Many studies have predicted that tradeliberalization harms the environment. Most of these studies have assumedthat environmental policy is exogenously given. I will in this paper focus on the case where environmental policy is in fact determined within the model. My intention is to explain how environmental policy is affected bytrade liberalization.
The government can have different approaches to how it sets itsenvironmental policies. In uncorrupt societies we may think that thegovernment focuses on maximizing social welfare for the population as a whole. This aggregated welfare function can for example be a weighted sum of all individual utility functions. Another approach is that the government maximizes some form of political support function where the views of different interest groups are represented. By maximizing this function it will maximize the probability of being reelected. In more corrupt societies the government will probably pay less attention to the aggregated social welfare and be more concerned with how to maximize the amount of bribes the government officials can attract from the interest groups.
There has recently emerged a promising theoretical literature explaining the political interaction of governments with various interest groups in the setting of environmental standards and the choice of regulatory instruments.These papers are largely based on the common agency model of Benheim and Whinston (1986). Grossman and Helpman (1994) applied this model to trade policy. Among the first to adopt this model to study politically optimal environmental policy was Aidt (1998). He shows that in the political optimum the most effective regulatory instrument is used, but that due to distributional considerations sectorial green taxes will differ from the Pigovian rate. Aidt is not concerned with the linkages between trade integration and the environment. Bommer and Schulze (1999) combine the insights from these earlier papers. They focuse on the relationship between environmental policies and trade. In a model of political optimization they set out to explain how environmental policy is affected by trade liberalization. Environmental policies are in this framework chosen to maximize political support and are therefore endogenous, while trade liberalization is treated as given.
Based on the theoretical framework developed in Bommer and Schulze I will analyze how their conclusions change when their assumptions concerning policy means and characteristics of the economy are modified. Trade liberalization is treated as given. Trade agreements, when in place, cannot easily be abrogated unilaterally. Domestic environmental policy on the other hand can be changed unilaterally. When trade liberalization is agreed upon and opposition arises to the environmental consequences of the agreement, the government can only respond using environmental policy, since their hands are tied regarding trade policy in the agreement. The main question to be answered is what we can predict regarding changes in environmental policy if a country enters into a free-trade agreement.
Bommer and Schulze show that trade liberalization and improved environmental quality are mutually compatible in a setting where the environmental policy is modelled as limits on total environmental consumption. Their result depends on the export sector being pollution intensive, which they show empirically is the case for the US economy. Bommer and Schulze also claim that this result will hold if we look at pollution standards, i.e. restrictions on pollution per unit of output. My analysis, however, shows that this need not be the case. When trade is liberalized the government tightens the pollution standard, but whether this will lead to environmental improvement or not, depends on how much the environmental standard is tightened. My model simulation depicts a case where the total pollution level is increased even though the pollution standards are tightened. Thiscase arises because the increased production in the polluting export sector due to a price increase outweighs the effect of tightened pollution standards.
I further show that when an emission tax is used, we will get a stricter environmental policy when trade is liberalized. Whether this leads to lower emissions or not depends on how much the tax is increased, and cannot be seen directly from the model.
If we consider the import sector to be the most pollution intensive, our results may change drastically. We do not in this case get explicit results from the model, but it is most likely that the pollution limit will be increased, which means that improved environmental quality and trade liberalization no longer are mutually compatible goals. The reason is that a reduction in environmental standards has the reverse distributional effect as liberalization of trade for capital owners in the two sectors. A less strict environmental policy will also benefit workers, as their wages willincrease. The environmentalists, however, will decrease their political support due to a reduction in the environmental standards. It is therefore reason to believe that the government will reduce the environmental protection when trade is liberalized to secure maximal political support.