We begin the chapter with two provocative questions. First, is free trade anti-environment? We argue that it is not. There is no reason to think that trade generally promotes production or consumption of products that cause large harm to the environment. Surprisingly, the incentive to relocate production into “pollution havens” is usually small. Trade tends to raise world production and incomes. While some environmental problems become worse as production and income rise, others become less severe, in part because protecting the environment is a normal good. Figure 13.2 provides estimates from the trade liberalization of the Uruguay Round, for the composition and combined production and income effects. The overall environmental effects are generally small.
Second, is the World Trade Organization anti-environment? WTO rules recognize environmental-protection exceptions to its general thrust toward free trade, but the WTO also worries that restrictions that governments claim to be necessary to protect the environment are pretexts for common protectionism. A country can impose product standards to protect the environment, but the standards must apply to all consumption, not just imports, and the standards must be based on scientific evidence. In another area the position of the WTO seems to have evolved with recent rulings. The WTO now seems to be willing to permit countries to limit imports because they are produced in foreign countries using methods that the importing country considers to be damaging to the environment, but at the same time the WTO has imposed strict requirements to minimize the use of such policies as subterfuge for limiting imports for nonenvironmental (protectionist) reasons. The box “Dolphins, Turtles, and the WTO,” the fourth in the series on Global Governance, discusses cases that show the changes in WTO rulings.
Adverse environmental effects like pollution are negative externalities, distortions that lead to failures of the market to be fully efficient. The specificity rule introduced in Chapter 10 is a handy guide to government policy to address negative environmental externalities. In fact, there are two types of government policy that can directly attack the distortion—imposing taxes and subsidies, or changing property rights. As in Chapter 10, we usually use the tax-and-subsidy approach.
The specificity rule says to use the direct approach; for instance, tax pollution directly. If this is not possible, then the specificity rule says to select the tax or subsidy that is as close as possible to the act creating the pollution. An additional complication is that the source of the pollution can be our own country’s activity, another country’s activity, or the entire world’s activity. If our country cannot achieve an international agreement, we may be left to take our own policy action, even though the source of much of the problem is foreign activity. In this case trade barriers could be a second-best policy that can enhance well-being. Figure 13.3 is a useful summary of the main conclusions that can be drawn for the various possible cases.