Chapter 10 Trade and the Environment
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?
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. •
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.
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.
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).
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.
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.
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.
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.
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.
Endowment & Regulation • Ultimately, a country’s endowment of environmental resources is determined by environmental regulation. • The stringency of environmental regulation should reflect the population’s 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.
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.
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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