Policy Endogeneity and the Effects of Trade on the Environment

Agricultural and Resource Economics Review,  Apr 2005  by Copeland, Brian R

• E-mail
• Print
• Link

This paper reviews recent work on the implications of endogenous policy for the effects of trade on the environment and the sustainability of renewable resource stocks. A recognition that pollution policy is endogenous has had a major impact on the trade and environment literature and has reversed some of the previously established empirical findings. Work on pollution has proceeded faster than work on renewable resources. I suggest some directions for future work in this area.

Key Words: pollution, international trade and the environment, renewable resources, globalization

The central question underlying much of the recent work on trade and the environment is how globalization affects environmental quality and the sustainability of renewable resources. The work that attempts to answer this question can be divided into two very broad categories. One approach is to give answers contingent on the policy regime. For example, if agriculture is intensive in the use of pesticides, and if regulations restrict the amount of pesticide use per hectare of land, then if environmental policy is left unchanged, we might predict that trade liberalization that leads to an expansion of agriculture will increase water pollution because of increased pesticide use. Another approach is to treat the policy regime as endogenous. That is, the policy regime is treated as responsive to economic factors such as income and relative prices. Whether or not an expansion of agricultural output increased pollution would then depend on whether or not environmental regulations were tightened up in response to increased pressure on the environment.

While predictions contingent on the policy regime are useful and are crucial inputs in domestic policy analysis, there are many cases where ignoring the potential effects of globalization on the policy regime may be very misleading. For example, many common property resources in poorer countries are managed using traditional, norms and mechanisms based on a stable social structure. If globalization disrupts these practices, then the management regime may collapse, leading to much more adverse environmental consequences than might have been predicted based on the pre-trade management regime. In the context of transboundary or global pollution, attention to endogenous policy responses is critical because of concerns about leakage: the benefits of emission reductions by one group of countries may be undermined if other countries increase their emissions in response. Endogeneity is also important in the empirical literature. If policy is endogenous, then empirical work investigating the effects of environmental policy on trade and investment flows will give biased results if policy is treated as exogenous. Finally, and perhaps most obviously, concerns that trade liberalization may lead to a "race to the bottom" in environmental policy can be addressed only in a framework where policy is endogenous.

This paper reviews some recent work that explores the implications of endogenous policy responses for the effects of trade on the environment. The literature on endogenous policy responses in the context of pollution is much more extensive than that for renewable resources. I therefore begin by reviewing some of the recent work on pollution. I briefly discuss several ways in which a focus on endogenous policy has led to new insights. Part of my objective here is to suggest that the payoff to focusing on endogenous policy is high. I then look at some of the recent work on renewable resources, where there has to date been very little work on models with endogenous policy. As this work is still very much in its formative stages, I focus in some depth on three different approaches to modeling endogenous management regimes, and suggest some directions for future work in this area.

Trade and Pollution

A central theme underlying both policy debates and analytical work on trade and the environment has been the role of income effects in affecting both the demand for environmental quality and policy outcomes.

The pollution haven hypothesis proposes that trade liberalization will shift pollution-intensive production to low income countries because of their relatively weaker environmental policy. In the first wave of work on this issue, it simply was assumed that poor countries had weaker environmental policy than rich countries (see for example Pethig 1976 and Chichilnisky 1994); however, subsequent work (Copeland and Taylor 1994, 2003) studied models in which pollution haven effects emerged in models with endogenous policy-in these models, environmental managers in poorer countries choose relatively weaker environmental regulations than do those in rich countries.

Income effects are also central to analysis of the environmental Kuznets curve-the relation between pollution and per capita income. One of the leading explanations for the improvement in environmental quality in rich countries is that environmental quality is a normal good, and so governments who are responsive to consumers regulate pollution more intensively in higher income countries.