TRADE AND ENVIRONMENT A REVIEW OF CONTEMPORARY QUESTIONS INTERCONNECTING INTERNATIONAL TRADE AND ENV

TRADE
AND
ENVIRONMENT

A
REVIEW
OF
CONTEMPORARY
QUESTIONS
INTERCONNECTING
INTERNATIONAL
TRADE
AND
ENVIRONMENTAL
REGULATIONS

ShubhiSingh ResearchScholar

ABSTRACT

AstheglobalcommunityenteredtheParisClimateDeal,linkbetweenEnvironmentalRegulationsaswellasTradeNegotiationsoccupiedprimeimportancetofulfil theParisDealcommitments.ShouldtherebeanInternationalCooperationoverDomesticPolicies,especiallysinceEnvironmentalRegulationscanpotentiallyserve asDisguisedTradeBarriers?DoesInternationalTradeweakenDomesticEnvironmentalPolicy,andcreatesPollutionHavens?Shouldtradepolicybeusedtoachieve environmentalobjectives?ThispaperreviewsexistingtheoreticalliteratureonsuchpolicyquestionsandanalysesEnvironmentalEconomicsliteraturepertainingto India

Introduction

2015 was a milestone year for ClimateActivists demanding mainstreaming of the idea of “Sustainability” in Development - countries adopted the Paris ClimateDeal.TheParisAgreementof2015decisivelyexpressedan in-principal commitment to strengthening the global response to climate change, including “holdingtheincreaseintheglobalaveragetemperaturetowellbelow2°Cabove pre-industriallevels,increasingtheabilitytoadapttotheadverseimpactsofclimatechange,fosterclimateresilienceandlowgreenhousegasemissionsdevelopment,inamannerthatdoesnotthreatenfoodproduction”.Aspartoftheircommitments,partiestotheParisAgreementareobligedtoundertakeandcommunicate ambitious efforts in the form of nationally determined contributions to achievethegoalsoftheagreement.Itisthereforeexpectedthatallfuturedomesticregulationsaswellastradenegotiationswillhaveanunderlyingobjectiveof fulfillingtheParisDealcommitments.Inthiscontext,thelinkbetweenEnvironmental Regulations as well as Trade Negotiations occupies prime importance. ThispaperreviewsrelevantdiscussionsinvolvingcontemporarytheoriesinterconnectingInternationalTradeandEnvironmentalRegulations.

ShouldtherebeanInternationalCooperationoverDomesticPolicies?Case in point – Potential use of Environmental Regulations as

Disguised Trade Barriers

Themostdirectmeansofaffectingtradeflowsisthroughtradepolicy However, whencountriesareconstrainedintheirabilitytosettradepolicyfreely(e.g.,by aninternationaltradeagreement),domesticpoliciesactasapotentialmeansof trade protection measure (Second-BestArguments). These Second-BestArgumentsprovidetheoreticaljustificationforinternationalcooperationoverdomesticpolicy Thatis,thereismeritinrequiringcountries'domesticpoliciestoconformtointernationalstandards,inordertoprovidealevelplayingfield.Afree tradeagreementthatrestrictsonlyasubsetofinstrumentsisanincompletecontract that can be undermined as governments substitute towards unconstrained instruments.

Gawande(1999)findsevidencethatgovernmentsdosubstitutenontariffbarriers forotherinstrumentsofprotection,suggestingthattheconcernaboutloopholes intradeagreementsiswellfounded.Inthiscontext,theoptionofmanipulating environmental policy to improve the terms of trade creates a loop- hole in the tradeagreement.

Lax Environmental standards provide an unfair comparative advantage to domestic countries, which distorts the level playing field. However, Bhagwati andSrinivasan(1996)dismissthisargumentasamisunderstandingoftheprinciple of Comparative Advantage, claiming that there are legitimate reasons for diversityinenvironmentalregulationsacrosscountries(e.g.,differencesinpreferences,naturalendowments,orpopulationdensity),andthatdifferencesincomparativeadvantagearisingfromregulatorydifferencesarepartoftheargument formutuallybeneficialtrade.

Copeland(1990)howeverjustifiesexpandinginternationaltradeagreementsto coverdomesticpoliciesonEnvironmentalRegulation,assuchdomesticpolicies oftenactasSecondarymeansofProtection.Tradeliberalizationinducessubstitutiontowardthelessefficient,non-negotiableinstrumentofprotection(secondarytradebarriersuchasnon-tariffbarriersordomesticlegislation)duetocountries'incentivestomaintainlevelsofprotection. Signingafreetradeagreement limitstheinstrumentsofprotectionavailable,butdoesnoteliminatethepressure onthegovernmenttoprotect(CopelandandTaylor,2004).Ifthegovernmenthas accesstoinstrumentsthatcansubstitutefortradepolicy,thentheycanbeusedto

undermineatradeagreement.

According to Ederington & Minier (2003), as countries ratify agreements constrainingtheirabilitytopursuetradegoalsthroughtradepolicy,therewillbeunilateral incentives for governments to distort domestic policies as a secondary meansofprotection.Oneofthewaysofdecreasingimportswithinanindustryis torelaxEnvironmentalstandards(orotherdomesticregulation)inthatindustry

However, while lax regulatory standards may be unilaterally optimal, they are inefficient for the world economy (since they lead to a global loss of trade). Therefore, international cooperation over environmental policies that deters countriesfromrelaxingtheirenvironmentalstandardsasatradebarriercanlead toincreasedglobalwelfare.

The theoretical understanding of the Second-BestArgument rests on the joint assumptionthat(i)domesticregulationsactaspotentialmeansofmanipulating tradeflows;(ii)tradeflowsareinfactresponsivetoregulatorychoices.

Theearlyempiricalevidenceregardingthesesecond-bestarguments(i.e.empirical studies of environmental regulations and trade) however, has been unconvincing. If stringent environmental regulations are a major source of comparativedisadvantage,thenthemostregulatedindustriesshouldalsohavethehighest levelsofimportpenetration.Thereislittleempiricalsupportforthisproposition. Thus, 'second-best' arguments for cooperation over environmental regulation wereoftendismissedasbeingoflittlepracticalimportance.

Buttheseearliermodelsestimatedonlyasmalleffectofenvironmentalregulationsontradeflowsbecausethesestudiestreatedthelevelofenvironmentalregulation as exogenously determined, ignoring the possibility that trade considerationsmayitselfplayaroleinthesettingofenvironmentalpolicy(Ederington& Minier2003).

However, the recent empirical work on the second-best hypothesis argue that environmentalregulationsaresetendogenously,andthereexistsanecdotalevidence,suggestingthatconcernwithinternationalcompetitionhasplayedarole insettingenvironmentalregulation.Therehavebeenseveralinstancesfromthe USwhereinspecialcommitteesandTaskForceshavebeenconstitutedwiththe stated goal of relaxing domestic regulations that adversely affected U.S. trade competitiveness.

Ederington&Minier(2003)arguethattheendogeneityofenvironmentalregulationmayhavebiaseddownwardpreviousestimatesoftheeffectofenvironmental regulation on trade flows. For example, if countries tend to (endogenously) relaxenvironmentalregulationonthoseindustriesfacingstrongimportcompetition,thennetimportsandthelevelofenvironmentalregulationmayappeartobe onlyweaklycorrelatedacrossindustries,evenifstringentenvironmentalregulationsareamajorsourceofcomparativedisadvantage.

AparallelargumentwasputforthbyTrefler(1993),whonotedthatestimatesof thesmallimpactoftradebarriersontradeflowsarebiasedbecausetheyignore thetheoryofendogenousprotection(thatincreasedimportsintensifylobbying forprotection,leadingtohigherlevelsofprotection).SimilartoTrefler(1993), who examined the relationship between trade barriers and trade flows, Ederington & Minier (2003) examined the impact of environmental regulation ontradeflows,byinculcatingtheTheoryofEndogenousProtectionintheSecond-BestPropositionofEnvironmentalTradeProtection.

Copyright©2023,IERJ.Thisopen-accessarticleispublishedunderthetermsoftheCreativeCommonsAttribution-NonCommercial4.0InternationalLicensewhichpermitsShare(copyandredistributethematerialinany mediumorformat)andAdapt(remix,transform,andbuilduponthematerial)undertheAttribution-NonCommercialterms.

Theyaddressedthisconcerndirectlybyestimatingtheimpactofenvironmental regulationsonnetimportlevelswhilecontrollingforsimultaneitybetweennet importsandenvironmentalpolicy Theyfoundstatisticallysignificantresultsto supportthepropositionthatcountriesdistortlevelsofenvironmentalregulation as a secondary trade barrier and hence, a means of providing protection to domestic industries when environmental policy is modelled endogenously By modelling environmental policy endogenously, they also found that environmentalpolicyhas amuchstrongerimpacton netimportlevelsthanpreviously reported.Thisfindingprovidesstronggroundsforanaffirmativeanswertothe questions - whether international trade agreements include negotiations over environmentalpolicy

Does International Trade weaken Environmental Policy? The Tariff Substitution Effect, The Pollution Haven Hypothesis and the Environmental Kuznets Curve

1)TariffSubstitutionEffectofEnvironmentalRegulations

Whenenvironmentalpolicyisusedasasubstitutefortradepolicytohelpdomesticfirmscompetewiththeirforeignrivals,governmentsinvariablyweakenenvironmental regulations. Consequently, free trade may harm the environment because of an endogenous weakening of environmental policy Copeland and Taylor(2004)refertothismotiveas“TariffSubstitution”,asenvironmentalpolicy is substituting for the lack of available trade-policy instruments, typically becausetariffsandquotasareconstrainedbytradeagreements.

Governmentalmeasuresforenvironmentalprotectionaimedatproducts(suchas pesticideresiduesinfood,taxesontheleadcontentoffuels,andproductliability rules,etc)differfromthoseaimedatprocesses(suchaswaterpollutiondischarge regulation,miningreclamationlaws,tradeablepermitprograms,liabilityforhazardouswastedamage,etc)

In the case of product regulation, a nation that adopts relatively stringent standards can prevent some of the adverse impacts on the competitiveness of its industry by restricting import competition. In the case of process standards, a nationwithmorestringentstandardscannotunilaterallyneutralizeitsindustry's disadvantageininternationalcompetition(CopelandandTaylor,2004).

Governmentshaveanincentivetotakeadvantageofproductstandardsasaprotectionistdevice,toprotectlocalfirms.Toavoidthis,tradeagreementstypically requireaNationalTreatmentRuleunderwhich,countriesareallowedtoimpose any environmental standards they choose, but the standards applied to foreign productsshouldbenolessstringentthanthatappliedtolocalproducts.Thatis,a nationaltreatmentregimeattemptstocircumventtheprotectionisttendenciesby enforcinganon-discriminationrule.

Inthecaseofproductstandards,therehasbeenagradualshiftawayfromapure national treatment regime to one that requires increased use of scientific evidencetojustifyenvironmentalpoliciesthatimpedetrade.Thismayinhibittariff substitution,butitreducestheflexibilityofgovernmentstoimplementtheirown environmentalpolicy

Inthecaseofproduction-generatedpollution,governmentshaveretainedmore flexibility to adjust their environmental policy, but at the possible cost of increasedtariffsubstitution.Thisisbecauseexplicitexportsubsidiesaresubject tocountervaillawsundertheWTO,buttheuseofimplicitsubsidiesbyweakening environmental policy are not. One of the main reasons for this seeming inconsistencyinthetreatmentofsubsidiesisthattheinformationalrequirements ofdeterminingthe"correct"environmentalpolicyarehigh.

Hence there exists a trade-off between two different objectives: closing loopholesintradeagreementsbyconstrainingtheuseofdomesticpolicyinstruments inanefforttopreventtariffsubstitution;andallowinggovernmentsflexibilityto respondtolocalchangesinlocalconditionsandpreferenceswithrespecttotheir environmentalpolicy(CopelandandTaylor,2004).

Bagwell and Staiger's (2001) work on self-enforcing trade agreements throws freshlightonthetrade-offbetweenpreventingtariffsubstitutionandflexibility inimplementingdomesticenvironmentalpolicy Iftradeagreementsarenegotiationsto allowmarketaccessto tradingpartners,andiftheseobligationsbind, thentheyshowthatevenifthetradeagreementdoesnotconstraindomesticpolicy,itneverthelessremovestariffsubstitutionmotives.Ifeachgovernmentmaximizesitsobjectivefunctionsubjecttoitsmarketaccesscommitments,thenthe solutionistominimizethecostofachievingthoseobjectives.Thiseliminatesthe temptationtouseenvironmentalpolicytoreduceimports,sincesomeotherpolicywouldhavetobealteredtocounteractthenegativeeffectsonforeignmarket access.

2)TheEnvironmentalKuznetsCurve

TheEnvironmentalKuznetscurvehypothesizesisaninverse-U-shapedrelationshipbetweenacountry'sper-capitaincomeanditslevelofenvironmentalquality Anincreaseinincomeisassociatedwithanincreaseinpollutioninpoorcountries,butadeclineinpollutioninrichcountries.TheEKChelpsprovethepoint thatthattradeandgrowthmayactuallybegoodfortheenvironment.Ifenvironmentalqualityisanormalgood,increasesinincomebroughtaboutbytradeor

growthwillbothincreasethedemandforenvironmentalqualityandincreasethe abilityofgovernmentstoaffordcostlyinvestmentsinenvironmentalprotection.

CopelandandTaylor(2004)werehoweverscepticalabouttheexistenceofasimple and predictable relationship between pollution and per-capita income (i.e. EKC). The EKC estimation ignores national characteristics such as factor endowments, technologies and trading opportunities (comparative advantage andcurrenttraderestrictions)andreducesthissetofpossibleexplanatoryfactors toessentiallyjustone-incomespercapita.

Despiteitslimitations,theEKChasprovidedconvincingevidencethatthereis an income effect that raises environmental quality Moreover, there are strong indicationsthatthisincomeeffectworksbecauseincreasesinthestringencyof environmental regulation accompany higher per-capita incomes.Therefore, an analysis of the effects of trade and growth on the environment cannot proceed withouttakingintoaccountendogenouspolicyresponses(thisinsightwasalso incorporatedbyEderington&Minier(2003),intheiranalysisdiscussedabove)

Whilethelinkbetweenincomegrowthandtheenvironmentisimportant,trade may alter environmental outcomes through a variety of other channels. Trade mayencouragearelocationofpollutingindustriesfromcountrieswithstrictenvironmental policy to those with less stringent policy These shifts may in turn increaseglobalpollutionandtheymayhaveachillingeffectonenvironmental policy, as countries will be reluctant to tighten environmental regulations becauseofconcernsoverinternationalcompetitiveness.

3)EnvironmentalRacetotheBottom-ThePollutionHavenEffectandthePollutionHavenHypothesis

Atighteningupofpollutionregulationtendstohaveaneffectonplantlocation decisionsandtradeflows(PollutionHavenEffect).Further,areductionintrade barriers often lead to a shifting of pollution-intensive industry from countries withstringentregulationstocountrieswithweakerregulations(PollutionHaven Hypothesis). The pollution haven hypothesis predicts that countries with relatively weak environmental policy will specialize in dirty-industry production. While empirical evidence for the existence of a pollution haven effect exists, thereislittleconvincingevidence,tosupportthepollutionhavenhypothesis.

CopelandandTaylor(2004)viaahypothesizedmodelconcludedthatpollution risesinthecountrywithweakpollutionpolicy(oftenlow-incomecountries),and falls in the country with strict pollution policy (often high-income countries). Trade induced by pollution policy differences creates a pollution haven in the countrywithweakerpolicy.Thewelfareeffectsofsuchtradedependonthestringencyofpollutionpolicy.Ifpollutionpolicyistooweak,high-incomecountry must gain from trade, both because of an increase in purchasing power and because of the fall in pollution. Low-income country, however, may lose. Its incomerises,butsodoespollution.Andifexternalitiesarenotfullyinternalized, theincreaseinpollutionisharmfultothelow-incomecountry

Theconclusionsherearealsoconsistentwithsomecriticismsoffreetrade.Highincomecountrygainsfromtradebyoffloadingsomeofitspollutingproduction ontothelow-incomenation.Moreover,becausethedirtiestindustryisshiftedto thepartsoftheworldwithweakerenvironmentalpolicy,this"globalcompositioneffect"tendstoraiseworldpollution.

Mani and Wheeler (1997) examined the production and consumption of dirty goodsforseveraldeveloping-countryregionsplusEurope,NorthAmerica,and Japanoverthe1965-95periodandfoundapatternofevidencewhichdoesseem consistentwiththepollutionhavenstory Pollution-intensiveoutputasapercentageoftotalmanufacturinghasfallenconsistentlyintheOECDandrisensteadily inthedevelopingworld.Moreover,theperiodsofrapidincreaseinnetexportsof pollution-intensiveproducts from developing countries coincided with periods ofrapidincreaseinthecostofpollutionabatementintheOECDeconomies.

Can Trade Policy be used as a substitute for Environmental Policy i.e Should tradepolicybeusedtoachieveenvironmentalobjectives?

Because trade has the potential to increase pollution, the question of whether traderestrictionsshouldbeusedtodealwiththegeneralissueoftrade-induced increasesinpollutionmeritsadiscussion.Further,therearemanyissueswhere people in one country want to achieve an environmental objective in another country(Eg-proposalstobantropicaltimberimportstoprotectrainforests,banningoftunaimportsintotheUnitedStatesfromMexicotoprotectdolphins,etc).

Traderestrictionsarenotafirst-bestinstrumenttodealwithenvironmentalproblems.WhileTradeBarrierslimittheextentofpollution,theyareharmfulasstandardgainsfromtradearelost.

AccordingtoDixit(1985),ifpollutionpolicyfullyinternalizesexternalities,the optimaltaxontradeiszero.Ratherthanusingtradebarriers,countriescanmore effectively control environmental problems with instruments that are finely tunedtodealwiththesourceoftheproblem,suchaspollutiontaxesorquotas.If, howeverenvironmentalpolicydoesnotfullyinternalizeexternalities,thentrade policycanbeusedasasecond-bestinstrumenttocontrolpollution.

Copeland (1994) was also critical of the use of trade policy for environmental ends. Given the complicated general equilibrium effects of trade liberalization determiningtheoptimalsecond-besttradepolicytoavoidenvironmentaldamagecanbequitecomplicatedinitself.Hefurtheraddsthatevenifenvironmental policyisimperfect,trademaystillbebeneficial.Thisissobecausethewelfare resultsoftradeliberalizationdependonbothacountry'scomparativeadvantage andtheinstrumentsitusesforenvironmentalprotection.Ifacountryhasacomparativeadvantageindirtygoods,thenthewelfareimpactoffreetradedepends onwhetherimperfectregulationtargetsemissionintensitiesoroverallpollution.

Ifitistheformer,lossescanoccur;ifitisthelatter,gainsareassured.Alternatively,ifacountryhaslaxregulationbutacomparativeadvantageincleangoods, thentradeisnecessarilywelfareimprovingbecauseittakespressureofftheenvironment.

AnanalysisoftheEnvironmentalEconomicsliteraturepertainingtoIndia

Mukhopadhyay & Chakraborty (2006) evaluated the impact of international tradeonemissionsofCO2,SO2,NO2fortheIndianeconomyduring90susing Input-Output techniques. They concluded that India produces goods that are moreenvironmentfriendlythangoodsitimports,thuschallengingthepollution havenhypothesisforIndia.Sharma&Rana(2017)examinedthecausalityrelationshipsbetweenFDI,(GDP)andCO2emissionsalongwiththeleveloftrade (exportsandimports)takingplaceinIndiaandconcludedtheexistenceofboth Pollution Haven Hypothesis and Environmental Kuznets Curve hypothesis in India.

Notmuchempiricalworkisavailableestimatingtheextentofoverlapbetween Environmental Regulations and International Trade in India. Lack of a market for environmental goods as well as an absence of well-defined property rights complicatetheEnvironmentalPolicymaking.

Lack of data, especially on abatement costs, serves as a major hindrance in empirical analysis of the impact of environmental regulations on trade movements.Thereisaneedtopublishacomprehensiveperiodicalsurveyofthetechnologicalsolutionsadoptedbymostpollutingsectorsintheeconomy,inorderto getabetterideaofthetrueabatementcostsfacedbyimportcompetingsectors.

India'spolicyframeworkconcerningtheenvironment,isanaggregationofavariety of uncoordinated sources relating to discrete environmental topics such as pollution,water,energy,transport,wastemanagement,agriculture,mining,forests,environmentalclearance,finances,etc.Indiastronglyneedsacomprehensivepolicydocumentwithanewvisiontoguideitforwardinrespondingtothe rapidlychanginglandscapeoftradenegotiations.

India's domestic policy making is further

complicated by the country's federal structurewhereinthelegislativedomainsofthecentralgovernmentandthestate governmentaredistinct.Whiletradepolicyisalmostexclusivelydeterminedby centralgovernments,muchofenvironmentalpolicyissetatthelocal,regional, orstatelevel.Therefore,inordertoputintoplace,thetermsoftrademotivation foralteringenvironmentalpolicyagreatdealofcoordinationbetweendifferent levelsofgovernmentisneeded.Moreover,sincestates,regions,andevencities differgreatlyitisnotclearthiscooperationwouldbeforthcomingsincetheirconstituentsmaywellbehurtbyapricechangethatatthenationallevel,wouldbe welfare improving. India's domestic environmental policy urgently needs a coherent vision for tackling complex trade negotiations, that should be clearly reflectedintheframingoflegislationandpolicydocumentsaddressingmultiple sectorsandalignedwithmultiplefederallevels.

Anewdomesticenvironmentalpolicymustresultfromacollaborativeanddemocraticexercisethatactivelyseeksandincorporatesinputsfrompolicymakers,naturalandsocialscientists,theacademiccommunity,civilsocietyandcommunitiesfromacrossthecountry Stakeholderengagementmustbebasedonequitable terms,withduerecognitionandcompensationfortheutilisationofthelocalparticipants' knowledge, research, time and resources. The role of villages, cities and states in co-creating India's environmental policy must be explicitly endorsedandpromoted.

REFERENCES

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4. Copeland, Brian, 1990. “Strategic Interaction among nations: negotiable and nonnegotiabletradebarriers”

5. Trefler,Daniel,1993.“TradeLiberalizationandthetheoryofendogenousprotection: aneconometricstudyofU.S.importpolicy”

6. Gawande,Kishore,1999.“TradeBarriersasOutcomesfromTwo-StageGames:Evidence”.

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8. Dixit,AvinashK.andNorman,Victor(1980).“TheoryofInternationalTrade”.