Can Trade Be Good for the Environment?

Abstract

We analyze the impact of trade in a differentiated good on environmental policy when there is local and transboundary pollution. In autarky, the (equivalent) pollution tax is set equal to the marginal damage from own emissions. If the strategic policy instrument is a tax, leakage occurs under trade and tends to lower the tax. The net terms of trade effect, due to the exportable and importable varieties of the differentiated good, tends to increase the tax. We derive conditions under which pollution taxes under trade are higher than the marginal damage from own emissions, i.e., higher than the Pigouvian tax and than that under autarky. Then, pollution falls under trade relative to autarky. When countries use quotas/permits to regulate pollution, there is no leakage, while the net terms of trade effect tends to make pollution policy stricter. The equivalent tax is always higher than the marginal damage from own emissions, i.e., always higher than the Pigouvian tax and than that under autarky; hence, pollution always falls under trade. Our analysis provides some insight into the findings in the empirical literature that trade might be good for the environment.

Is Trade in Permits Good for the Environment?

“…This incentive is absent when pollution is a pure global public bad since the source of emissions does not matter as the marginal damage is the same irrespective of the origin of pollution. Lapan and Sikdar (2017), Proposition 3, show that (in a similar setup) with internationally nontradable permits, irrespective of the public good nature of pollution, intra-industry trade leads to higher permit prices and lower pollution relative to autarky. 9 Hence, we have:…”

“…Intra-industry trade in the differentiated good arises due to consumers' preference for both varieties of the differentiated good, which are imperfect substitutes (see Armington 1969;Lapan and Sikdar 2017). Preferences of the representative agents in the home and foreign countries are given by, respectively:…”

“…Lapan and Sikdar (2017), Lemma 1, prove that, given policies and the world prices of goods, opening up to trade in goods increases (decreases) the spending on, and the demand for, the differentiated/tradable good if the price elasticity of demand for the tradable aggregate is greater (less) than one. This result follows since the price index of the differentiated good falls as countries move from autarky to trade.…”

“…In our model, which follows Lapan and Sikdar (2017), countries produce different varieties of a differentiated good along with a homogeneous good. Consumers' preference for different varieties of the good gives rise to intra-industry trade (see Armington 1969).…”

“…Since a tradable permit issued in one country can be used in either country, there is no impact of issuing an additional permit on the terms of trade. With internationally nontradable permits (Lapan and Sikdar 2017), the terms of trade effect makes environmental policy stricter under trade. Hence, internationally tradable emission permits always result in higher pollution than nontradable permits due to the absence of the incentive to make pollution policy stricter to gain terms of trade advantage.…”