading to exports.
• Production rises from Q to Qx whilst consumption
  falls to Cx. The change in economic surplus is
  given by eik although there is an increase in
  environmental costs of dekm.
• The relative size of these areas and therefore
  the overall welfare impact is unclear.
• Consequently if a country without environmental
  taxes ends up being a net exporter then the gains
  from trade may be more than outweighed by the
  losses from increased production and the external
  costs that this generates a situation of some
  concern.

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Cases a) and b) efficient environmental tax
already imposed

• If the pollution tax is already in place when
  trade is liberalised then benefits from trade are
  secured irrespective of whether the final
  position of the country is one of exporter or
  importer.
• For the case in which the good ends up being
  imported, Figure 10.1 shows that the change in
  welfare is qcf.
• For the case in which the commodity ends up
  being exported, Figure 10.2 shows that the change
  in welfare is cij.
• So even if production is increased to supply the
  export market the benefits from trade more than
  outweigh the monetised losses from increased
  pollution.

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Is a pollution tax superior to a tax on exports
or a subsidy to imports as means of controlling
environmental problems?

• Suppose that rather than imposing an
  environmental tax on pollution, a tax is instead
  imposed on the exports of the polluting
  commodity. This reduces the price faced by
  domestic consumers of that commodity, meaning
  that they will now purchase too much of the good.
  More specifically, they value infra marginal
  units of the good less than do foreign consumers.
  Accordingly, whilst trade taxes and subsidies can
  influence domestic pollution levels they do so by
  imposing higher costs.
• What happens to the small country when emissions
  taxes are placed upon the production of an
  environmentally damaging commodity in the rest of
  the world? Does this increase or decrease the
  benefits from free trade to the small open
  economy?
• If the country is already an exporter of the
  commodity, Anderson shows that an increase in the
  international price of the commodity increases
  pollution levels in the small economy. However,
  the benefits to the economy are always positive
  if the correct tax on pollution is already in
  place since the gains from trade always outweigh
  the losses from more pollution.
• If the appropriate tax is not already in place
  there could be either benefits or disbenefits
  since the quantity of pollution is already
  excessive.
• If, on the other hand, the country is an importer
  and remains an importer then the gains from trade
  are reduced.
•  

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Summary of the partial equilibrium analysis

• Free trade is better than no trade provided that
  the requisite efficient environmental taxes, or
  their equivalent, are in place provided, that
  is, that the externality is efficiently
  internalised.
• Taxes or subsidies on trade could alter domestic
  production levels and hence pollution but they
  are inferior to taxing environmental pollution.
• Countries have no incentive to depart from the
  economically efficient level of tax placed on the
  production of environmentally damaging goods.
• What about the assumptions underlying the
  analysis?
• As developed countries raise their environmental
  standards the production of environmentally
  damaging goods will move to developing countries.
  Eventually developing countries will become
  exporters of environmentally damaging products.
  But any further increases in international
  standards will benefit developing countries.
• The ability to import or export factors of
  production assumed absent in the foregoing
  discussion in response to changes in
  environmental targets actually enhances the gains
  from trade.
• The assumption that pollution does not cross
  national boundaries is important since with
  transboundary pollution increases in pollution
  affect all countries. Such transboundary
  pollution would, however, occur even in the
  absence of trade.

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Limitations of partial equilibrium models of
trade and the environment

•  
• Partial equilibrium models are used for the
  purposes of analysing the effects of liberalising
  trade in one sector of the economy, when that
  sector is small in relation to the rest of the
  economy.
• But there are important questions that a partial
  equilibrium approach cannot answer.
• What happens when trade is liberalised across
  several sectors of the economy at once such that
  the economy grows?
• What happens to the shadow price of pollution?
• What happens to economy-wide emissions?
• Answering these and other questions requires a
  general equilibrium approach in which all markets
  clear simultaneously.

33
10.3 General equilibrium models of trade and the
environment

•   
• We show the derivation of a general equilibrium
  level of pollution in an open economy as a
  function of the general equilibrium marginal
  abatement cost curve and marginal damage curves.
• It goes on to consider the general equilibrium
  effect of trade liberalisation on economic
  welfare.

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The Copeland and Taylor Model

• Deals with a small open economy facing prices p
  for two commodities x and y.
• Production of commodity x results in pollution
  and is referred to as the dirty good.
• Production of good y produces no pollution and is
  the clean good.
• Economy has at its disposal L units of labour and
  K units of capital.
• Emissions are denoted z and are proportionate to
  potential output of good x.
• Emissions can be reduced by sacrificing some of
  the output of good x.
• Reducing emissions shifts the economys
  production possibility frontier.

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Model Specification (1)

• The national income function G of the economy has
  as its arguments world prices, the level of both
  factor inputs, and permissible emissions
•  
• G returns the maximum value for national income
  which can be achieved given prevailing world
  prices, available factor inputs and production
  technologies, and maximum allowable emissions.
• Differentiating the national income function with
  respect to emissions yields the general
  equilibrium marginal abatement cost function. It
  indicates by how much national income would
  increase if emissions were allowed to rise by one
  unit.
• Associated with the general equilibrium marginal
  abatement cost function is the marginal tax rate
  t necessary to ensure that emissions do not
  exceed z.
•  

36
Model Specification (2)

• We turn now to the consumer side of the economy
  in which there are N individuals.
•  The indirect utility function V of each
  individual is given by
• where IG/N is per capita income.
• The indirect utility function gives the maximum
  amount of utility as a function of prevailing
  prices, available income and emissions (which
  impact negatively on utility).

37
Deriving the Model Solution (1)

• The indirect utility function gives the maximum
  amount of utility as a function of prevailing
  prices, available income and emissions (which
  impact negatively on utility).
• This function is maximised subject to the
  constraint linking national income to permitted
  emissions.

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Deriving the Model Solution (2)

• The first order conditions include
• Given the assumption that world prices are wholly
  independent of national emissions rearranging
  equation 10.4 yields

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Deriving the Model Solution (3)

• The RHS of (10.5) is the Marginal Damage (MD)
  from emissions. This will be a function of
  prices, per capita income and emissions.
• For optimality we already know aggregate marginal
  damage should be set equal to the tax on
  emissions so

40
Deriving the Model Solution (4)

• The optimal level of emissions is therefore
  implicitly defined by
• The optimal level of emissions and the emissions
  tax rate are jointly determined by the
  intersection of the supply of emissions (i.e.
  the aggregate marginal damage curve) and the
  demand for emissions (i.e. the marginal
  abatement cost curve).

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The Copeland and Taylor model and the EKC

• This framework can be used to trace out the
  relationship between national income and
  emissions the environmental Kuznets curve.
• There is no straightforward relationship between
  national income and emissions.
• Both z and G are endogenous variables and the
  precise relationship between national income and
  emissions depends on what underlies the economic
  growth.
•  If economic growth is caused by an accumulation
  of human capital then the economy will
  increasingly specialise in the labour intensive
  non polluting commodity (Rybczynski T). Hence
  demand for pollution falls whilst the growth in
  income causes the supply of pollution to fall.
  These effects are reinforcing gt a negative
  relationship between economic growth and
  emissions.
• If growth in income is caused by an increase in
  the capital stock then the demand for pollution
  increases. This may be more than sufficient to
  offset any income-induced reduction in the supply
  of emissions gt positive relationship between
  economic growth and emissions.
• Economic growth first characterised by increased
  capital and latterly by increased human capital
  generates the stylised inverse U-shaped
  relationship between income and emissions - the
  EKC. But that is only one of many possible
  outcomes.

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The effects of trade liberalisation

• What do CT mean by trade liberalisation?
• Trade liberalisation means either reducing the
  level of some tariff which has been placed on
  some imported commodity or alternatively, a
  reduction in trade frictions.
• In order to export a unit of a commodity an
  amount (1?) units has to be shipped, where ?gt0.
  This is known as the iceberg model for obvious
  reasons.
• This generates a real resource cost to
  international trade representing perhaps, the
  transportation costs of international trade.

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Trade Frictions

• Trade frictions create a difference between
  foreign and domestic prices but do not result in
  any Government revenue.
• If the home country imports x the domestic price
  will be pdp(1?) where p is the world price.
• If x is exported then pdp/(1?).
• These frictions serve to reduce trade.

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Trade liberalisation key results due to Copeland
and Taylor

• If trade is distorted by the presence of trade
  frictions, then trade liberalisation will
  necessarily increase welfare providing that the
  tax is set optimally.
• C T demonstrate that the same analysis can also
  be carried out when the trade distortion is in
  the form of a tariff.
• Once more, we see that if the pollution tax is
  set optimally trade liberalisation would be
  necessarily beneficial.
• C T enquire further under what circumstances
  the change in emissions will be positive or
  negative as a result of trade liberalisation. But
  irrespective of whether or not emissions increase
  or decrease following trade liberalisation
  provided that the tax on emissions has been set
  optimally welfare is guaranteed to increase.
• And if emissions are controlled via a system of
  tradable permits then welfare necessarily
  improves following trade liberalisation.
• Trade liberalisation can therefore have quite
  different consequences depending on whether the
  country has a comparative advantage in the
  production or the clean good, and depending on
  whether environmental policy is optimally
  adjusted, and if not what policy instruments are
  used to control pollution.

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Scale, composition and technique effects
Grossman and Krueger (1993)

• G K give a useful decomposition for thinking
  about the reasons underlying changes in
  emissions.
• Emissions are by definition equal to the overall
  scale of activity S, multiplied by the share of
  dirty goods in total output s, multiplied by the
  emissions per unit of the dirty good, e.
• Taking logarithms and then totally
  differentiating this expression gives
• This says that the percentage change in
  emissions is equal to the percentage change in
  the scale of output plus the percentage change in
  the share of the dirty commodity plus the
  percentage change in emissions intensity of the
  dirty commodity.

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Reasoning which follows from this

• Trade liberalisation boosts market access which
  will generate economic growth, so likely to lead
  to an increase in the scale of economic activity.
  
• Other things being equal the scale effect will be
  environmentally damaging.
• Trade liberalisation is also likely to alter the
  composition of output.
• If a country enjoys a relative abundance of the
  environmental factor of production then that
  country will increasingly specialise in the
  production of environmentally intensive dirty
  commodities.
• Similarly, if a country possesses a relative
  abundance of capital then that country will
  specialise in the production of capital intensive
  commodities. In fact many goods are both capital
  intensive and environmentally intensive.
• The overall effect of the composition effect on
  the environment is therefore ambiguous.
• Insofar as trade liberalisation increases per
  capita income levels the public will call for
  greater environmental quality.
• Assuming that the Government is responsive to
  such demands it will tighten environmental
  regulations.
• Put another way, less of the environmental
  resource will be allocated to production thereby
  compelling producers to adopt different
  production techniques.
• This is the technique effect of trade
  liberalisation.
• The detrimental impact of trade liberalisation on
  the scale effect, the ambiguous impact of trade
  liberalisation on the composition of output
  effect, and the likely beneficial impact of trade
  liberalisation on the technique effect means that
  the overall impact of trade liberalisation is an
  empirical question.

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Box 10.1 The effect of trade liberalisation on
emissions An empirical test 

• Cole and Elliott (2003) empirically analyse
  (using panel data regression techniques ) the
  effect of an increase in trade intensity (the
  ratio of imports plus exports to GDP) on the per
  capita emissions of four different pollutants
  SO2, NOx, CO2 and Biological Oxygen Demand (BOD).
  
• An increase in trade intensity is taken as
  synonymous with trade liberalisation.
• With regards to the situation under autarky, Cole
  and Elliott find that increases in the
  capital-labour ratio increase per capita
  emissions of SO2, NOx and CO2 although for SO2
  each additional increase in the capital labour
  ratio has a diminishing impact. For BOD, they
  find no statistically significant relationship
  between emissions and the capital-labour ratio.
  The combined impact of the scale and technique
  effects appears to be negative for SO2, positive
  for NOx and CO2, and curvilinear for BOD.
•  
• The effects of an increase in trade intensity
  depend on the relative value of the
  capital-labour ratio. A high income country with
  a high level of environmental regulations will
  find that an increase in trade intensity
  increases SO2 emissions. Nevertheless, a high
  income country will experience falls in NOx and
  BOD emissions in response to an increase in trade
  intensity.
• Cole and Elliotts findings for NOx and BOD are
  quite different to those for SO2 and CO2. For
  BOD, the trade intensity coefficient is negative
  and significant, whilst for NOx it is positive
  but insignificant.
• With regards to SO2 emissions, an increase in
  income of 1 percent will generate a reduction in
  per capita emissions of 1.7 percent whereas the
  trade intensity elasticity is 0.3 percent. The
  results for BOD suggest that increased trade
  intensity will reduce per capita emissions for
  NOx and CO2 it is likely to increase emissions.
• In an attempt to isolate the technique effect,
  Cole and Elliott also estimate the impact of
  changes in income and trade intensity on
  emissions per unit of output. For all four
  pollutants, growth in per capita income appears
  to reduce the emissions intensity of output. The
  trade intensity elasticity of emissions per unit
  of output is either negative or statistically
  insignificant.

48
Do governments have an incentive to manipulate
environmental standards for trade purposes?

• Do governments distort their environmental
  policies for trade purposes and if so what can or
  should be done about it?
• Environmentalists often express the concern that
  Governments have an incentive to engage in
  ecological dumping i.e. lowering environmental
  standards in order to gain competitive advantage.
  
• This claim can be examined in the context of a
  model of duopoly.
• Analysis suggests that because international
  trade agreements severely restrict the use of
  more preferred policy instruments, policy makers
  might strategically manipulate environmental
  standards.
• But, critically, policy makers sometimes have
  incentives to adopt stronger rather than weaker
  environmental standards.
• In the context of a two-stage game Barrett (1994)
  examines the incentives for Governments to behave
  strategically whilst setting environmental
  standards.
• Production is assumed to generate environmental
  emissions which cause localised environmental
  damage even though such emissions may be abated
  there are no transboundary pollution flows and
  for convenience consumers are located in a third
  country.
• In the first stage of the game Governments choose
  permissible emissions. In the second stage of the
  game the firms choose their output.
• Depending on the form of competition that ensues,
  Governments have an incentive to set an
  environmental policy that is either too weak or
  too strong.
• Whilst Governments have an incentive
  strategically to manipulate environmental
  standards, such a measure is always inferior to
  conventional export subsidies or taxes.
• Governments would always prefer using such
  measures if they were permitted.

49
Other results

• Brander and Spencer (1985), employing a similar
  setup, find it optimal for Governments to
  subsidise their own firms.
• However, Barratt demonstrates that although the
  Government is able to provide an implicit subsidy
  by increasing the limit on emissions this has a
  cost in the form domestic pollution problems. In
  this sense it differs from a pure subsidy.
  Consequently, a Government would prefer to use a
  pure subsidy for the purpose of inducing a higher
  level of output if only such a measure were
  available to it.
•  The foreign Government would also respond
  strategically. This gives the Nash response and
  ironically both firms earn lower profits and
  experience higher levels of pollution. However
  neither country has the incentive to alter its
  behaviour. Barratts paper further shows that
  both countries have an interest in cooperating
  and imposing and stronger environmental standards
  than that corresponding to the environmentally
  optimal emissions standard.
• Although there is policy competition between the
  two Governments this does not result in a race to
  the bottom since there is a cost to Governments
  engaged in an attempt to gain an increased share
  of the world market in the form of increased
  levels of domestic pollution.
• Finally Barratt considers the case of Bertrand
  competition where firms compete over prices
  rather than output. The analytical model suggests
  that Government should strategically reduce
  permissible emissions.
• Governments need to know the form of
  oligopolistic interaction being used in the
  market in which they want strategically to
  intervene.

50
Other results (2)

• How important are the assumptions of no domestic
  consumers and no transboundary pollution flows to
  this particular model?
• Ulph (2000) explains that relaxing these
  assumptions actually reinforces the conclusion
  that Governments have incentives to engage in
  ecological dumping.
• Since imperfect competition implies less output
  than socially desirable, Governments would
  positively desire that their firms expand output.
  Similarly, where there are transboundary
  pollution problems Governments have an incentive
  to reduce foreign output and hence foreign
  pollution flows.
• Do these arguments carry over to other kinds of
  markets? There is no strategic element in
  competitive markets since the world price cannot
  be altered. In the monopoly case there is no
  rival firm whose output can be manipulated.
•  
• There are however circumstances in which
  Governments have incentives to manipulate the
  terms of trade in their favour but, where
  prevented from using export taxes and subsidies
  for this purpose, manipulate environmental
  standards as a second best.
• For example, a country that is a major importer
  of a polluting commodity will increase
  permissible emissions to encourage domestic
  production if unable to use an import tax to
  depress world prices. Likewise a country which is
  a major exporter of a dirty commodity will reduce
  permissible emissions if it cannot use an export
  tax to raise world prices.

51
What can be done about Governments using
environmental policy for trade purposes?

• One possibility is to allow countries to take
  action against those believed to be engaged in
  environmental dumping.
• However to substantiate such a claim it would be
  necessary at the very least to demonstrate that
  the standards are even lower than would be
  expected on the basis of such factors as the
  level of per capita income and the
  characteristics of the physical environment.
  Clearly that would be very difficult to do
  (GATT, 1992).
• Another possibility is to allow environmental
  policy to be set at the supranational level e.g.
  at the level of the EU.
• What form might such intervention take?
• It is is very difficult to support the
  harmonisation of biophysical standards and
  environmental taxes.
• Harmonisation is inappropriate because
  environmental preferences differ as well as
  differences in the ability of countries to
  dissipate waste whereas minimum standards
  presumes that if one country increases its
  environmental standards to the required minimum
  that another country is not then tempted to
  reduce its own standards, standards that
  currently exceed the minimum.

52
Environmental policy and competition between
jurisdictions for mobile capital

• The view that national and regional Governments
  are likely to compete to attract new firms in
  part by relaxing environmental standards is
  pervasive.
• Numerous calls have been made for minimum
  standards to prevent the excessive degradation of
  environmental standards (e.g. Cumberland, 1981).
• But what precisely are the incentives to engage
  in a race to the bottom?
• If residents care about environmental quality as
  well as labour income then competitively lowering
  environmental standards patently imposes a cost
  on the community.
• Indeed, rather than a race to the bottom arguably
  we are witnessing the perpetual tightening of
  environmental standards.
• But is this the consequence of federal
  Governments actively restricting the ability of
  jurisdictions to use environmental regulation as
  a tool to attract new businesses?

53
Oates and Schwab (1984) model of
inter-jurisdictional competition

• In a community composed of homogeneous and
  geographically immobile individuals, workers
  select a tax rate on capital and simultaneously
  the level of environmental quality.
• Attracting capital boosts wages.
• But attracting capital via reducing taxes reduces
  non-labour income, whilst attracting capital via
  increasing permitted emissions reduces utility.
• Model conclusions
• Only in very specific circumstances is there a
  tendency for Governments to competitively lower
  environmental standards.
• And there are even circumstances in which
  Governments might wish to competitively raise
  standards.

54

• Oates and Schwab then go on to consider the
  situation in which the economy is populated by
  heterogeneous individuals those who work and
  those who rely on revenue from taxing capital.
• Labourers would prefer an influx of capital that
  will raise wages whereas non-workers want higher
  capital tax revenues.
• What happens depends on which group is in the
  majority. If workers are in the majority then
  there will be a subsidy to capital. Workers gain
  the benefit of a larger capital stock in the form
  of higher wages but bear only a fraction of the
  cost of providing the subsidy.
• To summarise, Governments have no incentive to
  manipulate environmental standards in order to
  attract capital unless they are obliged to tax
  capital for revenue raising purposes.
• In this case the marginal benefit of improving
  the environment should exceed the marginal cost.
• But in regions populated by heterogeneous
  individuals this rule can be reversed.

55
Banning trade in endangered species

• Measures to protect endangered species often
  include banning international trade in animal
  products e.g. skins and ivory, as well as better
  enforcement of anti-poaching regulations and
  compensation for preservation benefits enjoyed by
  rich countries.
• The 1973 Convention on International Trade in
  Endangered Species (CITES) banned trade in animal
  products listed in Appendix 1 to the agreement.
  Trade in the animal products of species listed in
  Appendix II to the agreement is also tightly
  regulated.
• The African elephant was added to Appendix 1 in
  1989 following a serious decline in elephant
  numbers during the 1970s and 1980s. Some sales of
  ivory from stockpiles have nevertheless been
  permitted. Since then elephant populations in
  Eastern and Southern Africa have been steadily
  increasing to the extent that South Africa is now
  considering a culling program. According to the
  IUCNs African Elephant Status Report 2007 there
  are between 470,000 and 690,000 African elephants
  in the wild.
• Although adding the African elephant to Appendix
  I has seemingly increased numbers, the following
  question arises Does banning international trade
  in endangered species like the African elephant
  necessarily increase stocks?

56
Does banning international trade in endangered
species like the African elephant necessarily
increase stocks?

• Addressed by the model of Bulte and Van Kooten
  (1996).
• Key finding is that the effect of a trade ban on
  stock levels is ambiguous remain.
• A key matter is the changed incentives of the
  Government to limit the activities of poachers
  under a trade ban.
• There can be no presumption that banning trade
  will necessarily increase the stock of an
  endangered species.
• At a minimum it is necessary to know about the
  prevailing interest rate and the growth rate of
  the species before recommending a trade ban.

57
GATT and WTO

• The objective of the General Agreement on Tariffs
  and Trade (GATT) is the reduction of barriers to
  international trade achieved through the gradual
  elimination of tariffs, quantitative restrictions
  and subsidies.
• The GATT treaty was created in 1947 and lasted
  until 1995 when it was subsumed into the World
  Trade Organisation (WTO).
• Discussing the lowering of tariffs is undertaken
  in periodic rounds of negotiations frequently
  extending over several years. Recent rounds have
  dealt with amongst other things trade in
  services, agricultural products and property
  rights.
• The latest of these, the Doha round, collapsed in
  2008.
• Amongst other things the WTO administers trade
  agreements, serves as a forum for negotiations
  and the resolution of disputes, monitors trade
  policies, provides assistance to Less Developed
  Countries and cooperates with other international
  bodies.
• The original GATT agreement contained a list of
  38 articles of which the two most important are
• the most favoured nation provision (Article I)
  and
• the national treatment provision (Article III).
• Under the GATT agreements, countries cannot
  discriminate between trading partners. What this
  means is that imports from any contracting party
  should be treated no less favourably than like
  products imported from any other contracting
  party. Imported and locally produced goods should
  be treated equally.

58
GATT Article XX

• Deals with measures to protect human, animal or
  plant life or health.
• Extracts from text of GATT article XX
•  
• Subject to the requirement that such measures
  are not applied in a manner which would
  constitute a means of arbitrary or unjustifiable
  discrimination between countries where the same
  conditions prevail, or a disguised restriction on
  international trade, nothing in this agreement
  shall be construed to prevent the adoption or
  enforcement by any contracting party of measures
• ...
• (b) necessary to protect human, animal or plant
  life or health
• ...
• (g) relating to the conservation of exhaustible
  natural resources if such measures are made
  effective in conjunction with restrictions on
  domestic production or consumption
• Source the WTO website http//www.wto.org/

59
Tuna and dolphins

•  A dispute between Mexico and the US over tuna
  and dolphins has come to assume particular
  importance in how many environmentalists view the
  GATT and the WTO.
• When tuna are fished using purse seine nets
  dolphins can become unintentionally trapped and
  suffocate. The US Marine Mammal Protection Act
  (MMPA) sets out standards for the protection of
  dolphins in the Eastern Tropical Pacific Ocean.
  If a country exporting tuna to the US cannot
  prove that its standards meet those enshrined in
  US law then the US must embargo all imports of
  tuna and tuna products from that country and any
  intermediary countries that purchase tuna from
  the country subject to the embargo.
• The US embargoed tuna from Mexico, Venezuela and
  Vanuatu, as well as a number of intermediary
  countries because the methods used to catch the
  tuna in these countries did not meet the
  requirements of the MMPA.
• In 1991 Mexico alleged that the US embargo on
  their tuna exports was inconsistent with the
  provisions of GATT.
• The dispute settlement panel found that article
  III requiring that imported products be accorded
  a no less favourable treatment than domestic
  products had indeed been violated. The US could
  not curtail imports of tuna from Mexico simply
  because the fishing method employed did not
  satisfy regulators in the US.
• The dispute settlement panel also declined to
  uphold the embargo under article XX since
  although the article dealt with measures
  necessary to protect animals and exhaustible
  natural resources this did not permit a country
  to enforce measures falling outside its
  territorial jurisdiction.
• The argument of the dispute panel aimed to avoid
  countries attempting to impose ethical standards
  on other countries over which they have no
  jurisdiction.
• Although the US and Mexico ultimately decided to
  settle their dispute bilaterally the tuna dolphin
  case seemed to have troubling consequences.
• Environmental impacts often cross national
  boundaries. Surely a country can have a
  legitimate interest in environmental events
  occurring in areas outside its legal
  jurisdiction?
• Furthermore, the dispute resolution panel seemed
  not to distinguish between environmental
  resources which were not in the jurisdiction of
  any state such as atmospheric or oceanic
  resources, and those that were within the
  jurisdiction of a state. The GATT secretariat
  soon after made it explicitly clear that it was
  not possible under GATT rules to make access to
  ones own market dependent on the domestic
  environmental policies or practices of the
  exporting country.

60
A critique of Article XX

• For a measure to be justified under Article XX it
  must be first shown that it falls under at least
  one of ten exceptions under Article XX of which
  only (b) and (g) allude to the environment, and
  then that the measure satisfies the introductory
  paragraph (referred to as the chapeau of
  Article XX), i.e. that it does not constitute a
  means of arbitrary or unjustifiable
  discrimination between countries where the same
  conditions prevail and is not a disguised
  restriction on international trade.
• Article XX does not even use the word
  environment. Likewise, article XX does not make
  clear what it means by exhaustible natural
  resources. Obviously, the GATT was drafted at a
  time when the environment was not the priority
  that it is today.
• The insistence that Governments should employ
  measures that are least inconsistent with GATT
  policies is hard to understand.
•  
• The suggestion that scientific evidence is
  required before a commodity can be restricted
  even on a non-discriminatory fashion raises
  further issues.
• Environmentalists antipathy towards the GATT and
  the WTO seems partly based on the belief that
  trade causes environmental degradation and
  competitive lowering of environmental standards.
  But such beliefs might be misplaced.
•  
• GATT does not prevent countries from using market
  based instruments or traditional command and
  control techniques for the purposes of
  environmental protection. Neither does the GATT
  prevent a country from dealing with environmental
  problems arising from goods whose production is
  linked to environmental externalities whether
  these goods are produced domestically or
  imported.
• The absence of any clause in Article XX allowing
  trade sanctions to be used in the case of
  pollution spillovers or degradation of the global
  commons is troubling.
• There is nevertheless, justifiable concern about
  environmental issues being exploited by those
  with protectionist motives. We have already
  explained the risk that environmental regulations
  will be used in place of the kind of exports
  taxes and subsidies that the GATT has done so
  much to combat.

61
Summary (1)

•  Basic trade theory suggests that countries will
  specialise in those commodities that are
  intensive in their most abundant factor of
  production. Countries can be considered abundant
  in environmental resources if they are sparsely
  populated, possess environments capable of
  dissipating environmental residues and have
  populations that do not much care for
  environmental quality, perhaps because of low
  incomes. Such inter-country differences as exist
  make it hard to sustain calls for the
  harmonisation of environmental standards.
• A partial equilibrium model suggests that trade
  liberalisation could have a positive or negative
  effect on the environment, but that even if it
  did have a negative effect this might well be
  outweighed by the real resource gains. And even
  this could be avoided by imposing the appropriate
  environmental tax from the outset. In a general
  equilibrium model changes in trade frictions or
  resource endowments cause changes in
  environmental emissions. These can be usefully
  decomposed into changes arising from the scale of
  economic activity, changes in the composition of
  output and changes in production technique.
• It is possible to construct models in which there
  are incentives to lower environmental standards
  for trade purposes but this generally occurs
  because countries are not allowed to use more
  conventional measures. Depending on the precise
  form that competition takes a country might even
  have incentives to raise environmental standards.
  Likewise there are circumstances in which
  Governments might wish to lower environmental
  standards in order to attract capital inflows.
  This could occur if the Government is obliged to
  tax capital. But there is an optimal degree of
  relaxation involved and certainly no race to the
  bottom.

62
Summary (2)

• Banning trade in animal products may raise or
  lower the stock of the species depending amongst
  other things on the prevailing interest rate and
  the species growth rate.
• The GATT is required to deal with instances in
  which calls for environmental protection have
  protectionist motives.
• Empirical studies have generally found little
  evidence to suggest that patterns of trade are
  determined by environmental standards in the
  manner suggested by theory.
• Although it might be correct in particular
  instances, the belief that trade is bad for the
  environment, that countries are forced to lower
  environmental standards, that the WTO undermines
  attempts to improve environmental quality and
  that footloose firms exploit differences in
  environmental regulations is not generally
  correct.  

63
Discussion questions

• I think the economic logic behind dumping a load
  of toxic waste in the lowest wage country is
  impeccable and we should face up to that. Do you
  think that the economic reasoning displayed here
  is right or wrong? This is another quotation is
  taken from an infamous memo allegedly written by
  Lawrence Summers. The full memo can be found on
  our website (as well as many other internet
  sites).
• Does international trade compel countries to
  lower environmental standards?
• Do you think that it is acceptable for the EU to
  try to ban US beef containing growth hormones? Do
  you think that such a manoeuvre would be
  acceptable under GATT rules?
• How would you test empirically the hypothesis
  that differences in environmental regulations
  provide a basis for trade? What difficulties
  would you expect to encounter?