Introduction

Chapter 7 described how trade-environment theory has evolved. This chapter takes the next step and uses diagrammatic analysis to clarify and illustrate the linkages. The six cases, or models, are in the general equilibrium tradition and for the most part are extensions of the basic Ricardian and Heckscher-Ohlin (H-O) trade models. The general equilibrium approach has advantages and disadvantages. Its strong point is the emphasis on the interconnections among the parts of a system – in this case an open economy operating in an environmental-resource matrix. But this advantage comes with a price. Even a simplified system will have a rather large number of variables, and diagrammatic analysis, which helps us “see” interconnections and feedbacks, tends to become complex.

We believe it is desirable for students and policy makers to understand connections within an integrated system, but we recognize that not everyone will have patience to work through the rather complicated analytical diagrams in this Chapter. Therefore we start with a verbal description of the six cases, and present the general conclusions. Those readers with sufficient stamina are invited to a more thorough presentation in subsequent sections.

Summary of the Cases

As initially analyzed in Chapter 2, we continue to view the environment in its dual role: providing valuable services that are directly consumed – environment as a consumption good – and providing services as inputs to the production of conventional goods – environment as a producer good.

The Theme and Thesis

The central theme of this book is the meshing of economic and environmental systems in an international context. Broadly speaking, the systems interact at two levels. The first is the interaction between international trade and investment and the environment, and the second is transnational pollution and the management of international environmental resources. The trade-environment nexus raises a number of interesting questions. How do trade and foreign investment affect environmental quality? What are “pollution havens”? Do the rules of a liberal trade system as exemplified by the General Agreement Tariffs Trade/World Trade Organization support or undermine environmental protection? Are environmental regulations used as covert trade barriers? Is comparative advantage determined by environmental resource endowments? Should poor countries specialize in producing “dirty” products?

Transnational pollution and the protection of international environmental resources such as a biological diversity and global climate raise equally interesting questions. What is the economic explanation for transnational pollution, and how can international environmental resources be protected? Who should pay? How can international environmental agreements be reached when environmental values, attitudes toward risk, and abatement cost burdens differ greatly, and nations assert sovereign rights? Are trade sanctions useful tools to prevent “free riders” and to enforce management of international resources? What are the connections between trade liberalization, international environmental agreements, and the attractive but vague concept of sustainable development? Is liberal trade consistent with sustainable development?

Introduction

Economic activity and environmental resources interact in a number of ways. We need a framework or model to sort out the channels. The framework should capture the important relations, but not be so complex that the details obscure the main connections. One purpose in this chapter is to reconcile two different views of the relationship between economic activity and environmental quality. A popular view is that there is a trade-off between the two – improvements in environmental quality can only be obtained by sacrificing some output of conventional goods and services. A second view, associated with the concept of sustainable development, is that environmental protection is necessary to support conventional economic output, and failure to maintain environmental quality undermines income and output, at least in the longer run. The second view suggests a positive relation between conventional economic output and environmental quality. We show in this chapter that elements of both views are valid and can be reconciled if one recognizes a dual role for the environment: to provide valuable services that are directly consumed (environment as a consumption good) and to provide inputs into the production of conventional goods (environment as a producer good). A second purpose of this chapter is to sketch out how economic-environmental connections might change as economic output and income grows. What factors are likely to determine the longer run relations between gross domestic product (GDP) and environmental quality?

Introduction

Partial equilibrium analysis has long been applied to trade policy and environmental policy. While the interconnections among markets and between aggregate production and consumption are suppressed, the greater simplicity of the partial equilibrium approach allows for a more detailed focus on particular market and policy features. This chapter extends and amplifies the general equilibrium analysis in Chapter 8 with partial equilibrium tools. The emphasis is again on the effects of trade and trade policy on the environment and the effects of environmental policy on trade.

Section 2 starts with a standard welfare economic analysis of externalities in production and consumption set in a trade context, and examines the effects of corrective environmental policies. It demonstrates how uncorrected production externalities constitute a subsidy and a distortion to international trade. As a general proposition, it is easy to show that the first-best policy response to externalities in production and consumption is to correct the distortion at its source, which means either controlling production if pollution abatement is not feasible or taking measures to control pollution, which will indirectly reduce output. Using trade policy in general will create by-product distortions and may worsen welfare. Nevertheless, first-best policies may be unavailable or ignored by governments. Section 3 delves into the murky world of the second-best.

Introduction

The term sustainable development was popularized in the 1987 report of the World Commission on Environment and Development (Brundtland Commission), Our Common Future, although its first general use was in 1980 by the International Union for the Conservation of Nature in World Strategy: Living Resource Conservation for Sustainable Development. Since then sustainability has become a principal benchmark against which economic development policies are assessed by national governments, development assistance agencies, and NGOs. Although the adoption of sustainability as a benchmark for development has been hampered because of ambiguities in definition and interpretation, there is a consensus that sustainable development implies an active role for government in efficient and equitable management of natural and environmental resources. This is not a totally new idea. Pigou, writing in 1932, states, “It is the clear duty of Government, which is the trustee for unborn generations as well as for its present citizens, to watch over, and if need be, by legislative enactment, to defend the exhaustible natural resources of this country from rash and reckless spoilation.” At one level, this active role fits uneasily with another major trend in the past two decades – deregulation and privatization – in which the driving force for development is an increased role for the private sector and decreased government involvement. At a more basic level, however, both sustainability and the freeing up of private markets seek greater efficiency, although sustainable development stresses intertemporal efficiency and tempers this with a strong dose of equity concerns.

Introduction

This chapter reviews trade models that include environmental resources and environmental policy. Our purpose is to explain how the environment has been fitted into trade theory and to describe some of the major conclusions. The presentation is more or less chronological but first makes some general observations about the environment and the theory of comparative advantage (Section 2). Early work through the mid-1980s was primarily concerned with modifying positive trade theory to incorporate environmental resources and drawing conclusions with respect to traditional trade theorems (Section 3). More recent work has a broader policy orientation: North-South trade-environment interactions and the effects of trade liberalization on the environment (Section 4) and trade-environment policy coordination (Section 5). The chapter continues with a discussion of the effects of lifting two restrictive conditions, the small-country, constant terms of trade assumption and the assumption of immobility of factors internationally (Section 6). Section 7 examines the integration of strategic trade theory and environmental policy.

Environment and Comparative Advantage

The theory of comparative advantage asserts that countries will tend to specialize in the production and export of goods they produce relatively efficiently. Relative efficiency involves a double comparison, as among goods and as among countries. In the Ricardian one-factor input model, the source of relative efficiency is not explicit but resides implicitly in differences among countries in factor productivities.

Introduction

Ocean fisheries are a resource of great value but their efficient management leaves much to be desired. Total marine catch increased from about 60 million tons in the early 1970s to almost 91 million tons in 1995 (Food and Agriculture Organization [FAO] 1997). But increasing aggregate catch may simply imply unsustainable exploitation levels. The FAO estimates that for 1994,35 percent of major fisheries were showing declining yields, 25 percent were at high exploitation levels, and 40 percent were capable of higher yields (and thus implying a need to reduced fishing pressure for restocking); no underdeveloped fisheries remain. It concludes that “given that few countries have established effective control of fishing capacity, these resources are in urgent need of management action to halt the increase in fishing capacity or to rehabilitate damaged resources” (FAO 1997, p. 43). The composition of the fish harvest is also shifting toward lower-valued species. The proportion of catch by weight of pelagic (that is, open ocean) fish, which except for tuna tend to be low-valued fish, has increased from 50 percent in 1950 to over 60 percent in 1994 (FAO 1997, p. 33). This is consistent with data showing that the proportion of the total catch used for fishmeal and fish oil has increased from about 16 percent in 1953 to about 28 percent in 1994. From an economic perspective, fishing effort is highly inefficient.

Introduction

This chapter explains the causes of environmental degradation, using the analytical tools of microeconomics, especially environmental economics. Before investigating the root causes, however, it is useful to develop a monetary measure of welfare using the concepts of consumer surplus and producer surplus and to relate welfare to the concepts of efficiency and equity. Section 2 introduces consumer and producer surplus. For marketed goods, consumer surplus and producer surplus are convenient to estimate but are not exact measures of welfare, and the appendix to this chapter explores more precise measures. Section 3 uses these concepts to illustrate efficient and inefficient allocations of resources and to relate efficiency to equity. Section 4 analyzes three interrelated sources of inefficiency in the allocation of environmental resources, collectively known as market failures. They are public goods, externalities, and open-access common property resources. The common thread to the three is defective or nonexistent property rights. Section 4 also examines so-called government failures, which also frequently contribute to environmental degradation. Finally, Section 5 presents the influential Coase Theorem, which concludes that in some situations a private “market” might be developed between those who generate environmental externalities (in short, polluters) and those who bear the cost of externalities (victims). Under certain conditions such a market can be shown to allocate resources efficiently regardless of the initial system of property rights, and this strategy has been proposed as an alternative to more direct government regulation of the environment.

Introduction

Chapter 3 explains the roots of environmental degradation in terms of private market and government policy failures. Private market failure invites government intervention to improve social welfare. Government policies that inadvertently damage environmental and natural resources need to be modified. Before action is taken, however, it is necessary to refine the objectives of policy. Measures to protect and conserve environmental resources involve substantial economic costs. The opportunity cost of pollution abatement, or the protection of wilderness areas and endangered species, is the output of conventional economic goods and services foregone, while the benefits are, of course, environmental damages avoided. The shorthand question can be framed as “how clean is clean enough?”

Section 2 provides an analytical framework for answering this question. Not surprisingly, it concludes that at a high level of abstraction the optimal level of environmental protection is such that the marginal costs of protection equal the marginal benefits of damages avoided. This is equivalent to saying that total social costs (abatement costs thought of as opportunity costs plus residual environmental damage costs) are minimized. To operationalize this goal requires knowledge of pollution abatement (environmental protection) technologies and their costs. But it also requires linking pollution abatement to environmental quality; investigating the effects of environmental quality on human health, biological and ecological systems, and other resources; and establishing monetary values for environmental damages (or damages avoided).

It is time to draw together the main themes and conclusions of the book and to look ahead toward the next steps in merging environmental and international economics. Our basic thesis has been that the discipline of economics provides powerful and useful tools for understanding environmental degradation and for devising policies to moderate conflict between economic and environmental systems, and that with some modifications economic analysis can perform these roles in an international context. There is little question that over the past 30 years economics has advanced our understanding of the roots of environmental degradation. The related concepts of externalities, public goods, and open-access common property resources, together with the notion of government failure, provide a coherent and durable explanation of pollution and misuse of natural resources. Economics has also made considerable progress in assisting the formulation of policy. Two notable areas are new, innovative techniques for monetizing environmental damages, permitting environmental policies to be analyzed in a cost-benefit framework, and research showing the efficiency advantages of market friendly policy instruments such as tradeable permits. Policy analysis has also been assisted by improved data on the links between economic activity and environmental variables and improved accounting techniques, such as the extension of input-output tables linked to environmental vectors and the “greening” of traditional national income accounting.

The limits to economic analysis are also more clearly seen, and this, too, is progress. One limit is grounded in the inherently political nature of environmental policy.