Chapter 13: Trade and the Environment Is Free Trade Anti-Environment? There are several effects of increasing international trade on pollution and the environment. • Free trade will alter the composition of what is produced and consumed in each country. As the composition changes, the total amounts of pollution will change © 2016 McGraw-Hill Education. All Rights Reserved. 2 Is Free Trade Anti-Environment? Additional gains from trade have two different effects on the economy • The increased production and consumption due to increased trade probably leads to more pollution, i.e. the larger size of the economy contributes to more pollution (the size effect) • Since demand for a cleaner environment is a normal good, the higher income can lead to pressure on governments to enact tougher environmental protection policies, resulting in less pollution per unit produced. (the income effect) © 2016 McGraw-Hill Education. All Rights Reserved. 3 The Size and Income Effects There are likely to be different general patterns for the combined size and income effects, depending on what kind of environmental problems we are examining: • Environmental harm declines with rising production and income per person. Income effect dominate the size effect • Environmental harm rises with rising production and income per person. Size effect dominates the income effect • The relationship is an inverted U-shaped function. This is the environmental Kuznets curve © 2016 McGraw-Hill Education. All Rights Reserved. 4 Environmental Problems by Income Level © 2016 McGraw-Hill Education. All Rights Reserved. 5 Environmental Effects of the Uruguay Round (Percentage Changes in Emissions) © 2016 McGraw-Hill Education. All Rights Reserved. 6 Is the WTO Anti-Environment? There are three important types of policies that may qualify for environmental exception by WTO. 1. When consumption of products can cause damage • WTO position: a country generally can impose product standards or other limits on consumption to protect the country’s health, its safety, or the environment, even though such a policy may limit imports. • The key is that the policy applies to all consumption, not just to imports. © 2016 McGraw-Hill Education. All Rights Reserved. 7 Is the WTO Anti-Environment? 2. Production in foreign countries can cause environmental damage WTO position has evolved to one that permits an environmental exception for national rules that limit imports of products produced using procedures that harm the environment, but with strict standards • The rules must demonstrably assist in pursuing a legitimate environmental goal, and must limit trade as little as possible. • The rules must be applied equally to domestic producers and to all foreign exporting firms. • The country imposing the rules should be engaged in negotiations with other involved countries to establish a multilateral agreement to address environmental issues. © 2016 McGraw-Hill Education. All Rights Reserved. 8 Is the WTO Anti-Environment? 3. Global environmental problems that require global solutions negotiated among many governments • Two important multilateral agreements, the Convention on International Trade in Engendered Species and the Montreal Protocol use trade bans, even for trade with countries that have not signed the agreements. • The WTO has not ruled on this type of multilateral agreement, but seems to be OK. © 2016 McGraw-Hill Education. All Rights Reserved. 9 The Specificity Rule Again • An externality exists when somebody’s actions bring direct costs or benefits to anybody who is not part of the marketplace decisions to undertake the activity. • Pollution is an externality that imposes an external cost on people who do not have any say over the pollution. This distortion leads to market failure. • For government policy to address the market failure, the specificity rule says to intervene as closely as possible to the source of the problem. © 2016 McGraw-Hill Education. All Rights Reserved. 10 Alternative Government Policy Approaches There are two alternative government policy approaches to resolve the market inefficiency resulting from externalities: 1. Use government taxes and subsidies to monetize the externalities. 2. Change property rights so that all relevant resources are somebody’s private property. © 2016 McGraw-Hill Education. All Rights Reserved. 11 Preview of Policy Prescriptions When we have to choose between doing nothing and intervening in the product markets related to externalities, as a substitute for controlling the externality directly, we should follow the guidelines summarized in the following table. © 2016 McGraw-Hill Education. All Rights Reserved. 12 Types of Externalities and Product-Market Prescriptions © 2016 McGraw-Hill Education. All Rights Reserved. 13 Trade and Domestic Pollution • Economic activities sometime produce significant amounts of domestic pollution. That is, the costs of the pollution fall only on people within the country • If there are no policies that force market decision-makers to internalize these external costs – Free trade can reduce the well-being of the country – The country can end up exporting the wrong products; it exports products that it should import © 2016 McGraw-Hill Education. All Rights Reserved. 14 When Domestic Production Causes Domestic Pollution © 2016 McGraw-Hill Education. All Rights Reserved. 15 Transborder Pollution • Transborder effects—effects not just on the country doing the pollution (e.g., Germany) but also on neighboring countries (e.g., Austria) • The “right” amount of pollution is the amount that brings the greatest net gain to the world as a whole © 2016 McGraw-Hill Education. All Rights Reserved. 16 A Classic Case of International Pollution with an Ideal Policy Solution © 2016 McGraw-Hill Education. All Rights Reserved. 17 The Next-Best Solution • If an international agreement is not possible, what can the government of the country that is being harmed by other country’s pollution do? – If Austria imports paper from Germany, then the Austrian government can impose restriction on imports of paper from Germany – If Austria exports paper to Germany, then the Austrian government can subsidize paper exports to Germany. © 2016 McGraw-Hill Education. All Rights Reserved. 18 NAFTA and Transborder Pollution • Environmental problems along the MexicoU.S. border provide a real case of challenges of transborder pollution – Prominent in the fight over the effects of the North American Free Trade Agreement (NAFTA) • NAFTA set up a commission and development bank, but with little effect to improve environmental conditions © 2016 McGraw-Hill Education. All Rights Reserved. 19 Global Environmental Challenges • Depletion of the ozone layer • Global warming as a result of greenhouse gases • When environmental problem causes only domestic costs, it is up to the government of the country to address it • When the problem is transborder but regional, it may still be solvable by negotiation • When the problem is global, a multilateral agreement is needed, but negotiating and enforcing the agreement may be difficult © 2016 McGraw-Hill Education. All Rights Reserved. 20 Global Environmental Challenges • • • • Extinction of species Overfishing CFCs and Ozone Greenhouse gases and global warming © 2016 McGraw-Hill Education. All Rights Reserved. 21 CFCs and Ozone • CFCS deplete ozone in the upper atmosphere. • In 1987 over 50 nations agreed to the Montreal Protocol banning exports and imports of CFCs and halons, extended in 1990 to phasing out production. • Has been achieving much of the intended environmental and economic effects. © 2016 McGraw-Hill Education. All Rights Reserved. 22 CFCs and Ozone Why has the Montreal Protocol been successful? • Scientific evidence clear and convincing • Small group of products, and substitutes feasible at reasonable cost • Production concentrated in the United States and the EU • These producing countries also likely to be among the countries most harmed by the damage to the atmosphere © 2016 McGraw-Hill Education. All Rights Reserved. 23 Greenhouse Gases and Global Warming The solution to excessive global warming should include the following elements: • Economic incentives are used to encourage reductions in greenhouse gas emission • All countries are involved • The policy extends over decades © 2016 McGraw-Hill Education. All Rights Reserved. 24 Carbon Tax to Stabilize Atmospheric Carbon Dioxide © 2016 McGraw-Hill Education. All Rights Reserved. 25