Global Relative Prices in the Face of a Pollution Transfer Problem

John Dogbey

doi:10.4236/tel.2012.25102

Abstract

This study focuses on the relationship between trade and relative prices of pollution intensive goods. Seminal to this idea is the transfer problem. It is based on the idea that environmental quality of two countries that engage in trade could be affected and this could also have possible environmental quality transfer effects in a third country (geographic neighbors or trade partners) and a result, terms of trade effects. The paper makes the case that whether the relative price of a pollutant would suffer during trade will depend on the kind of pollutant it is, distance between the countries involved, countries’ marginal propensity to consume and substitutability of the good. The nature of the pollutant (whether it is spatially separable in production and or consumption) determines whether it can spillover to trade neighbors or whether it is transferable to a trade partner with ramifications to its relative price. The paper uses indirect utility functions and compensated demand functions to analyze the terms of trade effects.

Highlights

The debate on the role of trade in environmental pollution has attracted a lot of attention in recent years
It is based on the idea that environmental quality of two countries that engage in trade could be affected and this could have possible environmental quality transfer effects in a third country and a result, terms of trade effects
The nature of the pollutant determines whether it can spillover to trade neighbors or whether it is transferable to a trade partner with ramifications to its relative price

Summary

Introduction

The debate on the role of trade in environmental pollution has attracted a lot of attention in recent years. The environmental impacts of trade policies as well the trade impacts of environmental policies have been investigated These researchers find that trade liberalization may increase specialization in sectors that cause little pollution. These studies include Grossman and Krueger [1], and Huang and Labys [2]. This paper attempts to fill the gap by providing a comparative statistics analysis to examine what happens to relative prices during trade when the good in question is a pollutant. It establishes a relationship between pollution, trade, welfare and relative prices.

The General Model

Case 1

Case 2

Case 3

Comparing Results for All Cases

Concluding Remarks