Cross-Border Externalities and Trade Liberalization: The Strategic Control of Pollution

Abstract

The authors examine international trade in a commodity whose production creates a negative externality for the importing country and they consider the nations' strategic policy choices when they can restrict trade and when they are bound by a free-trade agreement. When pollution-abatement technology is available, the exporting country induces its adoption, despite national indifference to the externality, in order to reduce the tariff. In a free-trade agreement, environmental policy is used to exploit monopoly power in trade. An alternative policy instrument, a process standard, is introduced. National competition in controlling emissions leads to very restrictive antipollution measures. We examine international trade in a commodity whose production creates a negative externality for the importing country; and we consider the nations' strategic policy choices, when they can restrict trade, and when they are bound by a free-trade agreement. When pollution-abatement technology is available, the exporting country induces its adoption, despite national indifference to the externality, in order to reduce the tariff. In a free-trade agreement, environmental policy is used to exploit monopoly power in trade. An alternative policy instrument, a process standard is introduced. National competition in controlling emissions leads to very restrictive anti-pollution measures.