Lesson 5: Trade and the Environment

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Economic Concepts

• Commons or common property
• Opportunity cost
• Incentives
• Property rights

Content Standards

Standard 1: Students will understand that: Productive resources are limited.  Therefore, people cannot have all the goods and services they want; as a result, they must choose some things and give up others.

• Scarcity is the condition of not being able to have all of the goods and services one wants.  It exists because human wants for goods and services exceed the quantity of goods and services that can be produced using all available resources.
• Like individuals, governments and societies experience scarcity because human wants exceed what can be made from all available resources.
• Choices involve trading off the expected value of one opportunity against the expected value of its best alternative.
• The choices people make have both present and future consequences.
• The evaluation of choices and opportunity costs is subjective; such evaluations differ across individuals and societies.
• Choices made by individuals, firms, or government officials often have long-run unintended consequences that can partially or entirely offset the initial effects of their decisions.

Standard 5: Students will understand that: Voluntary exchange occurs only when all participating parties expect to gain.  This is true for trade among individuals or organizations within a nation, and among individuals or organizations in different nations.

• When people buy something, they value it more than whatever it costs them; when people sell something, they value it less than the payment they receive.
• Free trade increases worldwide material standards of living.

Standard 16: Students will understand that: There is an economic role for government to play in a market economy whenever the benefits of a government policy outweigh its costs.  Governments often provide for national defense, address environmental concerns, define and protect property rights, and attempt to make markets more competitive.  Most government policies also redistribute income.

• Markets do not allocate resources effectively if 1) property rights are not clearly defined or enforced, 2) externalities (spillover effects) affecting large numbers of people are associated with the production or consumption of a product, or 3) markets are not competitive.
• An important role of government in the economy is to define, establish, and enforce property rights. A property right to a good or service includes the right to exclude others from using the good or service and the right to transfer the ownership or use of the resource to others.
• Property rights provide incentives for the owners of resources to weigh the value of present uses against the value of conserving the resources for future use.
• Externalities exist when some of the costs and benefits associated with production and consumption fall on someone other than the producers or consumers of the product.

Lesson Overview

Perhaps the most emotional opposition to globalization comes from those who fear that international trade, spurred by consumer demand in developed nations, is wreaking environmental havoc in impoverished but resource-rich areas of Asia, Latin America and Africa.  Research studies suggest, however, that the relationship between environmental quality and the drive to improve economic well-being is complementary rather than competitive; economic wealth enhances environmental quality.  This compilation of findings about the impact of trade on the environment focuses on the two main concerns of environmental activists:

• Does international trade increase pollution?
• Is international trade responsible for resource depletion?

Key Points

The Economic Way of Thinking:  Trade Creates Wealth and Creates Environmental Quality

1. The common view that pollution is bad in any quantity ignores the reality that the “environment” is a combination of resources that is “consumed” in a fundamentally beneficial activity, the creation of goods and services that improve the quality of people’s lives.
   • Viewed in this way, pollution and other types of environmental “degradation” indicate that instead of a sin, a choice and trade-off have occurred.  For example, making a book requires labor, capital, and trees to make paper pulp.  In the process, exhaust emissions from power tools are released into the air.  Clean air is being “consumed” in the process of making the book, just as the tree, the labor, and the capital were consumed.
     • All the resources, including the air, could have been used in other ways:  the tree used to make the paper could have become house siding or remained standing in a forest park.  A choice was made to use them in the creation of the book.
   • Economic analysis tells us, then, that environmental regulations restrict the choices that can be made about resource use.  Therefore, they reallocate consumption.  If trees are protected for parks, there will be fewer books or homes.
     • If the air is kept cleaner through stringent pollution controls, there will be fewer goods and services (including visits to tree-filled parks) whose production emits pollutants.
   • While opinions differ on whether or not the tradeoffs are worthwhile, that the trade-offs exist is beyond dispute.
2. The pattern of the trade-offs in terms of resource use over time shows consistently that as wealth increases, individuals and nations typically expand their consumption choices beyond primary products such as food, shelter, and transportation to include more abstract forms of consumption such as leisure and the enjoyment of environmental amenities.
   • One of the dilemmas of using international trade and trade sanctions to reduce pollution lies in the ethics of determining other nations’ choices about the uses of their resources.
     • In considering the environmental choices of developing nations, the question of whether a clean environment is actually desired by the people of the nation is not moot.
     • The higher pollution levels of developing countries are an indication that the opportunity cost of environmental protection and clean-up are unacceptably high when basic food and shelter are priorities.
   • Demand for environmental quality is positively correlated with wealth.
     • As nations move beyond subsistence and experience successful industrialization (approx. $8000 per capita income), demand for environmental quality appears.  It then increases as wealth grows.
   • In addition, increasing wealth creates the ability to produce the desired environmental quality through development and acquisition of cleaner technologies, better monitoring and detection mechanisms, and more effective enforcement.
   • One implication of the correlation between wealth and environmental quality is that the best way to improve global environmental quality is to facilitate rapid development, moving poorer nations to a level of wealth at which the demand for a clean environment emerges.
     • Since trade creates wealth, it follows that trade sanctions imposed for the purpose of curtailing pollution actually work in opposition to that goal
3. Evidence:  Pollution and Levels of Development:  The historical pattern of economic development, which includes increasing international trade, has resulted in the world becoming less polluted over time.
   • Research data on common pollution indicators: (sulfur dioxide levels, airborne dark matter, deforestation, dissolved oxygen in river water) confirm that pollution levels are generally low in very low-income nations, are highest in middle-income countries, and fall sharply to their lowest levels in high-income countries.
   • As nations make the transition from low to middle-income status through industrialization, industrial pollution levels commonly increase.
   • However, as middle-income nations continue to develop, pollution levels drop sharply.
     • (While this leaves open the question of whether damage done during the industrialization phase may be “permanent,” historical examples suggest that, so far, at least, that has not been the case.
     • With the rapid spread of technology that has accompanied freer trade, water quality and urban sanitation have generally improved over time for countries in all categories of income and development.
4. The exception to the historical trend – environmental problems that are more severe in developed countries than in the very lowest income countries – is the pollution characteristic of highly mechanized, urban populations:  carbon emissions and municipal solid waste
   • (It should be noted, however, that the environmental problems that are greater in developed nations tend to have lesser impacts on health than those characteristic of developing nations.
5. Does Globalization of Industry Create “Pollution Havens”?   There is no conclusive evidence to support the contention that international trade spurs the creation of “pollution havens.”
   • The “pollution havens” argument suggests that increasing environmental regulation in developed countries pushes the worst industrial polluters to countries with weaker environmental standards.  It is even argued that some countries deliberately set environmental standards low to attract these so-called “dirty industries” and the wealth they generate.
     • Undermining this argument is a large body of established economic research showing that “As a generalization, the level or intensity of national environmental regulations appears to be a weak or negligible determinant of the pattern of trade and location of investment.” (“International Trade, Environmental Quality and Public Policy,” by Michael J. Ferrantino in International Economics and International Economic Policy, ed. by Philip King.  New York:  Irwin McGraw Hill, 2000:  98.)
       • For the United States, specifically, trade performance in more highly-polluting industries does not show the decline that would be expected were industries relocating to escape the costs of U.S. pollution control regulation.
     • The costs of pollution abatement, which tend to be concentrated in such “dirty” industries as paper, chemicals, petroleum and coal, leather, and primary metals, are only about 2%-3% of production costs.  Thus, abatement costs, at most, raise prices 2%-3% relative to prices of foreign competitors, not enough for a producer to seek a competitive advantage by locating away from regulation.
       • (Developing nations’ labor costs, at 50-70% below those of developed countries, provide a much greater incentive for relocation.)
   • Research further indicates that when multinational firms do locate in developing countries, they tend to replicate the technologies employed in their home markets, effectively expanding the reach of the developed nations’ more rigorous environmental standards.
   • The trade liberalization of recent decades has caused much chemical and primary metals production (two of the “dirtier” industries) to move back toward developed countries where pollution abatement is stronger.  Developing countries now tend to import the products of these industries from the more efficient and cleaner producers in developed nations rather than producing for themselves. (“International Trade, Environmental Quality and Public Policy,” by Michael J. Ferrantino in International Economics and International Economic Policy, ed. by Philip King.  New York:  Irwin McGraw Hill, 2000:  98.)
     • Two cases of acknowledged exceptions exist but appear to not significantly increase world-wide pollution levels:
       • In a small number of highly polluting industries (including asbestos and some pesticides, for example) there is evidence that U.S. environmental regulation has led to overseas relocation.
       • Ireland has a deliberate policy of attracting polluting industries.
         • However, Ireland seems to be exploiting its comparative advantage in a rainy, windy “self-cleansing” climate.
           • (The question of whether Ireland’s environment has a greater ability to absorb and deal with pollution, or whether it is just exporting pollution on the wind, remains open.
6. Does Globalization of Agriculture Cause Deforestation? – A 20th Century Case Study:  World-wide, there exists an environmental tradeoff in agricultural production between expansion of cropland and increased chemical use, thus there is concern over the environmental impacts of trade policies that promote the globalization of agriculture.
   • The associated environmental concerns are deforestation and contamination of water supplies.
   • Less-developed countries tend to expand agriculture by expanding cropland, while developed countries tend to farm smaller amounts of land with intense chemical applications.
   • Trade policies that substantially shift the location of agricultural production thereby change the type and level of agriculture’s environmental impact.
     • Developing countries experience higher rates of deforestation than developed countries.
     • A UN study at the close of the 20th century found 60% of global loss of forest cover taking place in 10 nations:  Bolivia, Brazil, Indonesia, Mexico, Paraguay, Sudan, Tanzania, Thailand, Venezuela, and Zaire.
       • However, contrary to popular belief, deforestation is largely the result of firewood gathering and clearing land for crops and pasture, not commercial timber harvesting.
     • Deforestation is positively correlated with lack of private property rights and ease of access.  (For example, increased road density in publicly-owned Amazon forests eases access for loggers, settlers, and fuel-wood gatherers.
       • The same UN study showed that forest sizes in the world’s developed nations had stabilized or were increasing.
7. Until the trade liberalization of the last decade the major increases in global agricultural production took place in developed countries using chemical fertilizers and pesticides to increase yields.
   • During that same period, the tendency of developing countries to increase agricultural production through clearing land was exacerbated by tariffs on high-tech agricultural inputs such as fertilizers, pesticides, and farm equipment.
     • Additionally, subsidized farming in Europe and the U.S. kept world prices lower than they would otherwise have been, serving to shift production away from developing countries to chemical-intensive developed countries.
   • Liberalization of trade policies dating to the WTO Uruguay Round in the mid-1990s has provided incentives to shift agricultural production toward developing countries.
     • In the initial stages, this may prove to increase deforestation as crop acreage increases.
     • Eventually, the increase in high-tech farming methods should slow or stabilize deforestation as should the shift away from wood fuel for cooking and heating to kerosene and propane use as incomes rise.
8. The Commons Problem and the Importance of International Agreements:  Discussion to this point has been focused on pollution and/or environmental degradation within the boundaries of a nation which, while it may be of concern to others outside the nation, is fundamentally a different problem than pollution that spills over to affect other nations.
   • Pollution that impacts the international community is most usefully conceived of as a property rights problem.
     • General economic thought proposes that when property rights are clearly established, pollution can be addressed through negotiation between owners and potential consumers.
       • The owner of an environmental property right (to land or water, for example) can choose to have the benefit of a clean environment or to be compensated for having some level of a dirty environment.
     • When property rights are not clear or when many hold a property right in common (to the air, to the existence of wild lands or endangered species, for example), disputes are much more difficult to resolve:
       • Determination and enforcement of acceptable pollution levels is more difficult.
         • For instance, how do we determine what is acceptable and what is unacceptable use (damage?) of the ozone level through industrial and mechanical emissions?
   • The incentives of common ownership discourage voluntary, individual restraint.
     • A decision by one common owner to reduce pollutants does not measurably improve the problem but does measurably increase the costs to that owner.  In such a circumstance there is little or no incentive to refrain from either pollution or over use of a resource.
9. Increasingly, in recognition of the commons nature of environmental problems, international trade agreements have included provisions to deal with issues of pollution.
   • NAFTA provides for dispute resolution if two of the three members (Canada, Mexico, and the U.S.) believe that the third is not enforcing its own environmental laws.
   • WTO has numerous provisions regarding trade-related disputes over pollution, environment, and species issues.
   • However, studies of the cases handled found that the difference between a completely trade-friendly decision and a completely environment-friendly decision would make less than a 1% difference in total trade volume.  (“International Trade, Environmental Quality and Public Policy,” by Michael J. Ferrantino in International Economics and International Economic Policy, ed. by Philip King.  New York:  Irwin McGraw Hill: 105.)
     • The implication is that despite the constant criticism they receive, as currently constituted these trade agreements are unlikely to significantly impact either living standards or environmental quality on a global level.
   • Important trade agreements that directly affect international trade include:
     • The Montreal Protocol designed to protect the ozone layer through a ban on CFCs;
     • The Convention on International Transport of Endangered Species (CITES) which bans the sale or trade of endangered species products, an
     • The Basel Convention regulating international trade in toxic wastes.
10. While problems of the environmental commons that transcend national borders are difficult to manage through trade agreements, it is clear that trade restrictions exacerbate problems by their tendency to lower incomes and therefore reduce a nation’s ability to acquire and apply technological solutions.

Michael J. Ferrantino, of the U.S. International Trade Commission,  writing in the 2000 edition of International Economics and International Economic Policy, summarizes current scholarship in “International Trade, Environmental Quality, and Public Policy:

A consensus of guarded optimism has gradually emerged on the . . .[issue of trade and the environment].  It is now widely recognized that developed countries, made wealthy in part by the pursuit of open trade regimes [emphasis added] enjoy superior environmental quality by virtue of the ability to afford both clean technologies and modern enforcement mechanisms against polluters.  In developing countries, accelerated growth fueled by economic liberalization can provide self-financing of environmental improvements . . . . [Additionally,] [i]mports of state-of-the-art capital equipment, fueled further by liberalization of direct investment, provide an immediate vehicle for North-South transfer of “green” production processes.”

Lesson 5 Activity: Trash