Theory of strategic trade policy is an important component of the new trade theory. It argues that trade policies can be employed by governments for strategic reasons, such as export promotion and rent-shifting.
However, with the trend of trade liberalization and under some important international agreements such as GATT, the traditional trade policy instruments, e.g. import tariff and export subsidy, are usually prohibited. Under this circumstance, governments may tend to use other domestic policies to serve as replacements. Environment policy is such an alternative.
Nowadays since environment problems are getting increased attention, there are more concerns that environment policies will be used as surrogates of strategic trade policies.
There is substantial literature contributed to this topic, most of which discusses the case where pollution/emissions is related to production. This thesis will focus on the case of emissions related to consumption, and product charge is assumed to be the environment policy instrument chosen by governments.
Two types of models construct the basic framework for research in this area. They are the so-called third-market model and reciprocal-markets model. The thesis first presents the basic version of both models, then discusses a variant for each model, and tries to show the inter-connection between them.
In this context, the thesis discusses the case of consumption-related emissions on the basis of both models. We will examine when product charge is imposed by governments for strategic trade goals, whether it will be set deviating from Pigovian charge level, which is equal to marginal environmental damage. And we will also check the direction of deviation, provided it does exist.
In the reciprocal-markets framework, the thesis explains the strategic reasons for governments to manipulate product charge level by deviating from marginal environmental damage. It is shown a higher product charge level will cause a fall in the outputs of both its own firm and its rival. Hence the direction for product charge to deviate from Pigovian charge is ambiguous.
In case of a linear demand function, when the domestic firm grasps larger home market share than its foreign rival, the government will tend to set a weak product charge level, which is lower than the marginal environmental damage. Under this condition, even if relaxing environment policy is beneficial for the foreign rival as well, the government still has incentives to do so. However, when the foreign firm has larger share in the domestic market, the government will tend to set a strict product charge level, even if this will cause reduction of the outputs of both firms. An extension of the above results is also discussed.
Then the thesis introduces product charge to a variant of the third-market model, with an additional assumption for domestic consumption. Decreasing marginal costs are also invited into the model to show the effect of economies of scale. By specifying the functional forms, its is shown that the domestic government always has motives to set product charge deviating from the first-best level. The realistic product charge level is a weak one. As long as the marginal environmental damage is not so great, the domestic government will loosen its environment policy for strategic reasons.