II. General equilibrium approaches—theory II-D II. General equilibrium approaches—theory

Trade and environment policies II-D Trade and environment policies Analytically, we want to be able to identify socially optimal policies in economies with environmental problems The following model does so for an economy with initial distortions due to trade policy and pollution What are the optimal trade and environmental policies in such an economy?

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II-D Insights -- summary In general equilibrium, there are both direct and indirect effects to be accounted for. Trade and environmental policies may interact. A tariff has direct welfare effects, and indirect effects through pollution. No single policy change will necessarily improve welfare. (Theory of the second best) Thus trade restrictions may serve as instruments of environmental policy. Free trade is not the same as laisser-faire.

II-D Some complications… Distribution of income: what if pollution taxes have greatest impact on the poorest? Non-traded goods and endogenous factor supplies There may be env. irreversibilities. Property rights/open access to natural resources, or free disposal of pollutants. Spatial variation may be important. More detailed models are more complex! Preceding results form a ‘benchmark’ when models cannot easily be solved for analytical results.

GE insights for environmental analysis II-D GE insights for environmental analysis In open economies, factor and product markets link all sectors. Indirect as well as direct effects of policies, price shocks, etc., must be measured. When people derive utility from the environment, ‘true’ welfare is hard to measure. Most people are willing to accept some degree of environmental damage in return for economic growth.