Trade and the Environment EC 434/534, Fall 2024 PDF

Trade and the Environment EC 434/534 University of Oregon Emmett Reynier Fall 2024 Housekeeping... 1. Problem set 4 due Tuesday, November 26th. 2. Written projects are due and presentations are on December 3rd Find time to meet with me before Thanksgiving break if you haven't alread...

Trade and the Environment EC 434/534 University of Oregon Emmett Reynier Fall 2024 Housekeeping... 1. Problem set 4 due Tuesday, November 26th. 2. Written projects are due and presentations are on December 3rd Find time to meet with me before Thanksgiving break if you haven't already You should be making progress on these now! 2 / 34 Where are we? Let's take a step back and put the course into context... Efficiency: Defined what desireable outcomes are, and under what assumptions free market gets us there Market Failures: When does the free market fail to get us to efficient outcome? Very common w/environmental goods Cost Benefit Analysis: Quantified costs/benefits of non-market goods so that we know what efficient outcome is Pigouvian Taxes and Permits: What policies can we implement to get to efficient outcome Examples Air pollution, climate change, water pollution Trade (today) Distributional Impacts: We care not just about "maximizing social surplus", but also about who accrues benefits and costs 3 / 34 Any news you'd like to discuss? 4 / 34 Introduction 5 / 34 Trade and the environment A few of the questions that we will investigate during this lecture... How does trade impact the environment? How does globalization affect air and water pollution? How important are the environmental impacts of transporting goods? Does trade create a race to the bottom in environmental policy? Many environmental problems are global in scope As a result, isolationism and unilateralism are not going to solve our environmental problems. Same for economic development. Both require international cooperation. But that doesn't tell us much about the link between environmental quality and economic development/trade. 6 / 34 What is globalization? Globalization ∼ the widespread movement of goods, services, and information across international borders Generally accompanied by ↓ in tariffs and other barriers to trade. After a long period of expanding international trade and liberalization, recent years have seen a retreat... 7 / 34 US and Mexico Source: Wall Street Journal 8 / 34 Russian sanctions Source: US Treasury and European Commission. 9 / 34 Trade, globalization, and the environment 10 / 34 Globalization's effect on environment Increases in income E.g. More demand for environmental quality at higher income? Gains from trade and comparative advantage E.g. Environmental benefits from concentrating production in most suitable (efficient) areas? 11 / 34 Income channel: Economic growth A central tenet of economics that free trade increases a country's (individual's) income. This increase in income will not necessarily be distributed equally. The Environmental Kuznets Curve (EKC) discussion relates this income growth to the environment. Trade may hurt or help the environment by moving an economy along the EKC. More on this idea later. 12 / 34 Trade channel: Comparative advantage Three main ways by which comparative advantage can impact the environment: 1. Scale effect 2. Technique effect 3. Composition effect 13 / 34 1. Scale effect Trade liberalization raises the scale of economic activity. More efficient use of global resources leads to more production and overall wealth ↑. s Global emissions ↑ as a result. Hold industry composition and emission intensity constant ∑ Yit i Scale = 100 × ∑ Yi,1995 i where Y is output for industry i in year t, relative to 1995 it 14 / 34 2. Technique effect Trade ↑ incomes, which in turn leads to greater demand for all normal s goods, including environmental quality. Governments respond to demand for cleaner environment by setting stricter environmental regulations For example, demanding cleaner production techniques. The belief in a strong "technique effect" is widespread. Trade improves the environment, because it raises incomes, and the richer people are, the more willing they are to devote resources to cleaning up their living space. Source: The Economist (following the Seattle WTO Round riots in 1999). 15 / 34 3. Composition effect Controlling for incomes and scale, trade can change the sectoral composition of clean and dirty industries within a country. This trade-induced composition effect will vary depending on where a country's comparative advantage lies. E.g. If a country has comparative advantage in dirty goods, trade liberalization ↑ the relative price of pollution-intensive goods. s This attracts capital and labor away from the rest of the economy, thereby ↑ emissions. ing ∑ Yit ei,1995 i Scale and composition = 100 × ∑ Yi,1995 ei,1995 i ∑ Yit eit i Scale, composition, and technique = 100 × ∑ Yi,1995 ei,1995 i where e is emissions rate for industry i in year t it 16 / 34 Which effect dominates? Empirical evidence suggests the technique effect is most important. Source: Copeland, Shapiro, Taylor 2022. Also supported in Levinson (2009) 17 / 34 EKC and PHH These findings plug into a larger literature on trade and the environment, which has historically been dominated by two ideas: 1. The Environmental Kuznets Curve (EKC) 2. Pollution Haven Hypothesis (PHH) 18 / 34 The Environmental Kuznets Curve (EKC) and Pollution Haven Hypothesis (PHH) 19 / 34 Environmental Kuznets Curve The EKC suggests an inverse-"U" relationship between per capita income (GDP) and environmental degradation. For low initial levels of per capita income, an increase in income worsens environmental quality. After a turning point, however, increasing per capita income leads to environmental improvements. Based on early empirical studies in the 1990s Seminal paper was Grossman and Krueger (1991). The EKC typically refers to changes in intensity not levels. E.g. Rich countries still use more energy, but they use less kilojoules (gigajoules?) per $ of GDP. 20 / 34 Environmental Kuznets Curve Source: Grossman and Krueger (1991) 21 / 34 Environmental Kuznets Curve Source: Grossman and Krueger (1991) 22 / 34 Environmental Kuznets Curve How credible is the EKC hypothesis? Early results were only for local, temporary pollutants → Didn't hold for carbon or energy use, and certainly doesn't work for species loss. Presumes that current cross-section represents a time path. Data discrepancies → Once corrected, you only find an EKC if you restrict your data to certain years. However... It is true that other evidence suggests rich(er) people are willing to pay more for the same environmental improvement. The problem is that their lifestyles might be proportionately "dirtier". Conclusion: Evidence for EKCs just aren't robust. 23 / 34 Environmental Kuznets Curve Source: Stern (2016) 24 / 34 Pollution Haven Hypothesis Will strict US regulations drive polluting firms to unregulated countries? Do lax environmental regulations attract foreign direct investment (FDI)? PHH ∼ All else equal between two countries (locations), profit-maximizing firms will choose to set up in the country (location) with cheaper environmental regulations. Implication is that poor countries will become pollution hotspots. The emphasis really is on "all else equal" → turns out that there are a lot of factors that make this unlikely (next few slides)... 25 / 34 Pollution Haven Hypothesis Pollution-intensive industries are capital-intensive Simultaneously, the least-developed countries (LDCs) are often: 1. Capital-poor. 2. Characterised by weak institutions (missing property rights, corruption, expropriation risk, etc.) Advantage of weak-regulation country Firms can use more polluting technology. However, when firms do set up abroad, they tend to use same technologies/procedures as in their parent country. Most MNCs claim they follow the health, environmental and safety standards as set in their home countries (UN surveys). Re-engineering is often more costly than (over)compliance. 26 / 34 Pollution Haven Hypothesis Other factors dampening PHH Transport cost for some dirty goods (e.g. cement) are considerable. Better to produce near consumers. Environmental compliance costs are simply not that large. Environmental compliance costs in the US are only ∼ 2-3% of GDP. In comparison, wages are ∼ 70% of GDP. 27 / 34 Pollution Haven Hypothesis PHH is ultimately an empirical question Little evidence that trade has led firms to move to less developed countries or countries with lax environmental regulation → no PHH. "Composition effect" from earlier is small But, policy is endogenous, may be that stringency of policy is determined by exposure of an industry to outsourcing There is robust evidence of a Pollution Haven Effect (PHE) Increase in stringency of regulation reduces exports of dirty goods But, not necessarily tied to an increase in imports from a less- regulated country (as in the PHH) However, environmental policy may just be too weak, PHH may still be a serious concern in the future as regulations tighten 28 / 34 Enviornmental bias of trade policy 29 / 34 Cutting edge research Shapiro (2021) shows that in most countries trade barriers are lower on dirty rather than clean industries. For more info, here is a blog post about it and here is a nice video. 30 / 34 Cutting edge research Lower tariffs on dirty industries are an implicity subsidy on CO emissions 2 Equivalent to $85-120/ton of CO ! (Estimates of SCC are $50-100/ton) 2 True even for countries that otherwise have strict envrionmental policy (largest implicity subsidy is in Norway!) Robust over many years worth of data Explanation: Industries convince governments they need cheap inputs The "upstreamness" of an industry reflects to what extent an industry sells to other firms or to final consumers For example: copper ingot production is upstream, sunglasses production is downstream Turns out upstream firms are dirtier and have lower trade barriers! 31 / 34 Upstreamness and trade barriers 32 / 34 Conclusion 33 / 34 Conclusion Globalisation has yielded an ↑ in trade/investment across borders. However, recent political events suggest a reversion back to some kind of trade war / protectionism... Of the various channels through which trade could conceivably affect the environment, it appears that the technique effect is by far the most important in practice. Trade ↑ incomes and leading to ↑ demand for environmental s ing quality. Little/weak empirical support for either the EKC and PHH. Although, there is robust evidence for the PHE 34 / 34