Environmental standards as barriers to trade

Socio-Economic Planning Sciences 37 (2003) 203–214

Environmental standards as barriers to trade

Robert E. Kohn*

Department of Economics, Southern Illinois University at Edwardsville, Edwardsville, IL 62026, USA

Abstract

This paper examines the case of a good, polluting in consumption, whose pollutive content is restrictedby a government with strong environmental policies. When foreign producers are unable to comply withthe restrictive environmental standard of such a country, to which they wish to export, they often allegethat those standards constitute illegal barriers to free trade. An example of such a good is gasoline,excessively pollutive formulations of which are prohibited from importation into the United States by the1970 Clean Air Act. Rather than banning them, such imports should be taxed, along with the domesticallyproduced substitute good, according to their respective pollutant contents. This would foster economicefficiency and should be more acceptable to foreign producers than the outright prohibition mandated bythe Clean Air Act. The results of this paper reaffirm the argument in a previous article in this journal(Socio-Economic Planning Sciences 29 (1995) 187), though the countries’ roles in the two papers arereversed, that free trade and Pigouvian environmental policies increase international welfare.r 2003 Elsevier Science Ltd. All rights reserved.

Keywords: Environmental tariff; Consumption externality; Pollutive import; Pigouvian tax

1. Introduction

When countries require importers to adhere to the same strict environmental standards thatthey impose on their domestic producers, they are often accused of using these standards asbarriers to trade. For example, the 1990 Clean Air Act [1] contains restrictions on the pollutioncontent of gasoline consumed in the United States, that have been extended to foreign refineriesshipping to the US [2, p. 44]. When the US blocked imports of gasoline from Venezuela andBrazil, because they violated federal clean air standards, a World Trade Organization (WTO)appeals panel overruled the US action as an unfair barrier to trade [3]. After environmentalistsprotested this ruling that would, in effect, have required Americans to consume more pollutivegasoline, the WTO panel clarified its position, explaining that it was not the imposition of

*Corresponding author. 52 Broadview Drive, Clayton, MO 63105-3029, USA. Tel.: +1-314-863-3051; fax: +1-314-

863-3690.

E-mail address: [email protected] (R.E. Kohn).

0038-0121/03/$ - see front matter r 2003 Elsevier Science Ltd. All rights reserved.

PII: S 0 0 3 8 - 0 1 2 1 ( 0 2 ) 0 0 0 4 1 - 1

pollution standards on gasoline imports that was unfair, but the fact that more stringent standardswere being imposed on foreign refineries than on their domestic counterparts [3]. Although the USmade the necessary administrative changes in their import restrictions, better results might havebeen achieved more efficiently by market incentives rather than command and controlregulations. According to the view presented in this paper, imports of more polluting gasolineshould be allowed, but all gasoline, whether domestically produced or imported, should be subjectto a Pigouvian tax on its specific pollutive content.If the imported substitute is more polluting in consumption, the tax per gallon will be higher

than the tax on the less polluting domestic gasoline. Alternatively, following [4], an environmentaltariff can be imposed on the imported gasoline so that the same emission tax per gallon can beuniformly imposed.1 In this context, an environmental tariff is as efficient as the Pigouvian taxthat it supplements—unlike the original environmental tariff conceived by Baumol and Oates forpenalizing imports of a good whose production in the exporting country generates emissions of atransnational or global pollutant that are not properly taxed by that country [5, pp. 222–231]. Thefocus of the present paper is on domestic rather than transnational pollution, on pollutingconsumption rather than polluting production, and on a first-best environmental tariff rather thanthe second-best environmental tariff of Baumol and Oates.Although the Pigouvian correctives modeled here fall harder on more pollutive imports, they

are not a barrier to trade because these imported goods necessarily cost less to produce than thedomestic substitute. Such correctives would surely be more acceptable to foreign producers thanthe outright banning mandated by the 1990 Clean Air Act. This is especially true for ‘‘manydeveloping countries, such as China, (that) cannot afford environment-friendly equipment’’ untiltheir economies develop further, when they are then ‘‘more likely to take measures againstenvironmental degradation’’ [6, p. 246]. As early as the 1960s, Kneese [7, pp. 82–85] and Vickrey[8] convincingly argued that emission taxes or charges are in many important ways superior tocommand and control regulations, such as those contained in the 1970 Clean Air Act.In general, when an imported good is more polluting in consumption than its domestically

produced, otherwise perfect substitute, a tariff on the excess pollution content of the import, incombination with a single Pigouvian tax per unit of product, imposed on all consumers, isefficient. Alternatively, in lieu of a tariff, it is efficient to impose a tax on consumers, based on thediffering emission rates of the domestic good and the imported substitute. The tax per unit ofpollution is the same for the import as for the domestic product; but, for the more pollutiveimport, it is higher per unit of product. However, market forces require the import to come into thecountry at a lower base cost so that its final price, which includes either the tariff or the higherPigouvian tax per unit of product, is competitive with the domestic product.The results in this paper are based on the marginal conditions for international economic

efficiency derived with a two-country model based on Samuelson [9,10], except that the results aremore complex than his when an imported good is more polluting in consumption than itsdomestically produced substitute. In that case, his well-known equality of marginal rates of

1 In the example of environmental barriers to trade presented here, it is the foreign countries that export a more

environmentally damaging gasoline to the United States. It should be noted that this has not always been the case.

There is a sad history, recounted in [23], of US refineries shipping leaded gasoline to developing countries long after its

consumption in the United States was banned.

R.E. Kohn / Socio-Economic Planning Sciences 37 (2003) 203–214204

substitution in consumption across countries does not hold. These marginal conditions providethe formula for an environmental tariff, for the uniform Pigouvian tax rate, and for the dual taxbase, one base for the imported good and the other base for the cleaner, domestic substitute. Thecase in which the importing country imposes the tariff-cum-tax or the dual-based Pigouvian tax,but the exporting country does not, is also examined here. Whether or not the exporting country isPigouvian, the importing country is always better off with either Pigouvian policy.The case presented here is one in which the tariff-cum-tax and the equivalent dual-based tax are

equally efficient. There are also cases, as in [11], in which the transport of the imported good isitself polluting, in which case an environmental tariff is necessary. Alternatively, as in [12, pp.128–135], there is the case, not modeled in the present paper, in which consumers of a pollutivegood, such as gasoline, are able to abate emissions. The dual-based tax is then preferable becauseit alone promotes the efficient abatement effort by consumers.

2. The Heckscher–Ohlin–Samuelson model

The results of this paper are derived from a simple mathematical model of comparativeadvantage. Equations are presented first in their general forms, from which are derived themarginal conditions for a Pareto optimum, that is, for an allocation of resources such that neithercountry can be made better off by a transfer of goods from one country to the second countrywithout making the first country worse off. Then the equations are presented in specific arbitraryforms, which facilitate illustrative computer simulations. The industry production functions,linearly homogenous with respect to labor L and capital K ; for goods Y and X are

Y ¼ Y ðLy;KyÞ ¼ 10L3=4y K1=4

y ð1Þ

and

X ¼ X ðLx;Kx;PÞ ¼ 10L1=3x K2=3

x 1� P2� �

; ð2Þ

where P; the level of pollution caused by the domestic consumption of good Y ; is less than unity.Pollution damage is represented as a reduction—at a realistically increasing rate with respect toP—of the output of industry X : Such a model, in which the pollutive good is gasoline, but theeconomy is closed, is presented in [12, pp. 128–135, 13].It is conventional, in models of international trade between a capital abundant, environmen-

tally protective country in the northern hemisphere and a labor abundant, less-environmentallyprotective country in the southern hemisphere, to characterize the former country as the ‘‘North’’and the latter as the ‘‘South’’[14,15]. In the present model, it is assumed that the North hasendowments of Ln

0 ¼ 1000 and Kn0 ¼ 100; whereas the South has endowments of Ls

0 ¼ 1200 andK s0 ¼ 50: Accordingly, the North exports XT units of the capital intensive good X to the South in

exchange for imports of YT units of the labor intensive good Y : The quantities actually consumedin each country are therefore

yn ¼ Yn þ YT; xn ¼ Xn � XT ð3Þ

and

ys ¼ Y s � YT; xs ¼ X s þ XT ð4Þ

R.E. Kohn / Socio-Economic Planning Sciences 37 (2003) 203–214 205

and the resulting utility levels in each country are determined from the common utility function

U ¼ Uðx; yÞ ¼ffiffiffiffiffiffiffixy:

pð5Þ

Pollution is generated during consumption so that

Pn ¼ ðenÞYn þ ðesÞYT ¼ ð0:00005ÞYn þ ð0:00006ÞYT ð6Þ

and

Ps ¼ ðesÞðY s � YTÞ ¼ ðesÞys ¼ ð0:00006Þys; ð7Þ

where en is the emission factor from the consumption of the units of good Y produced in theNorth, and es is the emission factor from the consumption of the units of good Y imported from,and produced by, the South. The emission factors are constants, and it is assumed that es isgreater than en, though not so much greater as to actually shift the comparative advantage in theproduction of good Y from the South to the North. Unlike the case of a pure global pollutant, itis assumed here, as in [16], that emissions damage production only in the country in which theyoriginate.

3. Marginal conditions for a Pareto optimum

The Lagrangian expression for deriving the first-order conditions for a Pareto optimum is

d ¼Uðxn; ynÞ þ l½xn � X ðLnx;K

nx ;P

nÞ þ XT� þ m½yn � Y ðLny ;K

ny Þ � YT�

þ u½Ln0 � Ln

x � Lny � þ p½Kn

0 � Knx � Kn

y � þ a½Uðxs; ysÞ � U s0�

þ b½xs � X ðLsx;K

sx;P

sÞ � XT� þ g½ys � Y ðLsy;K

syÞ þ YTÞ þ d½Ls

0 � Lsx � Ls

y�

þ Z½K s0 � K s

x � K sy� þ r½Pn � enYn � esYT� þ t½Ps � esys�: ð8Þ

Setting the derivatives of Eq. (8), with respect to the variables, equal to zero, yields thefollowing equations:

l ¼ �Unx ¼ b ¼ �aU s

x; m ¼ �Uny ; u ¼ �lXn

L ¼ mYnL � renYn

L ;

p ¼ �lXnK ¼ �mYn

K � renYnK ; r ¼ lXn

P ; g ¼ �aU sy þ tes ¼ mþ res;

d ¼ �bX sL ¼ �gY s

L; Z ¼ �bX sK ¼ �gY s

K ; t ¼ bX sP: ð9Þ

Eliminating Lagrangian multipliers yields the familiar equality of marginal rates of technicalsubstitution across industries within the same country,

YnL

YnK

¼Xn

L

XnK

;Y s

L

Y sK

¼X s

L

X sK

ð10Þ

and the equalities of marginal rates of substitution in consumption to marginal rates oftransformation within, but not across, countries,

Uny

Unx

¼Xn

L

YnL

� enXnP ;

U sy

U sx

¼X s

L

Y sL

� esX sP: ð11Þ


The efficient marginal rates of substitution in consumption differ across countries according tothe relationship

Uny

Unx

¼U s

y

U sx

� es½XnP � X s

P�: ð12Þ

It is the difference in marginal rates of substitution in consumption across countries thatdistinguish this model from the standard Heckscher–Ohlin–Samuelson prototype. The efficienttechnical relationship across countries is

X sL

Y sL

¼Xn

L

YnL

� XnP½e

n � es�: ð13Þ

In this model, the left-hand side ratio, X sL=Y s

L; equals the efficient terms of trade between thetwo countries

4. The competitive, free trade, Pigouvian dual of the Pareto optimum

Assume that the economy in each country is perfectly competitive and that the wage rate is oneunit of the respective country’s currency. It follows that the price of capital is r ¼ YK=YL ¼XK=XL and that the price of good X is px ¼ 1=XL: The Pigouvian tax on emissions generated bythe consumption of good Y is T ¼ �pxXP; which is the value of good X lost in productionbecause of pollution damage. It is assumed that each country taxes emissions from consumptionwithin its borders at a rate equal to domestic marginal damage and then redistributes the tax andtariff revenue in lump sums to its own citizens. There is either an environmental tariff, t; equal tothat rate of marginal damage, together with a single-based Pigouvian tax, or, instead of a tariff inthe importing country, a dual-based Pigouvian tax with a lower base for the domestic pollutivegood and a higher base for the more pollutive import.The producer price of good Y ; that is, the direct cost of manufacturing it, is 1=YL: In the North,

the domestically produced output of good Y sells at 1=YnL per unit, plus a tax on consumption of

enTn per unit, whereas the imported good sells at (1=Y sL)(p

nx=psx) per unit plus a tax of esTn per

unit. For the more pollutive imported good to be competitive in the North, its producer price,1=Y s

L; in the North’s currency, must be accordingly less than that of the domestic substitute. Theexchange rate, pnx=psx; in this formula for the price of the import, converts the South’s producercost to the North’s currency. In this model, good X functions as the numeraire good forcomputing the exchange rate. The equilibrium consumer price of good Y in the North, which isthe same under either the dual-based tax or the tariff-cum-tax, is

pny ¼1

YnL

þ enTn ¼1

Y sL

� �pnxpsx

� �þ esTn ¼

1

Y sL

� �pnxpsx

� �þ ðes � enÞTn þ enTn: ð14Þ

The second term in Eq. (14) is the price of the domestically produced pollutive good in theNorth and the third term is that same price, also in the North, of the imported good, given thatthe tax is dual-based, that is, higher on imported units of good Y than on units of the domesticallyproduced substitute. The third term in Eq. (14) represents the same price again of the importedgood Y in the North, except that an environmental tariff, t ¼ ðesFenÞTn; is imposed by the North


when the good comes into port and then is taxed at consumption at the same rate, enTn; per unit,as the less pollutive, domestically produced substitute. In the South, the consumer price of good Yis simply

psy ¼1

Y sL

þ esT s ð15Þ

because that country does not import the pollutive good.The free-market, equilibrium terms of international trade are

XT

YT¼

X sL

Y sL

¼Xn

L

YnL

þ XnP½e

s � en� ¼1=Yn

L þ XnPðe

s � enÞð1=XnLÞ

1=XnL

; ð16Þ

which equals the ratio of producer prices in the South as well as the adjusted ratio of producerprices in the North. The ratio, Xn

L=YnL ; is equivalent to the producer price of good Y divided by

the producer price of good X : This ratio must be lower in the South than in the North tocompensate for the social cost of the higher pollution content of good Y exported by the South.Accordingly, the higher ratio in the North is reduced (because Xn

P is negative) in the third andfourth equalities in Eq. (16), by terms that account for the decrease in pollution damage toindustry X in the North when the domestic rather than the imported good Y is consumed.Whereas the second equality in Eq. (16) represents the ratio of producer prices in the South,(1=Y s

L)/(1=X sL), the final equality in that equation represents the ratio of adjusted producer prices

in the North, which is ð1=YnL � Tn½es � en�Þ=ð1=Xn

LÞ: The second expression in the numeratorrepresents the reduction in pollution damage accruing to producers of good X in the North, whenNorthern consumers purchase the less polluting unit of domestic product rather than the morepollutive import.Cross-multiplying the terms of trade, which equals the left-hand side ratio in Eq. (16), with the

second ratio in that equation and then with the fourth ratio, yields the two sets of equalities thatconfirm that the total cost of each country’s imports, in its own currency, exactly equals the totalrevenue it receives for its exports, which is the condition for free trade equilibrium. Finally, itfollows from utility maximization in each country that

Uny

Unx

¼pny

pnx;

U sy

U sx

¼psy

psx: ð17Þ

It is relatively straightforward to show that the above Pigouvian tariff and/or taxpolicy, competitive markets and free trade yield an allocation of inputs and outputs that satisfyEqs. (10)–(13).2

2 It follows from producer cost minimization, as implied by the above definition of the equilibrium price of capital r;that Eq. (10) is satisfied. Then, dividing the first expression equal to Pn

y in Eq. (14) by Pnx; substituting for Pn

x and Tn;and using Eq. (17), yields the first equality in Eq. (11). Similarly, the second equality in that double equation follows

from the second equality in Eq. (17) and the formulas for Psx and Ps

y: Free trade at the equilibrium terms of trade in

Eq. (16) satisfy the efficiency condition in Eq. (13), and when Eq. (16) is combined with Eq. (11), which has already

been shown to hold in the competitive market-free trade-Pigouvian economy, the efficiency condition in Eq. (12)

follows.


5. Numerical simulations

To simulate the consequence of the 1970 Clean Air Act, in which excessively pollutive importsare banned, the numerical model was initially run for the case in which there is autarky, that is, notrade between the two countries. In the interest of realism, it was assumed that the North but notthe South is Pigouvian. In this case, the utility of the North, Un; is 1882, and that of the South, Us,is 1505.6. Both countries would be worse off not trading than they are in any of the three casessimulated in Table 1. Even when the South is Pigouvian and its utility level rises to 1506.3,

Table 1

Bilateral laissez faire, unilateral Pigouvian, and bilateral Pigouvian free-trade solutionsa

(1a) (1b) (2a) (2b) (3a) (3b)

North South North South North South

Laissez faire Laissez faire Pigouvian Laissez faire Pigouvian Pigouvian

Ly 460.1559 1063.886 457.0941 1048.322 453.8366 1045.648

Ky 12.43927 28.28631 12.30557 26.76491 12.16453 26.51557

Y 1865.853 4296.012 1851.525 4190.468 1836.320 4172.672

P 0.1850729 0.1659805 0.1773648 0.1666395 0.1777310 0.1644453

X 1550.575 389.3353 1559.581 422.1886 1564.159 428.0078

YT — 1529.671 — 1413.143 — 1431.917

XT 481.5789 — 437.3411 — 442.2267 —

y 3395.523 2766.342 3264.668 2777.325 3268.237 2740.756

x 1068.997 870.9142 1122.240 859.5297 1121.932 870.2344

YL 3.041121 3.028527 3.037983 2.997982 3.034662 2.992886

YK 37.49926 37.96901 37.61559 39.14143 37.73923 39.34172

XL 0.9574217 0.9534569 0.9575512 0.9278188 0.9546341 0.9243093

XK 11.80571 11.95360 11.85618 12.11354 11.87189 12.15012

XP �594.2947 �132.9056 �571.1985 �144.7254 �574.1351 �144.6802Uy=Ux 0.3148252 0.3148252 0.3437530 0.3094811 0.3432835 0.3175163

r 12.33074 12.53712 12.38177 13.05593 12.43606 13.14508

px 1.044472 1.048815 1.044331 1.077797 1.047522 1.081889

py 0.3288261 0.3301935 0.3589918 0.3335577 0.3595970 0.3435173

T — — 596.5200 — 601.4190 156.5280

tn — — 0.0059652 — 0.00601419 —

U 1905.204 1552.175 1914.090 1545.054 1914.873 1544.377

aLy and Ky are the quantities of labor and capital used by each country to produce Y units of good Y according to

the industry production function, Y ¼ 10L3=4y K

1=4y : The corresponding production function for industry X is X ¼

10L1=3x K

2=3x ð1� P2Þ; where the respective quantities of labor and capital used in that industry are 1000� Ln

y and

100� Kny in the North and 1200� Ls

y and 50� K sy in the South, and P is the pollution level inside a given country. The

North imports YT units of good Y from the South and then consumes yn ¼ Y n þ YT: In exchange, the North exports

XT units of good X to the South and then consumes xn ¼ Xn2XT: The South, in turn, consumes ys ¼ Y s2YT and

xs ¼ X s þ XT: The pollution level in the North is Pn ¼ 0:00005Y n þ 0:00006YT and in the South, Ps ¼ 0:00006ys: Theutility function in each country is U ¼

ffiffiffiffiffiffixy

p; the first derivatives of the production functions are YL; YK ; XL; XK and XP

and those of the utility function are Ux and Uy: The wage rate in each country is one unit of that country’s currency,

and the competitive market prices of capital, good X and good Y are r; px and py: The Pigouvian tax in each country isT ¼ �pxXP; and the environmental tariff is tn ¼ ðes2enÞTn:


autarky is still inferior to trade for both countries.3 Three environmental control scenarios underfree trade are simulated, and the results, rounded to seven digits, are depicted in Table 1.

5.1. The Pareto optimal solution

The solution in columns (3a) and (3b) in Table 1 satisfies all marginal conditions for a Paretooptimum derived in Section 3. The Pigouvian taxes, competitive market prices and terms of tradethat foster the international Pareto optimum are also listed in columns (3a) and (3b). Theunadjusted producer prices are the inverse of the corresponding marginal products, and theenvironmental tariff is simply (es � en), which equals 0.00001, times the Pigouvian tax, T : Thissolution is derived with a computer search for values of the variables that simultaneously satisfymarginal conditions (10) through (13) above. The optimal level of U s

0 is then used to reformulatethe model as a standard maximization of Un subject to U s

0; as implied by Eq. (8), to reconfirm thatthe original solution is correct.In the Pareto optimal solution in column (3a), the environmental tariff is 0.00601419 per unit of

YT. When the tariff is added to the cost of importing one unit of YT, which is (1/2.992886)(1.047522/1.081889)=0.323512 in its own currency, the gross cost of the North’simport is 0.329526 per unit, which equals its own unadjusted producer cost for manufacturingthat good domestically. The tariff having been paid, all units of good Y that are sold in the Northare taxed at the same domestic base, en ¼ 0:00005; per unit. If the dual-based Pigouvian tax isused instead of the tariff-cum-tax, units of the imported, pollutive good, costing 0.323512 in theNorth’s currency and Pigouvian taxed at (601.419)(0.00006)=0.0360851 per unit of YT, sell for0.359597. This is the same price as the domestically produced substitute, whose correspondingcost components are 0.329526 and 0.0300710. Because the import must be priced the same forconsumers as the domestic good, for it to compete, foreign producers must restrict their output ofthat good (which raises YL and reduces the producer cost of good Y) enough to compensate forthe tariff or for the higher Pigouvian tax per unit of that output sold in the North.

5.2. Non-Pareto optimal solutions

The analysis of columns (3a) and (3b) is based on the assumption that both countries adopt aPigouvian policy. It is useful to compare the Pigouvian solution in columns (3a) and (3b) with thesolution in columns (1a) and (1b) in which neither country taxes emissions, both choosing tofollow a laissez faire policy with respect to pollution control. In that case

Uny

Unx

¼U s

y

U sx

¼Xn

L

YnL

¼X s

L

Y sL

¼X s

K

Y sK

¼Xn

K

YnK

¼XT

YTð18Þ

and only Eq. (10) in Section 3 is satisfied. However, all of the symbols in the first column of thetable have the same straightforward interpretation. Because the marginal rates of substitution in

3The autarky solution for the North can be readily extrapolated from Lny ¼ 682:0119 and Kn

y ¼ 26:33311; the non-Pigouvian or laissez faire autarky solution for the South from Ls

y ¼ 830:7692 and Ksy ¼ 13:63636; and the Pigouvian

autarky solution for the South from Lsy ¼ 814:1532 and K s

y ¼ 13:00883: The Pigouvian autarky solutions satisfy

Eqs. (10) and (11), whereas the non-Pigouvian autarky satisfies Eq. (10) and the equality, ðUy=UxÞ ¼ ðXL=YLÞ:


consumption are equal across countries in columns (1a) and (1b), this is a standard Heckscher–Ohlin–Samuelson solution.A more interesting case than that in columns (1a) and (1b) is the one in columns (2a) and (2b) in

which the North is Pigouvian and the South laissez faire. Developing countries may not be readyto adopt market-based approaches to pollution control [17] or may be worse off if they do,whereas the industrialized country may choose to control pollution unilaterally. The numericalsolution in columns (2a) and (2b) corresponds to the case in [18, p. 951] in which the exportingcountry neither cares about nor acts on the externality, but the importing country does. In thissolution, Eqs. (10) and (13) are satisfied but Eq. (11) is only partially satisfied, because U s

y=U sx ¼

X sL=Y s

L; Eq. (12) is not satisfied at all. However, all three sets of solutions in Table 1 are unique. Ineach case, the value of exports necessarily equals the value of imports in a given country, based oneach country’s producer or adjusted producer prices.The utility level of the North increases from 1905 in column (1a) to 1914 in column (2a) when it

imposes the Pigouvian tax on the emissions of its consumers. The North reaps the benefit ofinternalizing external costs, whether by the tariff-cum-tax or the dual-based Pigouvian tax, andthereby optimizes the level of domestic pollution damage. Further, the activation of the negativeterm, Xn

P [es�en], in Eq. (16), lowers the terms of trade, XT=YT; in the North’s favor because itcan export fewer units of good X per unit of the imported good Y : In contrast, the utility level ofthe South decreases from 1552 in column (1b) to 1545 in column (2b) because of the adverse termsof trade effect of the North’s Pigouvian taxation.Were the South to follow the North’s lead and tax the emissions of its consumers, the domestic

demand for good Y would decline and that for good X increase, thereby reducing the relativeproducer cost of the good it exports and making the South still worse off. In this case, the adverseterms of trade effect of the South’s Pigouvian taxation reduces its utility more than the beneficialinternalization of externalities increases it. Whereas the South’s utility declines from 1545 to 1544in column (3b), the North, benefiting by the further terms of trade effect of the South’s Pigouvianpolicy, enjoys an increase in utility from 1914 to the 1915 in column (3a). Only if the emission rate,es, of the South’s pollutive product were so very high that its own benefits from domesticallyinternalizing external costs exceeded its adverse terms of trade effect, would it also be better offtaxing emissions, as in column (3b), than not taxing, as in column (1b) or (2b).The case in which both countries are better off Pigouvian than laissez faire is simulated in the

numerical model by tripling es from 0.00006 to 0.00020.4 In the absence of a higher emissionrate for es, it might be in the best interests of the North to make a lump-sum transfer to the South,as in the models developed in [19, p. 20, 20], to induce that country to tax its emissions. The factthat the solution in column (3a) and (3b) is Pareto optimal indicates that the North couldshare some of its gain with the South, as by an outright transfer of, say, some of its capital,as in [21], and both countries be better off than in columns (2a) and (2b). Because the South is somuch worse off under autarky in this model than it would be if the North accepted its morepollutive import in trade, it can be assumed, for purposes of analysis, that the South simplyagrees to follow a Pigouvian policy, that in column (3b), if trade is permitted. The solutions in

4The emission factor, es=0.00020, would still be well below the cut-off point, which occurs in this numerical example

between 0.00060 and 0.00070, at which the comparative advantage in the pollutive good shifts from the South to the

North.


columns (2a) and (2b) and (3a) and (3b) are both realistic, and, although only the latter is Paretooptimal, both allocations are fostered by the tariff-cum-subsidy or the dual-based Pigouvian tax.The results in Table 1 indicate that the North is always better off when it adopts a Pigouvianpolicy.

6. Summary and concluding remarks

When a foreign country wishes to export a good that is more polluting in consumption than thedomestically produced substitute, it may encounter an environmental standard in the importingcountry that limits emissions per unit of product and, in effect, bans the import. Such standardsare often denounced by foreign producers as barriers to trade, causing Esty [22, p. 114] to predictthat ‘‘There is no end in sight to ‘trade and environment’ cases’’ brought before the WTO, andthat the number of these cases will continue to rise as ‘‘global economic integration intensifies’’.To the extent that excessively pollutive imports are banned, both countries may be worse off, asillustrated with the numerical simulations in this paper.A better approach by the importing country is to impose a Pigouvian tax on the pollution

content of the good, impartially taxing the domestically produced good and the importedsubstitute on the basis of their respective emission rates. Equivalently, an environmental tariffcould be levied on the excessive pollutant content of the import, so that a uniform Pigouvian taxcould be imposed on all units, domestic or imported, of the pollutive good. Such a Pigouvianapproach would be less restrictive than an outright ban of the excessively pollutive import and,once the idea is understood, should reduce the number of trade disputes.The international environmental problem examined in this paper is one in which an externality

is confined to the country that imports a more pollutive good than the domestically producedsubstitute. In this paper, it is a capital abundant country with strict environmental standards thatimports the pollutive good. A comparable case is examined in an earlier issue of this journal [1],except that it is a capital poor country with weaker environmental standards that imports, thenprocesses and stores toxic wastes. Each model presents a real-world case in which trade has beenopposed.5 In both models, there is more pollution after trade, though less than there would be inthe absence of Pigouvian correctives. Although free trade is bad for the environment—it increasesPn þ Ps in the present model, and it increases Sw; the sum of stored toxic wastes across countries,in [1]—in both models, total production unambiguously increases.6

These are both cases in which consumers deem themselves better off because the consumptionof more goods sufficiently outweighs the decrease in environmental quality [11, p. 35]. It followsfrom the analysis in this paper that environmental standards should not be barriers to trade, and

5In contrast to the case of domestic externalities is that of transfrontier externalities studied by d’Arge [24] This

includes such cases as the importing of shrimp from foreign producers not equipped with devices that protect globally

endangered sea turtles from entrapment [25] and the international trade of a good whose production contributes to

global warming [26,27].6 In the autarky solution detailed in footnote 3, given that both countries are Pigouvian, the sum of pollution levels,

Pn þ Ps ¼ 0:3248371; and the sums of outputs are Y n þ Y s¼5917:823 and X n þ X s ¼ 1955:906: The corresponding

sums in columns (3a) and (3b) of Table 1 are SP ¼ 0:3421763; SY ¼ 6008:992 and SX ¼ 1992:167: From left to right in

Table 1, the sum of pollution levels, SP; decreases from 0.35105, to 0.34400, to 0.34218.


wherever possible, pollution should be controlled by market incentives rather than regulatorystandards.

Acknowledgements

I am grateful to Barnett Parker, the Editor-in-Chief of this Journal, for carefully reading mymanuscript, finding omissions that turned out to be opportunities to expand the scope of thepaper, for asking for clarifications that made me aware that I had not adequately thought throughsome important issues, for prodding me to put my analysis in a larger, more important context,and for his infectious attention to detail that made me aware of a transcribing error that hadpersisted from one draft to the next and would likely not have been caught until the paper wasalready published.

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Environmental standards as barriers to trade