Week 6 & 7: Trade and the Environment (Ch.13)

1. Is free trade anti-environment
Free trade will change the composition of production and consumption in each country. As the composition changes, the total amounts of pollution will change.
There are gains from trade, which set up two different effects
The size of the economy is larger, which implies more pollution, ceteris paribus
The higher income can lead to more pressure on governments to enact tougher environmental laws

Is free trade anti environment
Which effect is larger: harm from the size or the environmental protection from the income effect?
There are three basic patterns depending on the environmental problem we are examining:
Environmental harm declines with rising income per person (i.e. lead)
Environmental harm rises with rising income per person (i.e. emissions of carbon dioxide)
The relationship is an inverted U (i.e. air pollution and water pollution)

Environmental effects of the Uruguay Round (% change in emissions)

2. Specificity rule again
An externality leads to an inefficient allocation of resources, and there is a role for government intervention in the market
The specificity rule is a useful policy guide
The specificity rules says to intervene at the source of the problem

3. Guidelines for policy prescriptions
Following the specificity rule, if the externality is pollution, make pollution itself more expensive.
See Figure 13.3
The figure contains two sets of best-feasible prescriptions:
The whole world acting as one government
A single nation unable to get cooperation from other governments

3. Guidelines for policy prescriptions
If the world acts as one government there is no need for international trade policy (i.e. taxes on exports and imports): taxes are on production and consumption.
According to the specificity rule, taxes are near the source of the pollution.
If a nation must act alone, then trade barriers could be an appropriate solution.

Figure 13.3: Type of externalities and product market prescriptions

4. Trade and domestic pollution
Domestic pollution occurs when the costs of pollution fall (almost) only on people within the country
In this case, in the absence of any regulation:
Free trade can reduce the well-being of the country
the country can end up exporting the products that it should import
See Figure 13.4

4. Trade and domestic pollution
The top half of the figure shows:
Domestic supply curve (private MC of paper production)
Domestic demand curve (private MB of paper consumption)
The bottom half of the figure shows the cost of pollution or marginal external cost (MEC) of producing paper.
Marginal Social Cost (MSC)= Private MC+MEC

4. Trade and domestic pollution
With no international trade, the paper market clears at P=$1 per ream and Q=2 billion reams.
With no recognition of pollution costs, this is an over production of paper
Under free trade, the price rises to $1.10, domestic production rises to 2.3 billion, domestic consumption falls to 1.8 billion (a fall of 0.5 billion)
The free trade makes the country worse off: area a < area b (or the gain from trade is less than the cost of pollution)

4. Trade and domestic pollution
The government could impose a tax to tackle the pollution problem
The tax should equal the marginal external cost of production (t=MEC)
The domestic supply curve shifts up by the amount of the tax. Now the new supply curve reflects all social costs (SMC=Sd+0.30).

4. Trade and domestic pollution
If there is this a tax
Domestic demand=1.8 billion
Domestic production=1.4 billion
The country should import (M=0.4 billion) rather than export paper
The gain from trade is represented by the triangle e
With no government policy limiting pollution:
The country can end up worse off with free trade
The trade pattern can be wrong

Figure13.4: When domestic production causes domestic pollution

Trans-border pollution
Many types of pollution have transborder effects (i.e. air pollution, sulphur dioxide drifts across national borders)
It raises major issues for governments policy
Suppose there are two countries: Germany and Austria
Suppose a German paper company builds a new paper mill on the Danube and dumps chemical waste into the river
The river flows into Austria and imposes external costs on Austrians

Trans-border pollution
How do we determine the optimum amount of pollution? (See Figure 13.5)
The figure shows the Germany’s benefits and Austria’s costs from different rates of dumping waste into the river by the paper mill.
In a free market with no government intervention, the firm will pollute until benefits are equal to zero (point A).
This imposes a large costs on Austrians along the MC curve.

Trans-border pollution
Point A is also inefficient from a world perspective: MB
But a total ban on river pollution is inefficient as well. At zero pollution MB>MC.
The efficient level of pollution is 80 tons per year, where MB=MC

Trans-border pollution
A tax will not work in this situation because of the trans-border nature of the pollution
Austria has no direct taxing power over a paper mill in Germany
Germany might not tax the paper mill at all
International negotiations between the two countries is required to achieve the efficient outcome

Trans-border pollution
If they fail, the Austrian government could attempt to reduce imports from Germany
This could reduce pollution in the river if Austria is a major importer of paper from Germany
Problem: WTO rules prohibit import tariffs such as this

Figure 13.5: International pollution

Global environmental challenges
Extinction of species
Overfishing
CFCs and the Ozone Layer
Greenhouse gasses and global Warming
Kyoto Protocol
Copenhagen accord
A global approach