Three essays in trade and the environment

Abstract

This thesis comprises of three papers on various aspects of trade and the environment. The first paper takes a closer look at the interplay of international environmental agreements (IEAs), trade and welfare. It is well known from the literature of strategic environmental policy that governments bound by WTO-rules that preclude direct trade intervention may use environmental policy as a substitute for trade policy. Studying a third-market model with imperfect competition and global emissions, we first show that the strategic rivalry between exporter countries causes a welfare loss for both countries. Such a loss represents a motivation for the countries involved to conclude an IEA that internalizes the external effects. Welfare of the exporter countries increases as a consequence of such an IEA. However, we show that, taking into account the accompanying loss of consumer surplus in third countries, the overall welfare effect might be negative, so that the world as a whole is worse off with than without the IEA. The main conclusions drawn from the first paper are that IEAs are a useful tool to internalize environmental externalities, but that (i) malign welfare effects can arise in the presence of pre-existing distortions such as imperfect competition; (ii) an evaluation of the recent proliferation of regional IEAs has to take into account impacts on non-members; and (iii) regional IEAs may not be a fruitful way of addressing global environmental challenges such as climate change. The second paper analyzes the impact of decisions made by governments that are not strict welfare maximizers on strategic and cooperative environmental policy making. Again we analyze a version of the third-country model of strategic trade policy including pollution and, inspired by the public choice view on governments and bureaucrats, we show that decisions made by policy makers that have incentives diverging from pure welfare maximization can lead to quite distinct outcomes both from a positive as well as from a normative point of view. In particular, we show that even a fully cooperative IEA between governments that maximize tax revenue rather than welfare may lead to a welfare loss for the signatory countries. Furthermore, we demonstrate that tax revenue-maximizing governments may lead to a higher welfare than welfare-maximizing governments, because the former can credibly commit to higher emission tax levels. Finally, a delegation game between governments is used as an illustration to show that the strategic situation between the two exporter countries does not always correspond to the Prisoner’s Dilemma but might be of several other game-theoretic types. These results expose the sensitivity of many of the conclusions from the strategic trade and environmental policy literature to variations of the arguably optimistic assumption that governments are strictly welfare-maximizing. The third paper, which was written jointly with Prof. Frank Krysiak, is an attempt to find strategies of reducing the costs and increasing the effectiveness of unilateral climate policy. As a global climate agreement encompassing all major emitters of GHGs is unlikely to be forthcoming in the near future, but nonetheless some countries such as the EU and Switzerland have decided to pursue reduction targets independently, the question arises as to how such unilateral policies should be optimally designed. For the case of emitting intermediate goods sectors, this question has not been thoroughly addressed in the literature. Using a three-sector general equilibrium model it is shown that, if the production of an intermediate good, such as electricity or transportation services, causes GHG emissions, it can be optimal to (partially) contain the effects of climate policy to that sector. Containment consists of a subsidy or tax on the intermediate good and is a second-best policy in the presence of WTO rules for the cases of carbon leakage and market power; through containment, also climate policy-induced unemployment can be reduced. The results of this paper suggest ways in which countries that wish to be frontrunners could design climate policies that achieve reduction cuts at lower costs and thus also reduce domestic political pressure against unilateral action.