Explaining the direction of emissions embodied in trade from hypotheses based on country rankings

Abstract

We examine theories that take environmental aspects into account to explain exports and imports. They use a ranking of countries and the typical prediction in the case of bilateral trade is that the higher-ranked country (of the two) gains from extra trade whilst the lower-ranked country loses. Gains and losses are expressed in terms of the net emissions embodied in trade. The two best-known theories are the Pollution Haven Hypothesis (PHH) and the Factor Endowment Hypothesis (FEH). Using data for 40 countries (or regions), we have a set of 780 country-pairs. Only 32% of the predictions with PHH and 37% of the predictions with FEH turn out to be correct. Our next step is to start at the other end and ask which ranking of countries would have had the most correct predictions. It turns out that the success rate of the optimal ranking of countries is only 61%. The implication is that even the optimal ranking (or theory) performs poorly.