Globalization and the environment Workshop in Hanoi. Friday, 8 th May 2009 Jørgen Birk Mortensen Department of Economics Copenhagen University

Increasing concern over the effects of international trade on the local and the global environment. Even if increasing trade succeeds in raising incomes and consumption it will lead to more pollution. Income gains will increase the demand for environmental quality, increase investment in pollution abatement and generate revenues for enforcement of environmental regulation.

“Rather dramatic shift in Vietnam’s trading patterns has important implications for the environment and the use of natural resources”. Increasing manufacturing and export activity in water and toxic pollution-intensive sectors compared to less pollution-intensive sectors. (M.Mani & S. Jha: Trade Liberalization and the Environment in Vietnam. World Bank Policy Research Working Paper. 3879)

Some important environmental economic concepts: Market failure. Market system often generates the wrong level of environmental quality External costs. The market price or the production costs exclude its social impact, cost, or benefits. Public goods. A person or nation cannot be excluded from its provision. A potential problem is free-riding.

Government/regulation failure: Government intervention can make things worse or make the total costs too high. (The climate change policy of the European Union). Combining efficiency and goals for distribution.

International Trade. Why do countries trade? Adam Smith (1776) and Ricardo (1817): Greater efficiency result when countries specialize in producing those goods for which they have a natural advantage. Abundant resources will used more in the production of goods and services than scarce resources. A country benefit by an increase in welfare from freer trade and suffer a reduction in welfare when trade is restricted through quotas and tariffs.

Income and the demand for environmental quality. Do income influence demand for environmental protection? As people become wealthier, they seem to demand more and more environmental protection. Normal good. Luxury good. It is generally accepted that environmental quality is a normal good, whether it is a luxury good is less clear. Environmental quality is not a homogeneous good.

Is trade good or bad for the environment? The many possible effects of trade on the environment can be divided into categories: – those that operate via GDP in the same manner as investment, technology and other sources of economic growth; – and those that are peculiar for trade alone and thus hold even for a given level of GDP. In each category, there are beneficial and detrimental effects. Depends on what dimension of environmental quality is at stake.

The environmental Kuznets curve. In a developing industrial economy, little weight is given to environmental concerns, raising pollution. After attaining a certain standard of living focus change - greater weight to a cleaner environment. No evidence that this relationship hold for all types of pollutants.

It is not hard to explain why trade and growth could help reduce local air pollution but increase greenhouse-gas emissions. – The later constitutes a global externality. Due to the international “free rider problem” regulation on the national level is inadequate to address it: – Each country individually would have little incentive to cut back emissions because it would bear the economic costs alone even through the benefits accrue to all.

Decomposition: Scale, Technique and Composition Effects. Useful to decompose changes in pollution into fundamental forces: The scale effect: Measure the increase in pollution that would be generated if the economy were simply scaled up, holding constant the mix of goods produced and production techniques. The composition effect: The change in the share of the dirty goods in national income. Technique effect: Holding all else constant, a reduction in the emissions intensity will reduce pollution.

Trade liberalization and capital accumulation tend to raise the productive capacity of the economy (scale effects in each case) but they may stimulate very different types of economic activity (their composition effects will differ). Both types of change could lead the government to tighten environmental policy (which will lead to a technique effect). Trade and growth both stimulate economic activity, and therefore both increase the economy’s scale. The sum of these effects of trade on the environment may be positive or negative, depending on the industry or pollutant involved.

Consider a small country facing both market failures and the prospect of trade liberalization. The small country produces or consumes a commodity with adverse environmental impacts. The result of this externality is a “wedge” between private and social costs of production. Liberalizing trade in a good with adverse environmental impacts (uncontrolled) improves a country’s welfare, if it imports the good, but if it export it, the negative environmental effects are subtracted from the gains from trade. International Trade with market failures.

International Trade with optimal environmental regulation (Local pollution). Suppose the small country combine a trade reform with an environmental policy intervention sufficient to internalize the externality (pollution tax). In contrast to the situation in which no environmental intervention occurs, the importing and the exporting country will get a net gain from trade.

International Trade and transboundary pollution. When several nations are involved an international authority capable of levying and enforcing environmental regulation is absent. National governments must coordinate their actions. An increasing number of environmental externalities are truly global. The best examples are greenhouse gases. A ton of CO2 creates the same global warming potential regardless where in the world it is emitted. Even localized environmental damage, such as deforestation, is increasingly seen as a valid object of international concern. A country concerned about its own health or environment has the right to tax or ban products that it regards as harmful, so long as it does not discriminate against foreign producers.

International Trade and transboundary pollution. But is it also legitimate for importing countries to discriminate according to how a given product was produced? Foreign residents care about localized environmental damage even there is no evident link to their interests. Non –use value. People place value on keeping a piece of nature unspoiled, even if they know they will never see it. Citizen in one country may have a stake in another country’s environmental and nature politics.

The leakage problem. The “green paradox” of environmental policies. Demand control policies only lowers fossil fuel consumption to the degree that resource owners decide to decrease their supply. Countries doing nothing with regard to climate protection enjoy an implicit subsidy on their energy demand. Without supply cuts, world energy prices fall by so much that countries outside the Kyoto agreement consume and burn exactly the quantities not demanded by the Kyoto countries. The supplier reaction depends on the temporal course of the demand restrictions that the suppliers expect. If future restrictions are expected to be stricter, then suppliers have an incentive to extract more now.

The effects of environmental policy on competitiveness. There is little evidence that the stringency of environmental control measure caused export patterns to deviate from patterns predicted by the resource endowments of the countries. The explanation : Pollution abatements costs are a relatively small proportion of the total costs of production. There is little evidence that firms choose to locate new plants in states with less stringent environmental regulations. Firms operating in a number of states find it cost-effective to operate all plants to the same environmental standards.

The Porter hypothesis. Tighter environmental standards trigger innovations that may increase a firm’s competitiveness and outweigh short- run costs to firm of complying with the regulation. Supported by evidence from some case studies. At present there is no theoretical justification for the Porter hypothesis and no firm empirical evidence. However, it received widespread attention because it provided an attractive idea to policy-makers to justify tighter environmental regulations.

International competition among governments. Governments also compete against one another for economic gain - to attract firms, for the purpose of providing jobs, tax revenue, income and advantages for existing domestic firms. Governments use tax policy, including tariffs, and regulatory policy, including environmental regulation. The government may relax environmental regulation to attract new industries. Will countries with lax environmental regulation end up specializing in dirty industries?

Pollution Havens. Environmental regulations cost polluters money. A country with weak environmental regulations would offer a cost advantage to polluting industries and would thus tend to specialize in these industries. Low- income countries will become more pollution- intensive. The general consensus of the empirical literature on pollution havens and the effect of environmental regulation on trade is that the effect is very weak at best.

The “race to the bottom” hypothesis. International trade and investment will put downward pressure on countries’ environmental standards and thus damage the environment.

International trade, transport and pollution. The lack of environmental regulation in international transport. Social costs of emissions related to transport are not internalized. Transport prices are too low. Tax on air transport. Tax on maritime transport. Global maritime transport is the main vehicle for global trade – 80 % of flows in terms of volume and causes a considerable amount of pollution.

Conflicts between international trade and environmental agreement. Trade agreements have provided foreign producers with legal vehicle for challenging the domestic regulation of their trading partners, if those regulators appear to discriminate unfairly against their exports. The “tuna – dolphin” case. GATT dispute panel found that an American ban on imports of tuna from nations whose dolphin protection standards were laxer than US ones violated US treaty obligations under the GATT.

Do trade and environmental regimes always pull in opposite directions? Russia and the Kyoto Protocol. Russia decided to go along for EU support of Russia’s application to accede WTO. Europe wanted Russia to sign the protocol, and Russia wanted to become a member of WTO. An international ban on subsidies to fossil fuels - reducing carbon emissions. removing an economic distortion and contribution to deficit spending. Should green countries use trade restrictions as a way of changing the environmental practices of their less green trading partners?

Concluding remarks More trade among nations does not necessarily lead to greater pollution at home or abroad. But it could. Removing trade frictions without an efficient environmental policy, can create circumstances that decrease social welfare and greater levels of pollution.

Concluding remarks Local pollution: If a country already has efficient environmental policy in place, trade liberalization should increase welfare. Global pollution: If pollution is a public bad relocation of pollution intensive industries to countries with les stringent environmental protection may increase global pollution and decrease gains from trade. Uncoordinated regulation of pollution at a national level does not eliminate all market failures, and free trade need not raise wellfare.