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Nowhere has the divide between advocates and critics of globalization been more striking than in debates over free trade and the environment. And yet the literature on the subject is high on rhetoric and low on results. This book is the first to systematically investigate the subject using both economic theory and empirical analysis. Brian Copeland and Scott Taylor establish a powerful theoretical framework for examining the impact of international trade on local pollution levels, and use it to offer a uniquely integrated treatment of the links between economic growth, liberalized trade, and the environment. The results will surprise many.
The authors set out the two leading theories linking international trade to environmental outcomes, develop the empirical implications, and examine their validity using data on measured sulfur dioxide concentrations from over 100 cities worldwide during the period from 1971 to 1986.
The empirical results are provocative. For an average country in the sample, free trade is good for the environment. There is little evidence that developing countries will specialize in pollution-intensive products with further trade. In fact, the results suggest just the opposite: free trade will shift pollution-intensive goods production from poor countries with lax regulation to rich countries with tight regulation, thereby lowering world pollution. The results also suggest that pollution declines amid economic growth fueled by economy-wide technological progress but rises when growth is fueled by capital accumulation alone.
Lucidly argued and authoritatively written, this book will provide students and researchers of international trade and environmental economics a more reliable way of thinking about this contentious issue, and the methodological tools with which to do so.
"Copeland and Taylor have opened the way to a better dialogue between economists and environmentalists. Their book will surely take its place on the shelves of trade economists and environmentalists."—James Anderson, Journal of International Economics
"[A] well-written book. . . . As Copeland and Taylor make clear, there is a good deal of scope for additional research on the topic of trade and environment, and this book provides a great starting point for such research."—Josh Ederington, World Trade Review
"This book is systematically developed and well presented."—Richard N. Cooper, Environment
"This book takes 'trade and the environment' from toddling to a brisk walk and indicates that it has come of age as a subfield. . . . [It] strives, very successfully, to link its theory to empirical work."—Martin Richardson, Economic Record
1.1 Globalization and the Trade versus Environment Debate
"It was the best of times, it was the worst of times." This line, written by Charles Dickens over 100 years ago, captures the present-day divide between supporters and critics of globalization. During the 1990s, North America and much of Europe enjoyed its longest peacetime expansion, unemployment rates hit historic lows, and real income growth in much of the developing world soared. To many these are the fruits of globalization. But this same decade saw little progress in addressing climate change, a decline in fish and tropical forest stocks, and by some measures, rising inequality in the world distribution of income. To many others, these are its costs.
Debates over "globalization" have been going on for some time. But nowhere has the divide between the two views of globalization been more apparent than in recent discussions concerning trade liberalization and the environment.
For the last ten years environmentalists and the trade policy community have squared off over the environmental consequences of liberalized trade. This debate was fueled by negotiations over the North American Free Trade Agreement and the Uruguay round of General Agreement on Tariffs and Trade (GATT) negotiations, both of which occurred at a time when concerns over global warming, species extinction, and industrial pollution were rising. The debate intensified with the creation of the World Trade Organization (WTO) and proposals for future rounds of trade negotiations.
Trade negotiators saw the WTO as a step forward because of its improved dispute settlement procedures and because it closed loopholes in previous trade agreements. Environmentalists, however, were disturbed by the intrusion of trade agreements into what many thought were purely domestic matters. Perhaps not surprisingly, then, an attempt to initiate a new round of multilateral trade negotiations in Seattle became a flashpoint for growing unrest with globalization and efforts at further trade liberalization.
The purpose of this book is to study the interaction between international trade and the environment using both economic theory and empirical analysis. Our objective is to move the discussion forward by developing useful theory and devising methods to help in the empirical estimation of key magnitudes. We hope to enlist readers in further discussion and evaluation of trade's environmental effects, and this book is designed to equip them with the tools for doing so. In the end, differences of opinion will of course remain because the effects of international trade on the environment are still not fully understood. But we hope to give researchers and policymakers a common language and framework within which to discuss, debate, and continue their investigations.
1.2 Two Questions and a Preview of Our Answers
Throughout the book, we focus on two key channels through which trade can affect the environment. The first is via its effects on the level, or scale, of economic activity. If trade spurs economic activity, then the pure income-generating effects of trade may be harmful to the environment. The second channel is via a composition effect-a change in the mix of economic activity in countries, caused by trade. Many environmentalists are concerned that trade may lead to a shifting of polluting industry from rich to poor countries, and this global composition effect may also raise world pollution.
As we will see, both of these channels are more complex than these simple arguments suggest, and this leads to the two key questions that unify the book:
How does the increase in economic activity induced by international trade affect the environment?
Many in the "deep green" environmental movement believe unfettered access to world markets is necessarily harmful to the environment. While arguments differ in the details, the primary objection is that international trade leads to a greater scale of economic activity-be it transportation services, more production of goods and services, or more consumption-and that economic activity per se harms the environment. In this view, if international trade stimulates economic activity and if this activity is inherently environmentally damaging, then so too is international trade.
This concern forces us to think about the link between economic activity and environmental quality more generally and not just with regard to international trade. It leads us to define a measure of the scale of economic activity and to then link this measure to changes in the economy brought about by trade liberalization. But since any change in the scale of economic activity also affects incomes, we must also take into account the impact of income gains on environmental regulation.
If higher real incomes generate a greater ability and willingness to implement and enforce environmental regulations, then the logical chain linking trade liberalization to environmental destruction is broken. A trade liberalization that raises the scale of economic activity will then also lower the dirtiness of production techniques, and its full environmental impact can only be resolved through careful empirical investigation.
We address this first question by using our theoretical framework to separate the impact of economic growth on the environment from that caused by trade liberalization. We show that the relative strength of scale versus technique effects depends on how government policy is formed and how quickly it changes in response to new conditions. We also set out the theoretical conditions under which either the scale or the technique effect is stronger. But since theory alone cannot determine the answers to our questions, we also present empirical work undertaken using a large crosscountry data set on measured sulfur dioxide concentrations in over 100 major cities in the world.
By isolating the pure scale and technique effects of trade, we estimate that a trade liberalization that raises the scale of economic activity by 1% raises pollution concentrations by 0.25 to 0.5% via the scale effect, but the accompanying increase in incomes per capita drives concentrations down by 1.25-1.5% via a technique effect. These estimates imply a strong policy response to trade-inspired income gains. As we show, they also imply that economic growth created by neutral technological progress will both raise real incomes and improve environmental quality, but economic growth fueled by capital accumulation alone will worsen the environment.
Our estimates and analysis are important in establishing that we need to identify the source of income gains before we predict its environmental consequences. For example, neutral technological progress favors no industry, and we find that it improves environmental quality through its role in raising incomes and tightening techniques of production. And while capital accumulation raises both incomes and scale, it favors the production of dirty, capital-intensive processes. Hence capital accumulation creates an additional effect leading to a worsened environment. Trade liberalization can be environmentally friendly since it brings income gains and will lead some countries to specialize in relatively clean industries. But not all countries can specialize in the production of clean goods, and hence it is important to determine which countries are likely to specialize and export relatively dirty products. This brings us to our second question.
2. How does environmental policy affect a nation's trade pattern?
This second question arises from concerns that dirty industries will leave tightly regulated countries and migrate to countries with lax regulations. As a result, international trade could alter the composition of output across countries, leading poor countries with relatively weak environmental regulation to specialize in the production of dirty goods while rich and tightly regulated countries specialize in clean goods. Even if trade liberalization had no effect on the scale of economic activity or on the dirtiness of the techniques of production, it could create pollution havens in the developing world by altering the composition of their output toward dirty goods.
Dirty industry migration is a serious concern because it would imply that poor less developed countries are bearing the pollution burdens of rich developed country consumption. Despite the claims of some economists that this may well be efficient, it would be unpalatable to many. Dirty industry migration may also raise concerns about competitiveness and cause regulatory chill in the developed countries which could slow down ongoing efforts to raise environmental protection. At worst it could usher in a worldwide race to the bottom in environmental protection as nations relax standards to forestall dirty industry migration.
These are valid concerns that need to be seriously addressed. To examine dirty industry migration and the creation of pollution havens we investigate how differences across countries in both environmental regulations and other country characteristics interact to determine a country's trade pattern. We also have to isolate changes in the composition of output created by trade liberalization from those created by more mundane sources such as taste changes or ongoing growth in a nation's productive capacity. To do so we employ our theoretical framework to isolate the composition effect of trade liberalization on pollution.
Isolating changes in the composition of output created by trade is critical to examining whether lax-regulation countries are destined to become pollution havens. While this may appear obvious to some, it too is an empirical question. While developed and less developed countries differ widely in the stringency of their environmental regulations, they also differ widely in average education levels, in available infrastructure, and in capital equipment per person. If these other differences are significant determinants of production costs, then it is no longer clear that lax regulations alone create a cost advantage in dirty good production.
In fact, our empirical work indicates that greater access to international markets creates only relatively small changes in pollution via the composition effect, and that conventional determinants of production costs are more important in determining "international competitiveness" than are differences in meeting the costs of environmental regulation. We find little evidence for dirty industry migration, or the pollution haven hypothesis. Our empirical results suggest just the opposite: that relatively rich developed countries have a comparative advantage in dirty goods. As a result, freer international trade shifts dirty good production from lax-regulation countries to more stringent-regulation countries. If this is correct, then the global composition effect of trade lowers world pollution. Combining our estimates of scale, composition, and technique effects created by a trade liberalization yields a surprising conclusion: freer trade appears to be good for the environment-at least for the average country in our sample and for the pollutant we consider.
While this result will be of interest to policymakers because of the importance of sulfur dioxide pollution and its close connection to other equally noxious pollutants, the most important contribution of this book is the theoretical framework it presents, the methods it espouses, and its discussion of competing hypothesis linking international trade to environmental outcomes.
1.3 Our Method of Analysis
We do not present an exhaustive account or review of all that is known about international trade and the environment, but instead develop a simplified but cohesive framework to investigate the relationship. We show that our framework is useful for understanding the links between economic growth and the environment, useful in disentangling the many different motives for trade in environmentally damaging goods, and useful as a springboard for empirical work that estimates the environmental consequences of liberalized trade. The strength of the book lies in the consistent application of our theoretical approach to various questions and our integration of this approach with empirical work.
Some readers may prefer different methods to discuss different issues, or wish for a presentation less encumbered by formal theory. We chose to be constrained by our theoretical framework because much of the current debate is not constrained by either theory or empirical work, and this has produced an astonishingly high ratio of rhetoric to results. Strong ideologies are at play here. There are those for whom free trade is a goal in and of itself and who speak of it in reverential tones; and there are also those who scorn any exercise to evaluate trade's environmental impact because they view its costs as clearly self-evident. This is an area of public policy debate sorely in need of guidance from further theory and empirical work. Accordingly, our goal is to introduce the reader to a new set of issues and build understanding. To do so we use theory to identify the main forces at work, motivate our empirical approach, and constrain the conclusions that we can draw.
While the appeal of doing "international environmental economics" has surely been present before, various difficulties face those who attempt it. The key difficulty is in introducing public goods into a general equilibrium model rich enough to explore the implications of trade, yet tractable enough to examine policy and to serve as the basis for empirical work.
We have attempted to strike a constructive balance between model complexity and tractability. Our analysis is marked by three characteristics: we adopt general equilibrium models; we assume environmental policy can be altered in light of changed economic conditions; and we adopt relatively simple economic models where the economy is aggregated into only two sectors. Throughout we examine only local pollution, although our methods can be extended to consider transboundary or global pollution.
General equilibrium methods are necessary because they allow us to consider the full implications of international trade on the environment. For example, a partial equilibrium model of a clean industry might predict that the clean industry expands as a result of trade liberalization. Since the clean industry does not pollute, the partial equilibrium model does not predict any effects on the environment. But a general equilibrium analysis recognizes that as the clean industry expands, it must draw resources from other parts of the economy. If these other parts of the economy pollute, then the expansion of a clean industry can lead to a fall in the country's pollution.
In addition, a general equilibrium analysis allows us to grapple with income effects, which have played a central role in the debate over the effects of trade and growth on the environment. If trade stimulates a dirty industry, it will tend to increase pollution. But if trade also raises real incomes via general equilibrium effects, then it will increase the demand for environmental quality, and this can have a dampening effect on the increase in pollution via an endogenous policy response.
Some of the tools we employ are commonly used in competitive general equilibrium trade theory, but will be unfamiliar to many readers. In an attempt to engage those unfamiliar with general equilibrium methods, we develop special cases of our models in some chapters to provide explicit solutions and derivations of main results. The examples we provide have the twin purpose of clarifying and simplifying the more general analysis we present elsewhere, and on occasion demonstrating surprising counterexamples.
Endogenous policy is necessary if we are to capture the response of pollution policy to rising incomes and changing prices brought about by free trade. Much of the literature has focused on the role of differences in environmental policy between rich and poor countries in influencing the trade pattern and in determining the effects of trade on the environment. But if policy differences are caused in part by income differences, and if trade affects incomes, then we cannot evaluate the long-run effects of trade liberalization without taking into account the effects of changes in income and relative prices on environmental policy.
Excerpted from Trade and the Environment by Brian R. Copeland M. Scott Taylor Copyright © 2003 by Princeton University Press. Excerpted by permission.
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Chapter 1: The Trade and Environment Debate 1
1.1 Globalization and the Trade versus Environment Debate 1
1.2 Two Questions and a Preview of Our Answers 2
1.3 Our Method of Analysis 6
1.4 Plan of the Book 9
Chapter 2: Pollution in a Small Open Economy 12
2.1 Technology 16
2.2 Equilibrium along the Net and Potential Production Frontiers 26
2.3 Scale, Composition, and Technique Effects 45
2.4 Endogenous Pollution Policy 56
2.5 Conclusion 65
Chapter 3: Is There an Environmental Kuznets Curve? 67
3.1 Equilibrium Pollution and the Environmental Kuznets Curve 71
3.2 Sources of Growth 74
3.3 Income Effects 78
3.4 Threshold Effects 86
3.5 Increasing Returns to Abatement 97
3.6 Conclusion 104
Chapter 4: Trade Liberalization and Environmental Quality 107
4.1 Trade Frictions 110
4.2 Trade Liberalization with Rigid Pollution Policy 112
4.3 Trade Liberalization with Flexible Pollution Policy 123
4.4 The Political Economy Motive 132
4.5 Conclusion 139
Chapter 5: Pollution Haven Models of International Trade 142
5.1 Exogenous Policy Differences: Rigid Emission Intensities 146
5.2 Exogenous Policy Differences: Marketable Permit Systems 153
5.3 Endogenous Pollution Havens 158
5.4 Global Pollution and the World Composition Effect 164
5.5 Environmentally Friendly Pollution Havens 170
5.6 Northern and Southern Institutional Differences 171
5.7 Conclusion 183
Chapter 6: Factor Endowments, Policy Differences, and Pollution 187
6.1 Exogenous Policy: The Role of Factor Endowments 189
6.2 Endogenous Policy: Factor Endowments and Comparative Advantage 196
6.3 Correlated Characteristics: Being Rich and Capital Abundant 200
6.4 An Illustrative Example 206
6.5 Conclusion 213
Chapter 7: Is Free Trade Good for the Environment? An Empirical Assessment 215
7.1 Three Questions That Deserve an Answer 220
7.2 The Pollution Data 223
7.3 Deriving the Reduced Form 227
7.4 From Theory to Estimation 239
7.5 Empirical Results 250
7.6 Alternative Specifications and Theories 261
7.7 Conclusion 271
Chapter 8: Summary and Conclusions 275
8.1 Flexible Pollution Policy 275
8.2 Growth Is Not Trade 276
8.3 The Pollution Haven and Factor Endowments Hypotheses 277
8.4 Directions for Future Research 280
"This well-written book goes right to the jugular, presenting an integrated, coherent view of the 'trade and environment' issue. The authors, who are well known in the field, are right in not taking sides other than when opinions flow from logically consistent argument."—James Cassing, University of Pittsburgh
"This book provides a unified presentation of important themes relating to international trade and the environment. There is no team better qualified to write such a book, and there are no close substitutes to this book. Copeland and Taylor provide economic intuition where possible, and their mathematical derivations are detailed and easy to follow."—Larry Karp, University of California, Berkeley