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
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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)
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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
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Environmental Problems by
Income Level
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Environmental Effects of the Uruguay
Round (Percentage Changes in Emissions)
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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.
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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.
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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.
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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.
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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.
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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.
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Types of Externalities and
Product-Market Prescriptions
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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
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When Domestic Production Causes
Domestic Pollution
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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
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A Classic Case of International
Pollution with an Ideal Policy Solution
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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.
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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
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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
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Global Environmental Challenges
•
•
•
•
Extinction of species
Overfishing
CFCs and Ozone
Greenhouse gases and global warming
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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.
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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
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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
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Carbon Tax to Stabilize Atmospheric
Carbon Dioxide
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