WTO Report:
Environmental Cooperation and Trade

• Environmental degradation is driven by market and policy failures. While trade itself may be associated with environmental problems, such as pollution arising through the transportation of goods, most problems occur during production, consumption, and/or the disposal of waste products. Appropriate regulations and taxes can ensure that environmental impacts are accounted for by producers and consumers - the "Polluter Pays Principle". However, governments may not only omit to correct market failures, they may also aggravate the problems through subsidies.

• Trade would unambiguously raise welfare if proper environmental policies were in place. Without adequate environmental policies, trade can prejudice environmental quality. For example, demand from the world market may encourage unsustainable logging when no proper management scheme is in place. In other instances, trade liberalization may mitigate the underlying distortions. For example, a reduction in fishing subsidies, amounting to some $54 billion annually, would reduce overcapitalisation in the industry and lessen overfishing.

• Trade barriers are poor environmental policies. Environmental problems are best addressed at source, whether they involve polluting production processes or undefined property rights over natural resources. Targeting indirect linkages, such as exports or imports of goods, can only partially correct market and policy failures, and at a higher price to society. At the same time, governments have found trade measures a useful mechanism for encouraging participation in and enforcement of multilateral environmental agreements in some instances, and for attempting to modify the behaviour of foreign governments in others. However, the use of trade measures in this way is fraught with risks for the multilateral trading system, unless accompanied with rules agreed by all parties.

• Environmental standards should not necessarily be harmonized. This conclusion refers only to local pollution problems that are arguably best addressed by standards targeted to the specificities of the local conditions. Neither poor nor rich communities (countries) are well served by setting standards at the average. The case is different for transboundary and global problems where policy harmonization and collective management of common resources is perhaps the only effective policy option.

• The environmental repercussions of trade are theoretically ambiguous, and depend on three interacting factors: (i) trade-induced changes in industrial composition, and hence the pollution intensity of national output, (ii) changes in the overall scale of economic activity, and (iii) changes in production technology. The net outcome is a priori undetermined. Sweeping generalisations about the linkages between trade and environment, whether positive or negative generalisations, must therefore be rejected.

• The gains from trade are sufficient to pay for additional abatement costs. The income gain associated with trade could in principle pay for the necessary abatement costs and still leave an economic surplus. This has been shown in various economic simulations. In other words, by combining trade and environmental reforms one can find ways to raise income and consumption without compromising the natural environment. At least in this sense, there is no inherent conflict between trade and environment. Rather, the conflict arises as a result of the failure of political institutions to address environmental problems, especially those of a global nature which require a concerted effort to solve.

• The competitiveness effects of environmental regulations are minor. The direct cost of pollution control in the OECD is minor, just a few percentage points of production costs for most industries. No corresponding estimates are available for developing countries, but unless the regulatory cost is zero, the cost savings of moving offshore are less than suggested above. Moreover, some observers have noted that these numbers are in any event exaggerated. The "Porter hypothesis" holds that regulatory pressure, just like competitive pressure, encourages industrial innovations that make production both leaner (less energy and resource demanding) and cleaner at the same time, thereby offsetting the direct compliance costs. The empirical evidence partly supports this hypothesis, although it would be wrong to conclude that environmental regulations do not cost anything. They do cost, but they also bring significant benefit to society and the quality of life.

• Environmental leaders are not less profitable. Studies that have compared the profitability of firms in the same industry have not found much evidence that environmental leaders pay a price in terms of reduced profitability. For several reasons, environmental leaders can often recoup costs in the marketplace. Firstly, a growing number of consumers are willing to pay a premium for "green labels." Secondly, firms that accord with the environmental management standards promulgated by the International Organization for Standardization (ISO 14000) seem to enjoy certain competitive advantages, including lower liability insurance, less regulatory oversight, and increased access to customers (including the public sector) that care about their own environmental reputation.

• Polluting industries are not migrating from developed to developing countries to reduce environmental compliance costs, although there are of course exceptions. While it is certainly true that developing countries are net recipients of foreign direct investment, the composition of investments they receive is not biased towards polluting industries, but rather to labour-intensive industries that are less polluting on average. What the data tell us is that, to the extent developed countries are exporting their dirty industries, they are exporting them to each other, not to less developed economies. This suggests that environmental regulations are at most of secondary importance for international investment decisions.

• Multinational firms are moving towards a policy of standardised technologies for all their production plants in the world. The reason is simple. It is less costly to duplicate the home technology than to modify the process in each country. What is more, the choice of technology is not just based on current standards, but on what is expected in the future. It makes commercial sense to install state-of-the-art technology at the time an investment is made rather than retrofitting abatement equipment at a later stage at a much greater expense. Finally, multinationals are becoming more sensitive to the reputation they earn in the market place, at least those multinational firms that are based in countries with an active environmental community. Market forces often reward good environmental performance rather than cost savings at any price, including financial markets that react negatively to environmental mishaps. It has not always been this way, but the tide has changed in recent years. Much of this advance is thanks to the relentless efforts of non-governmental organizations around the world that have made consumers sensitive to the environmental profile of products and producers. In short, when consumers care, producers care.

• Yet, environmental measures are sometimes defeated because of competitiveness concerns. Market forces cannot be entrusted to solve all problems themselves. Governments must do their part by regulating polluting and resource degrading activities appropriately. This creates a difficult political dilemma. If policy makers and voters think that domestic industry is crumbling under environmental regulations at the expense of domestic investments and jobs, it may be difficult to forge the necessary political support for new regulatory initiatives. And this problem may become worse still when trade and investment barriers are removed, since industries then become more mobile and more difficult to regulate. Indeed, some evidence suggests that industries often appeal to competitiveness concerns when lobbying against environmental regulations, and on occasion with some success.

• How serious is this problem? It would clearly be a serious problem if competitiveness concerns prevented environmental standards from being raised to appropriate levels, or if governments were compelled to build in protectionist elements in environmental regulations to "compensate" industry for alleged adverse competitive effects. However, competitiveness concerns could potentially be a positive force if governments that find it difficult to act individually for political reasons seek cooperative solutions to environmental problems. The growing number of multilateral environmental agreements (currently some 216) may be one indication of the trend in that direction. The lasting effect of "regulatory chill" may then be more procedural than substantial. That is, initiative may have to shift from the national to the supranational level, just as we saw a shift from the local to the central level in federal states in the 1970s to overcome environmental policy foot-dragging at the local level. Admittedly, however, international cooperation in these matters is not easy to achieve unless governments are convinced of its urgency.

• Is economic growth, driven by trade, part of the problem or part of the solution? One reason why environmental protection is lagging in many countries is low incomes. Countries that live on the margin may simply not be able to afford to set aside resources for pollution abatement, nor may they think that they should sacrifice their growth prospects to help solve global pollution problems that in large part have been caused by the consuming life style of richer countries. If poverty is at the core of the problem, economic growth will be part of the solution, to the extent that it allows countries to shift gear from more immediate concerns to long run sustainability issues. Indeed, at least some empirical evidence suggests that pollution increases at the early stages of development but decreases after a certain income level has been reached, an observation that has become known in academic circles as the Environmental Kuznets Curve (EKC).

• How does trade enter the growth and environment debate? Trade enters into this debate for several reasons. The most direct reason is that trade is one cylinder that propels the engine of growth. Another reason is that trade may affect the shape and relevance of the EKC. It is at least conceivable that the turning point enjoyed by developed countries as far as certain pollutants are concerned is partly due to migration of polluting industries to developing countries, although the evidence does not seem to support this position. A third reason why trade comes into the picture is the political economy of environmental policy making. Competitive pressure may prevent environmental standards from being upgraded to turn around the pollution path. Growth driven by liberalization of the world economy may then defeat the mechanisms that in principle could generate an environmental Kuznets curve. As observed before, there is some evidence of a "regulatory chill" which may call for increased policy coordination among governments.

• Economic growth may be part of the solution, but primarily for local pollution problems. The empirical evidence in support of the EKC hypothesis is mixed. The evidence suggests that the EKC hypothesis may be valid for some types of environmental indicators, but equally untrue for other important indicators. Those indicators that appear to demonstrate some characteristics of an inverted U-shape pollution path are certain types of local, primarily urban air pollution, and to a lesser extent some types of freshwater pollutants. In contrast, pollutants of a more global nature do not seem to accord with the EKC hypothesis, notably emissions of carbon dioxide. In essence, countries seem more prone to act on pollutants that affect their own backyard than pollutants that degrade the global environment, although there are also some encouraging developments in respect of the latter, such as the reductions in ozone-depleting substances rendered possible by international cooperation under the Montreal Protocol.

• Economic growth is not sufficient for turning environmental degradation around. It should also be emphasised that nothing in the EKC literature suggests that environmental degradation will turn around with increasing income by compelling necessity. If economic incentives facing producers and consumers do not change with higher incomes, pollution will continue to grow unabated with the growing scale of economic activity. In other words, income growth, while perhaps a necessary condition for allowing countries to shift gear from more immediate economic and social concerns to more long term sustainability issues, is not sufficient to reverse environmental degradation. Environmental polices must be brought to bear.

• Accountability and good governance is critical. The importance of a democratic political process cannot be underestimated in this regard. Governments that are not held accountable for their actions, or rather inaction in this case, may fail to deliver the necessary upgrading of environmental polices. Comparing countries at the same income level, pollution tends to be worse in countries with skewed income distribution, a high degree of illiteracy, and few political and civil liberties. Moreover, these "political access" variables considerably weaken the relationship between per capita income and environmental quality. This suggests that the EKC relationship is not so much dependent on income levels per se, but rather on institutional and democratic reforms that tend to go hand in hand with increased income, and which are necessary for allowing ordinary citizens to articulate their preferences for environmental quality and influence the political decision-making process.

• Good governance is also needed at the international level. One of the disturbing conclusions of the empirical literature is that the turning points of global environmental problems, such as global warming driven by CO2 emissions and other greenhouse gases, are estimated at considerably higher incomes than more localized problems. One interpretation of this is that people do not care much about global warming and climate change. They would rather accept the consequences (on behalf of their children and their children's children) than the costs of curbing emissions. Another possible reason for political foot-dragging is that governments seek to free ride in the context of weak political institutions at the international level, including weak enforcement mechanisms. Indeed, one reason why the WTO has become the focal point for environmental disputes is that the WTO has an integrated adjudication mechanism backed by trade sanctions as the ultimate enforcement tool.

• Environmental degradation will turn around when political conditions are ripe. The political obstacles to sound environmental policy should not be exaggerated. The turning points that have been estimated for different kinds of pollutants have a tendency to fall within the income range of leading countries at the time the specific problems became an issue of intense public debate. For example, there may be nothing special about a turning point for CFC emissions at some $12,000 to $18,000 - it just happened to be the income range of the leading countries (which have also assumed the fastest phase-out commitments) at the time the Montreal Protocol was signed in 1987. And although we find estimates of a turning point for CO2 emissions of up to several hundred thousand dollars in per capita income, the fact that global warming has now risen to the forefront of public attention may result in a curbing of emissions at an earlier date. This will require, however, that countries go from words to actions and honour their commitments under the Kyoto Agreement. In the end, the environmental Kuznets curve may not have a "natural" turning point - it will turn whenever political conditions are ripe for delivering the necessary policies to address environmental degradation effectively, including through transfers of resources and technologies to allow developing countries to modernize their production.

• Not all kinds of growth are equally benign for the environment. Economic growth requiring ever more inputs of natural resources is obviously not as benign for the environment as economic growth driven by technological progress that saves inputs and reduces emissions per unit of output. This kind of growth will not necessarily emerge spontaneously, but may require economic incentives that steer development in a sustainable direction.

• Trade could play a positive role. Trade could play a positive role in this process by facilitating the diffusion of environment-friendly technologies around the world. Of course, this would require that countries are ready to scrap trade barriers on modern technologies and suppliers of environmental services to reduce the cost of investing in clean technologies and environmental management systems. A new round of trade liberalization negotiations could make a contribution here. Another potential contribution of such a round would be to address subsidies that harm the environment, including energy, agricultural and fishing subsides. This would yield a double dividend by benefitting the environment and the world economy at the same time.

• The way forward is multilateral environmental cooperation. Let us conclude with an observation quoted by Long (1995), which summarizes the core of the trade and environment debate. During an OECD meeting of Environment Ministers, one Minister noted that "his country, along with most others, had committed itself at the 1992 Earth Summit in Rio to the pursuit of sustainable development. However, whenever he tries to promote the behavioural and technological changes necessary to move in that direction, i.e., when he attempts to internalise the costs of environmental pollution and resource degradation, he is branded a 'green protectionist' outside his country, and a destroyer of national competitiveness at home."

  In short, trade is really not the issue, nor is economic growth. The issue is how to reinvent environmental polices in an ever more integrated world economy so as to ensure that we live within ecological limits. The way forward, it would seem to us, is to strengthen the mechanisms and institutions for multilateral environmental cooperation, just like countries 50 years ago decided that it was to their benefit to cooperate on trade matters.

Source:

Hakan Nordstrom and Scott Vaughan (1999) "Trade and Environment" WTO Special Studies 4, Geneva: World Trade Organization