Environmental policy and commercial policy: The strategic use of environmental regulation

Abstract

Using a duopoly model in which one home firm and one foreign firm compete in a third country market, this paper analyses how environmental regulation affects the optimal commercial policy and the strategic use of environmental policy. In particular, this paper reviews the typical outcome that environmental regulation reduces welfare in the absence of commercial policy and that, under environmental regulation, in order to maximise welfare, a stronger commercial policy is required when firms compete in quantities, while when competition is in prices policy should be weaker. The paper also pays attention to the outcome that the strategic use of environmental policy consists of weakening it in the former case and strengthening it in the latter one. The paper makes two contributions. First, it proves that in addition to market structure and firms behaviour, outcomes are sensitive to the way in which environmental regulation is determined. Secondly, considering that environmental regulation is determined by the pressure ability of that sector of society environmentally concerned on the polluting firms, this paper proves that under price competition environmental regulation may be welfare improving in the absence of commercial policy. In such a case, the optimal policy is not necessarily an export tax (the outcome obtain in the literature) but may be an export subsidy or, under certain conditions, free trade. Then, the strategic use of environmental policy doesn't necessarily consist in strengthening that policy, but it may consist in weakening the environmental policy or doesn't change that policy.