Choosing emission taxes under international price competition

Abstract

The relationship between trade and environmental policies will emerge as a major topic of debate in the next few years. Pollution control and abatement expenditures are likely to affect production costs and prices of many products will increase, especially for those products that involve a relatively pollution intensive production process. The result of an enforcement of the national environmental policy will be the loss in international competitiveness of domestic firms, which might give rise to the introduction of new trade restrictions motivated by international differences in environmental regulation. When pollution problems are global rather than local in nature, then national environmental policy has only a limited influence on the global environmental resources but rather strong local economic impacts resulting in less employment in highly regulated industries. Therefore it is reasonable to expect that governments will act strategically when setting their national environmental policy instruments. Although a tax on the polluting activity equal to the divergence between social and private cost attacks the problem of negative externalities in an efficient way, there is no reason to expect that under imperfect competition, international market share rivalry and transboundary pollution such a tax is equal to Pigou’s marginal damage.