CHAPTER 2 TRADE AND ENVIRONMENT: LINKAGES AND POLICY ISSUES 1.

Introduction The multilateral trading system (MTS) created after the Second World War, after several rounds of trade negotiations culminating in the Uruguay Round, led to the establishment of the World Trade Organization (WTO) on January 1, 1995. The main objective of the WTO is promotion of world trade by gradually reducing tariffs and eliminating non-tariff barriers. The WTO envisages an open equitable and nondiscriminating multilateral trading system. As on February 28, 2005 the WTO had 148 member nations that accounted for 97 percent of the global trade. Even though there is a provision in the General Agreement on Tariffs and Trade (GATT) 1947 Article XX which allows countries to sidestep the normal trading rules to protect human, animal or plant life or health, or to conserve exhaustible resources, interest in environmental issues was awakened only at the time of the UN Conference on Human Development held in Stockholm in 1972. The UN Conference on Environment and Development (UNCED) held at Rio de Janeiro in 1992, particularly the Rio Declaration on Environment and Development, stressed the need for understanding the linkages between trade and environment and translating the Rio principles in terms of trade and environmental policies at national and global levels. The Marrakesh Decision on April 14,1994 identified ten items for discussion on trade and environment. The General Council of the WTO established the Committee on Trade and Environment (CTE) to consider the ten items and report to the WTO Council. Even though the CTE holds the view that there should not be nor needed to be any policy contradiction between upholding and safeguarding an open equitable and non-discriminatory MTS on the one hand and acting for the protection of the environment on the other, there are many contentious issues on the trade and environment debate. Some interesting questions in the debate are: (a) whether trade liberalization is harmful to the environment particularly to the environment in developing countries? (b) What are the implications of cross-country diversity in environmental standards for trade policy? (c) What kind of policy regimes are

needed to handle pollution, which is domestic, and pollution, which involves crossborder transfers or/and global in nature? (d) Is use of trade measures tariff and non-tariffs legitimate in achieving a countrys environmental goals, targets in multilateral environmental agreements? (e) To what extent the MTS is successful in implementing the Rio principle of common but differentiated responsibilities and special provisions in the WTO agreements giving developing and least-developed countries special and differentiated treatment? (f) Does the environmental requirements of some developed countries act as non-tariff barriers for developing countries exports to developed countries? (g) Are the use of environmental measures legitimate in achieving trade policy goals? This chapter considers these questions from the perspective of developing countries, utilizing information available in the literature on trade and environment covering theory, empirical work and policy regimes. The specific issues relating to leather exports, particularly the impacts of environmental requirements abroad on market access and market entry will be considered in Chapter 3. The plan of this chapter is as follows. Section 2 deals with the evolution of the MTS since 1947 focusing on the linkage between trade and environment and the WTOs position on the linkage. Section 3 summarizes theoretical results of the impact of trade liberalization on social welfare, with and without sound environmental policies, when the pollution is domestic. Section 4 is devoted to a critical review of the theoretical, empirical and policy literature dealing with the impact of crosscountry differences in environmental standards on trade patterns, production patterns and environmental quality. It addresses the concerns of both developed countries and developing countries and discusses the problems in cross-country harmonization of the standards. Section 5 considers policy options available for dealing with cross-border environmental externalities. The last section looks at the MTS through the lens of the emerging global public goods literature. 2. Environment in GATT and WTO Trading Regimes1 Evolution till 1992 The main objective of the international trading regime established after the Second World War was trade liberalization. There was no reference to environment in the
1

See Nordstrom and Vaughan (1999) and WTO (2004) for details. 7

general proceedings of the contracting parties.

Only the GATT 1947 Article XX

allows countries to sidestep the normal trading rules, if necessary, to protect human, animal or plant life or health, or to conserve exhaustible natural resources, provided that such measures do not discriminate between sources of imports or constitute disguised protection on international trade. The UN Conference on Human Development held in Stockholm in 1972 awakened interest in environmental issues. The GATT Council established a Group on Environmental Measures and International Trade (EMIT) with a mandate to examine upon request any specific matters relevant to the trade policy aspects of measures to control pollution and protect the human environment, especially with reference to applications of the provisions of the GATT, taking into account the particular problems of developing countries. However, no request was made to convene the EMIT until the beginning of the 1990s. During the Tokyo Round of trade negotiations (1973-79), the question of the degree to which environmental measures (technical regulations and standards) could form obstacles to trade was taken up. An Agreement on Technical Barriers to Trade, known as the standards code, was negotiated. It called for nondiscrimination in the preparation, adoption and application of technical regulations and for their transparency. The issue of exports of domestically prohibited goods (banned on health or environmental grounds) to developing countries was on the GATTs work programme at the 1982 Ministerial meeting. In July 1982, the Council established a Working Group on the Export of Domestically Prohibited Goods and other Hazardous Substances. As no agreement could be reached till July 1991, it was agreed in the Marrakesh Ministerial Decision on Trade and Environment to incorporate this issue into the work programme of the WTO Committee on Trade and Environment. During the Uruguay Round of negotiations (1986-1993), modifications were made in the standards code and some environmental issues were addressed in the General Agreement on Trade in Services, the Agreement on Agriculture, Sanitary and Phyto-sanitory Measures, Subsidies and Countervailing Measures, and Trade Related Intellectual Property Rights.

In the nineties a series of contentious environmentally related disputes arose. See WTO (2004). The UNCED held at Rio de Janeiro in 1992 was an opportunity to activate the EMIT Group. The European Free Trade Association (EFTA) urged the need for studying the linkages between trade policy and environmental policy. It noted that the approach to environmental policy making varied considerably from country to country due to differing geographical settings, economic conditions, stages of development and environmental problems. Accordingly, governments priorities on these problems differed as well. The important point here was that the resulting differences in actual policies could set stage for trade disputes. The GATT Council requested its Chairman to conduct informal consultations to promote a structured debate. The EMIT Group met from November 1991 to January 1994. The Group agreed that there was no policy contradiction between upholding the values of the MTS on the one hand, and acting individually or collectively for the protection of the environment and the acceleration of sustainable development on the other. The UNCED at Rio de Janeiro from June 3 to 14, 1992 was a milestone in working towards international agreements that respect the interests of all and protects the integrity of the global environmental and development system. The Rio Declaration The Rio Declaration on Environment and Development proclaims the followings principles that are relevant for environment policy and trade policy of developing countries: Principle 2: pursuant to States have, in accordance with the Charter of the United Nations and their own environmental and development policies, and the

the principles of international law, the sovereign right to exploit their own resources responsibility to ensure that activities within their jurisdiction or control do not cause damage to the environment of other states or of areas beyond the limits of national jurisdiction. Principle 4: In order to achieve sustainable development, environmental protection

shall constitute an integral part of the development process and cannot be considered in isolation from it.

Principle 6: The special situation and needs of developing countries, particularly the least developed and those most environmentally vulnerable, shall be given special priority. International actions in the field of environment and development should also address the interests and needs of all countries. Principle 7: States shall cooperate in a spirit of global partnership to conserve, protect and restore the health and integrity of the Earths ecosystem. In view of the different contributions to global environmental degradation, States have common but differentiated responsibilities. The developed countries acknowledge the responsibility that they bear in the international pursuit of sustainable development in view of the pressures their societies place on the global environment and of the technologies and financial resources they command. Principle 11: States shall enact environmental legislation. and developmental context to which they apply. other countries, in particular developing countries. Principle 12: States should cooperate to promote a supportive and open international economic system that would lead to economic growth and sustainable development in all countries, to better address the problems of environmental degradation. Trade policy measures for environmental purposes should not Unilateral actions to deal with environmental constitute a means of arbitrary or unjustifiable discrimination or a disguised protection on international trade. challenges outside the jurisdiction of the importing country should be avoided. Environmental measures addressing transboundary or global environmental problems should, as far as possible, be based on international consensus. The Marrakesh Decision At the July 1992 Council meeting, the Director-General noted that Agenda 21 contained a number of recommendations directly relevant to the work of the GATT in the field of trade, environment and sustainable development. The Marrakesh Ministerial Conference decided to adopt a work programme on trade and environment. This led to the adoption, on April 14, 1994, of the Decision on Trade
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Environmental

standards, management objectives and priorities should reflect the environmental Standards applied by some countries may be inappropriate and of unwarranted economic and social cost to

and Environment (Marrakesh Decision). The trade Ministers noted that (a) it should not be contradictory to safeguard the MTS on the one hand, and act for the protection of the environment and the promotion of sustainable development on the other hand, and (b) policies in the field of trade and environment be coordinated, but without exceeding the competence of the MTS, which is limited to trade policies and those trade-related aspects of environment policies which may result in significant trade effects. The Marrakesh Decision lists the following ten items: 1. The relationship between the provisions of the MTS and trade measures for environmental purposes, including those pursuant to multilateral environmental agreements (MEAs), 2. The relationship between environmental policies relevant to trade and environmental measures with significant trade effects and the provisions of the MTS, 3. The relationship between the provisions of the MTS and (a) Charges and taxes for environmental purposes (b) Requirements for environmental purposes relating to products, including standards and technical regulations, packaging, labelling and recycling, 4. The provision of the MTS with respect to the transparency of trade measures used for environmental purposes and environmental measurements and requirements which have significant trade effects, 5. The relationship between the dispute settlement mechanisms in the MTS and those found in MEAs, 6. The effect of environmental measures on market access, especially in relation to developing countries, in particular to the least developed among them, and environmental benefits of removing trade restrictions and distortions, 7. The issue of exports of domestically prohibited goods, 8. Trade-related intellectual property rights (TRIPs), 9. Services, and 10. Appropriate arrangements for relations with non-governmental organizations referred to Article V of the WTO and transparency of documentation.

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Committee on Trade and Environment The General Council of the WTO established the Committee on Trade and Environment (CTE) at its first meeting, held on 31 January 1995. governmental organizations. It reports to the WTOs General Council. The CTE in its report to the Singapore Ministerial Conference in December 1996, noted that there should not be nor needed to be any policy contradiction between upholding and safeguarding an open, equitable and non-discriminatory MTS on the one hand and acting for the protection of the environment on the other. It said that the WTO members were committed not to introduce WTO-inconsistent or protectionist trade restrictions or countervailing measures in an attempt to offset any real or perceived adverse domestic economic or competitiveness effects of applying environmental policies. Governments had the right to establish their national environmental and developmental conditions, needs and priorities. It also noted that it would be inappropriate for them to relax their existing national environmental standards or their enforcement in order to promote their trade. On the issue of the relationship between trade measures in MEAs and the MTS, the Report endorsed and supported multilateral solutions as the best and most effective way for governments to address global and transboundary problems. The Report also summarizes the deliberations of the Committee on the ten items. Multilateral Trade Rules Governing Environmental and Health Requirements WTO Agreement on Technical Barriers to Trade (TBT) The TBT Agreement governs the preparation, adoption and application of product technical requirements, and of procedures used for the assessment of compliance with them. It defines technical regulation a document that lays down product It defines standard a document approved by a characteristics or their related processes and production methods (PPMs) with which compliance is mandatory. recognized body, that provides for common and repeated use, rules, guidelines or characteristics for products or related PPMs, with which compliance is not mandatory. The CTE is composed of all the WTO members and a number of observers from inter-

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The main principles of the TBT Agreement are: (a) non-discrimination, (b) avoidance of unnecessary obstacles to trade, (c) harmonization, (d) equivalence, (e) mutual recognition, and (f) transparency. The non-discrimination principle requires satisfying Most-favoured Nation (MFN) and National Treatment (NT) principles. The WTO members shall ensure that products imported from other member countries shall be accorded treatment no less favourable that accorded to like products of national origin and to like products originating in any other country. Likeness is determined on a case by case using four criteria namely, physical characteristics, tariff classification, consumers tastes and habits, and product end uses. Governments must ensure that technical regulations and standards do not create unnecessary obstacles to trade. The mandatory technical regulations must not be more trade-restrictive than necessary to fulfill legitimate objectives such as national security requirements, protection of human health or safety, protection of animal or plant life or health, protection of the environment and prevention of deceptive practices. The Agreement encourages countries to use international standards developed by International Standardizing Bodies except when inappropriate because of climatic or geographical factors or fundamental technological problems. The equivalence principle recognizes acceptance of other regulations as equivalent even when they differ provided that they fulfill the objectives of their own regulation. Conclusions of mutual recognition arrangements are also encouraged. It provides for transparency via notification of draft technical regulations, conformity assessment procedures and standards, establishment of national enquiry points providing the information and establishment of a panel of technical experts to examine disputes between members. The Agreement contains provisions for developing countries. Article 12 of the

Agreement states that all members shall take into account the special needs of developing countries and avoid creating unnecessary obstacles to exports of special interest to developing countries. Developing member countries shall only use international norms appropriate to their needs and they can be granted specified,
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time-limited exceptions from obligations of the Agreement. terms.

There are also

provisions for technical assistance for developing countries on mutually agreed

The Agreement on the Application of Sanitary and Phyto-sanitary (SPS) Measures These measures relate to human or animal or plant life. Their aim is to ensure that food is free from risks arising from additives, contaminants, toxins or diseasecausing organisms, to prevent the spread of plant, animal or other disease-causing organisms to prevent or control pests. Governments are encouraged to harmonize their SPS requirements i.e. to base them on international standards, but they are entitled to set more stringent national standards in case the relevant international norms do not suit their needs. life or health. However, the SPS measures must be based on scientific justification or on an assessment of the risks to human, animal or plant It recognizes the right of governments to take precautionary provisional measures when scientific evidence is lacking, while seeking further information. As in the TBT Agreement, it contains principles such as equivalence, mutual recognition and transparency. The Doha Ministerial Conference The Doha Ministerial Conference, November 2001, placed trade and environment work at the WTO on two tracks. The CTE Special Session (CTESS) is to deal with the three issues: (i) the relationship between the WTO rules and specific trade obligations set out in MEAs, (ii) on proceedures for information exchange between MEAs and the relevant WTO Committees, and on the criteria for the granting of observer status in the WTO bodies, and (iii) on the reduction or, as appropriate, the elimination of tariff and non-tariff barriers to environmental goods and services. The CTE Regular is to deal with all the items of the Marrakesh Decisions and to give special attention to (i) the effect of environmental measures on market access and the win-win- win situations, (ii) the relevant provisions of the TRIPs Agreement, and (iii) labelling requirements for environmental purposes. The Doha Declaration calls the CTE, together with the Committee on Trade and Development, to act as a forum within which the environmental and developmental aspects of the negotiations can be debated, in order to help achieve the objective of sustainable development.

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The Cancun Ministerial Conference of the WTO held in September 2003 ended in a stalemate. Many developing countries opposed Singapore issues relating to investment, procurement and competition, and demanded time bound elimination of all forms of export subsidies to agricultural products in developed countries. The WTO Framework Agreement, adopted on August 1, 2004 by members of the WTO, has ensured that the negotiations are back on track. As per the Framework Agreement, developing countries are eligible to designate an appropriate number of products as special products based on food and livelihood security or rural development needs as regards tariff reduction formula, the number and treatment of sensitive products, expansion of the tariff quotas and the implementation period. Regarding industrial products under non-agricultural market negotiations, developing countries concerns about reduction of peak tariffs and tariff escalations in products of export to these countries will be addressed. A note prepared by the WTO Secretariat (2004) reports the different perceptions of developed and developing countries as follows: Whilst developed countries were subjected to increased pressure from environmental interest groups to reconcile what they perceived as incompatibles between trade and environment policies, developing countries feared that environmental concerns would be addressed at the expense of international trade. In particular, they feared that a new green The Note conditionality would be attached to market access opportunities. discussions at the WTO: (i) (ii) (iii) (iv) The WTO is not an Environmental Protection Agency, GATT/WTO rules provide significant scope for environmental protection, Increased market access for developing countries, Trade and environment coordination should be enhanced. 3. Trade Liberalization and Welfare Gains For a small country, it is well known that, in the absence of pollution, trade liberalization will result in an increase in social welfare. It can also be shown that trade liberalization in the absence of a sound environmental policy will result in

mentions that the following parameters have guided trade and environment

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decrease in social welfare. Trade liberalization with sound environmental policy will increase welfare. We present the above results using simple models. a. No pollution We use a two-commodity model to illustrate that by opening up the country for foreign trade the country can attain higher welfare. The country is small in the sense that its trade volumes have no effect on the world prices. In Figure 1, the product transformation curve is denoted as TT and a social indifference curve is denoted as S0. In a closed economy, that is, before trade, the production optimum and the consumption optimum are at the point e0 where the marginal rate of transformation in production equals the marginal rate substitution in consumption. The common slope of the TT curve and the S0 curve at e0 indicates the domestic relative price. The slope of the pp line gives the external (world) relative price. A comparison of the slope of the pp line with the common slope at e0 shows that, at e0 the domestic price of y (in terms of x) is cheaper than the external price of y (in terms of x). On the other hand, the domestic price of x (in terms of y) is higher than the external price of x (in terms of y). Hence, the country has a comparative advantage in the production of y. The country can achieve the production optimum, by moving along the TT curve to the point e1 where the slope of TT curve (the marginal rate of transformation between x and y) equals the external price ratio. Then it can achieve the consumption optimum at the point e2 on the social indifference curve, s1, where the slope of the social indifference curve (the marginal rate of substitution between x and y) equals the external price ratio. The social welfare at e2 is higher than at e0. The country exports y1 y2 of good y and imports x2 x1 of good x.

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Figure 1 Trade Liberalization and Welfare Gain: No Pollution y p

T y1 e1

y0 y2

e0

e2 s0 s1 p

x1 b. With Pollution

x0

x2

Suppose production of y generates negative externality in the form of local environmental pollution. With trade liberalization, production of y will increase and hence the volume of pollution. What would be the effect on welfare in the absence of any environment policy. It is possible to carry out the analysis using a general equilibrium model. See for example Bhagwati and Srinivasan (2002). However, we prefer the Marshallian partial equilibrium framework with the welfare criterion of consumers surplus and producers surplus, because it is a convenient apparatus for measuring the external costs and the economic welfare. First, we consider the autarchy case, without and with sound environmental policy. Second, we study the situation after trade liberalization, without and with sound environmental policy.

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Autarchy: without and with environmental policy We consider the case where the production of a commodity causes local pollution. In Figure 2 MCs and MCp represent social and private marginal costs of producing the output. Domestic market demand is given by the curve D. In the absence of environmental policy, the private competitive market outcome corresponds to the point c with output q3 and price p1. The marginal social cost of q3 at e is higher than the market price. The social welfare is, abc minus bce, which also equals abddce. The negative externality can be internalized by levy of a Pigouvian tax (social marginal cost minus private marginal cost). When a tax equals (d-k) is levied and collected, the new equilibrium will be at the point d, with output q2 and price p2. The social welfare corresponding to d is abd, which is greater than the social welfare corresponding to c, by the area of the triangle dce. Trade Liberalization: without and with environmental policy If the world price for the good is pw, there is an export opportunity. The exporting country is assumed to be small in the sense that its volume of export does not affect the world price. output. In the absence of an environmental policy, the private market equilibrium will be at the point f with output q5. The country will be exporting (f-j) The social welfare is given by abfj minus bfh where bfh is the negative With an imposition of a Pigouvian tax equal to (g-l) the externality; or abgj-gfh.

social optimum is at the point g corresponding to output q4. Production and export values corresponding to the social optimum are lower than the ones corresponding to the private optimum, but the social welfare corresponding to the social optimum is higher by the area of the triangle gfh. Hence, in the presence of negative externality in the production of an exportable or /and absence of sustainable management policy for natural resource, trade liberalization will result in deterioration in environmental quality and degradation of natural resources.

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Figure 2 Trade Liberalization, Environmental Policy and Welfare MCH MCs

h

pw p2 p1

i e c

g f l

MCp

D b

q1q2

q3q4

q5

Output

In the above analysis, MCs may be interpreted as the marginal social cost of complying with domestic environmental standards. The choice of standards and their levels are based on an assessment of the domestic trade-offs between environment and development. Both the UNCED and the WTO allow each country to choose its own environmental standards based on their trade-offs between development and environment. Suppose the importing countries prescribe environmental standards that are higher than the ones in the country, then the cost of compliance with the higher standards will be higher. Let the dashed MCH line represent the marginal compliance cost corresponding to the higher standards. The imposition of higher standards results in reductions in the export and the production. It may be observed that the resulting output (q1) is even below the social optimum output under autarchy (q2). The domestic consumer would face a higher price pw and the volume of export will be only i-j. Hence, the country may

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prefer no trade (point d) to a trading regime when importing countries prescribe higher environmental standards. The results corresponding to the different policy regimes are summarized in Table 1. Table 1: TRADE LIBERALIZATION AND ENVIRONMENTAL POLICY: EQUILIBRIUM OUTPUT, PRICE AND SOCIAL WELFARE UNDER ALTERNATIVE POLICY REGIMES Trade Liberalization No With No Domestic Higher environmental environmental environmental environmental standards policy policy policy policy from importers c d f g i q3 p1 abd-dce q2 p2 abd q5 pw abgj-gfh q4 pw abgj q1 pw abij Autarchy

Equilibrium Output Price Social welfare

MCp: private marginal cost MCs: social marginal cost corresponding to domestic standards MCH: marginal cost of meeting higher standards of importers Trade liberalization and stringent environmental standards also provide an opportunity for developing countries to undertake structural reforms, technological upgradation and joint ventures and creation of a policy environment to lower the marginal social costs (rightward shifts of the MCS and MCH curves) and thereby increase production and exports without an increase in pollution. See Porter and Van der Linde (1995). Trade liberalization may result in over exploitation of natural resources in developing countries. Chichilnisky (1994) notes that the south has an apparent comparative advantage in natural resource extraction because natural resources are often managed as common properties with open (free) access regime.

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4. Diversity in Environmental Standards The Rio Principle 11 recognizes diversity in environmental standards across countries and notes that any attempt toward harmonization of the standards may be inappropriate and of unwarranted economic and social cost to other countries, in particular developing countries. The WTO also recognizes diversity in environmental standards and the WTO agreements contain provisions giving developing and least-developing countries special and differential treatment. Diversity in environmental standards across countries can be justified on theoretical grounds. First, the social welfare function that reflects the trade-off between income and environmental quality depends on the stage of economic, social and political development. The Environmental Kuznets Curve postulates that as income goes up environmental quality worsens up to a point after which environmental quality improves. Trade liberalization that results in an increase in income can generate more resources for improving environmental quality. But, apart from an increase in income, institutional and democratic reforms are necessary to articulate peoples preferences for environmental quality and influence the political decision making process. Second, there are large variations in baseline emissions across countries. The factors responsible for these variations include composition of and levels of outputs of various activities, technologies used, types and intensity of energy used, levels of pollution abatement etc. Third, the pollution absorption capacities of regions differ depending on topological conditions, meteorological factors and existing pollution loads. Despite the theoretical case for cross-country diversity in environmental standards and its acceptance by the global community, there is a debate on the outcomes when high standard and low standard countries engage in free trade. Developed countries are concerned about industry flight, a tendency towards a race-to-thebottom in environmental standards, unfair trade and export competitiveness. The developed countries responses to these perceived or real threats are demands for harmonization of the standards, import ban on products coming from countries with low environmental standards, levy of countervailing duty on imports from low standards countries because the trade is unfair and use of non-tariff barriers such as ecolabelling, tighter environmental requirements on products, processes and

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methods, life cycle assessment and so on. The developing (low standard) countries view these responses as a new form of protection. They consider the contemplated measures as WTO-inconsistent and contrary to the special provisions for developing countries agreed upon in the UNCED and the WTO. Trade Patterns and Pollution Havens Grossman and Kruger (1991) study on North American Free Trade Agreements (NAFTAs) environmental effects uses a general equilibrium framework and decomposes the environmental impact of trade into three interacting elements a composition effect, a scale effect, and a technique effect. The composition effect arises from trade-induced specialization. The net effect on the local environment will be positive if the expanding sectors are less polluting on average than the contracting importcompeting sectors, and negative if the opposite holds. For a given composition of production and given pollution coefficients, enhanced economic activity will increase pollution (the scale effect). They name the incomeinduced reduction in pollution per unit of output as the technique effect. This effect assumes that the willingness to pay for goods produced with higher environmental standards increases with income. They conclude that the combined net effect is uncertain. Copeland and Taylor (1994) consider the effect of trade liberalization on environmental quality in the North (developed countries) and in the South (developing countries). They find that (a) the composition effect mitigates pollution in the North and magnifies in the South, (b) the scale effect is bad for environment in the North and in the South, and (c) the technique effect reduces pollution in the North and increases pollution in the South. South. Sorsa (1994) finds that the industrialized countries share of manufacturing exports in world trade declined from 91 percent in 1970 to 81 percent in 1990, but most of the decline was recorded in labour-intensive sectors such as textiles, apparel, footwear and other light manufacturing, in which comparative advantages have drifted to developing countries with lower labour costs. In contrast, developed Therefore, trade liberalization will mitigate local environmental problems in the North but magnify the problems in the

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countries share of world trade in environmentally sensitive sectors, which are capital-intensive remains unchanged. Using world trade data for the years 1965 and 1988, Low and Yeats (1992) find that developing countries had increased their share of world trade in polluting industries from 22 to 26 percent. But the World Bank (1998) data on net exports of pollution intensive industries for 1986 and 1995 give a different result. The export-import ratio in pollution-intensive goods is small (around 0.3) for low-income countries, a little higher but less than 1 for middle -income countries but above 1 for high income countries. The results show that the developing countries, with a few exceptions, do not specialize in highly polluting industries; rather they import more pollution-intensive goods than they export. Based on a survey of international and domestic evidence on environmental regulations and industry location, Levinson (1996) concludes that environmental regulations have not affected inter-jurisdictional trade or the location decisions of manufacturers. Using the dataset of annual trade flows of environmentally sensitive goods disaggregated at the four-digit level of the Standard International Trade Classification (SITC) from 1965 to 1995 for 34 reporter countries, Xu (2000) finds no systematic changes in trade patterns of environmentally sensitive goods between 1965 to 1995, despite the introduction of more stringent environmental regulations in most of the developed countries in the 1970s and 1980s. It must be noted that most of the empirical studies suffer from one or more of the following limitations namely, assumptions of constant returns to scale and same pollution intensities across countries in each industry in input-output based models, use of pollution intensities based on the US data and high level of aggregation. By concentrating on pollution intensities, some of these studies do not recognize differences in pollution abatement levels among countries. It is possible that an industry may be highly polluting but if it undertakes abatement upto the level of prescribed standard, there is no harm to the environment. What matters is the share of environmental compliance cost in the total cost and whether or not the compliance cost erodes the comparative advantage. Most of the studies are carried out at 2 digit or 3 digit industrial classifications. In many industries environmental

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pollution occurs only in certain stages of processing. trade policy intervention by States.

Also these studies ignore

Studies on foreign direct investment flows also do not provide support to the hypothesis that stricter environmental standards encourage migration of polluting industries from countries with high environmental standards to those with low standards. Nordstrom and Vaughan (1999) identify the restraining factors that prevent the migration of polluting industries. These factors are: (a) pressure from local communities in developing countries to clean up their act, (b) effort by foreign firms to safeguard their reputation, to avoid consumer boycotts in environmentally conscious markets, and to reduce the risk of legal liabilities, (c) multinationals base their technology decisions not only on the current regulatory framework, but on what they expect in the future, and (d) rapid adoption of voluntary environmental managements promulgated by the International Standardization Organization (ISO) e.g., ISO 14,000. Neumayer (2000) mentions a few other factors that make Migration itself is costly because of Factors other than migration difficult. Some dirty industries cannot migrate when they are dependent on being close to their product markets. dismantling, transportation, and new establishment costs.

differences in environmental costs are likely to be much more important in determining investment location decisions, e.g. poor infrastructure, trained labour force, proximity to natural resources, and tax incentives. Race-to-the-bottom and regulatory chill Critics of stringent environmental regulations argue that different jurisdictions compete to attract international business by lowering their standards below socially efficient levels. A race-to-the-bottom may occur if the industrial lobby has the upper hand over the green lobby. On the other hand, a race-to-the-top is likely to bid up standards in a race to prevent the pollution from locating in their territory the not-in-my-backyard (NIMBY) phenomenon. Presenting a synthesis of the theoretical findings, Nordstrom and Vaughan (1999) note that race-to-the-bottom is likely when capital is mobile and (a) there is access only to distortionary policy instruments and high unemployment or polluting industries more profitable than clean industries, (b) there is transboundary/global

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pollution and, (c) there is industrial capture of the political process. Race-to-thetop is likely when capital is mobile and (a) polluting and clean industries are equally profitable, and (b) greens capture the political access. The empirical evidence for regulatory chill is of anecdotal nature. In political

debates over new environmental regulations or tightening enforcement of existing regulations, competitive concerns are raised both in developed and developing countries. The reluctance of the United States to sign the Kyoto Protocol is due to the likely adverse impact of an increase in energy price on the countrys growth prospects. Competitiveness Concerns The basic argument underlying the pollution haven, race-to-the-bottom and regulatory chill hypotheses is that stricter environmental regulation will increase the environmental compliance costs of the firms and thereby erode their competitive advantages. As pointed out by Nordstrom and Vaughan, comparison of compliance costs with different national environmental regulations is seriously hampered by lack of data. Even for the US, the data are at the two digit level and more than ten years old. Pollution abatement operating costs as percent value of shipment for different industries in 1993 varied from 0.12 to 1.93. They cite a study prepared by the Organization for Economic Cooperation and Development in 1997, which gives pollution abatement costs between 1to5 percent of production costs. The overwhelming share of production costs is determined by other factors, such as wages, payroll taxes, capital costs, import tariffs on intermediate inputs, corporate taxes and so on. The US data on pollution intensities and abatement cost as percent of production cost cannot be transplanted for application in developing countries. The reasons are differences in technologies, scale of operations, and more importantly differences in environmental standards. The pollution abatement costs given above are average values at the industry level. For compliance or non-compliance what is relevant is the marginal abatement cost of achieving the specified standard. For a discussion on the measurement and estimation problems, see Sankar (2001b), Chapter 14.

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Porter and Van der Linde (1995) argue that the environmentcompetitiveness debate has been framed incorrectly. The notion of an inevitable struggle between ecology and the economy grows out of a static view of environmental regulation, in which technology, products, processes and customer needs are all fixed, (p.97). According to them, competitive advantage rests on the capacity for innovation and improvement that shift the constraint (p.98). Environmental Diversity and Free Trade Bhagwati and Srinivasan (2002) discuss the issue Does environmental diversity detract from the case for free trade?. They consider the following four objections to diversity of standards. First, diversity of standards is tantamount to lack of level playing fields and therefore amounts to unfair trade. Their response to this objection is: the fact that others abroad do not carry the same burden is symmetric with the fact these countries have different wages, capital costs, skills, infrastructure, weather, and what have you: all of which lead to differential advantages of production and trade competitiveness. Diversity of environmental tax burdens is thus no ground for complaints of unfairness (p.75). They argue that attributing competitive disadvantage to differential pollution tax burdens in the fashion of cross country inter-industry comparisons for individual industries confuse absolute with comparative advantage. The second objection is that if free trade occurs with countries having lower environmental standards, the effect will be to lower their own standards. This argument is related to a race-to-the-bottom argument. They note that independent governments (or jurisdictions), setting public policy for environmental protection (via taxes and abatement) and competing for investment by reducing environmental standards in a world of mobile and scarce capital, will set these standards at levels that are too low, that is, that are inefficient for the world economy . We have non-Pareto optimal CournotNash equilibriacharacterized by lower environmental standards than in the cooperative equilibrium (p.76). They find weak empirical evidence in favour of interjurisdictional mobility in response to cross-country interindustry differences in environmental standards.

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The third objection is about the compatibility of ethical preferences and free trade among trading nations who do not share the same ethical preferences. Bhagwati and Srinivasan argue that the values sought to be imposed are lesser values and culture-bound. They note that there are alternative ways in which ones values can be propagated than via unilateral suspense of trade access. The fourth objection is that the GATT procedures that enable low standards act as a threat to the high standards. The GATT rules place no constraints on a countrys right to protect its own environment against damage from either domestic production or the consumption of domestically produced or imported products. Bhagwati and Srinivasan throw lights on three issues: the intention issue, the scientific test issue and the circumventing-democracy issue. Neumayer (2000) observes that the dispute settlement system of the WTO favours trade interests over environmental protection. In all four decisions (Canadas export prohibition of unprocessed salmon and herring, Thailands levy of higher taxes on imported as opposed to domestically produced cigarettes, US measures on automobiles and US regulation of fuels and fuel additives), the dispute panel of the WTO has stressed that it did not decide against the protection of the domestic environment but merely against the intended or unintended effects of domestic regulation on imports from trading partners. In all cases, the panel has suggested ways to protect the domestic environment without interfering with the trading rights of foreign countries. Developed Countries Proposals When Harmonization Does Not Occur The proposals currently in vogue to deal with the problem of imports coming from countries with lower environmental standards are (i) ban on the imports, (ii) ecodumping duties on the imports, and (iii) imposition of mandatory and nonmandatory environmental requirements for market access to the imports. Import ban is allowed in certain multilateral environmental agreements to achieve specified environmental goals. Regarding eco-dumping and levy of countervailing duties, Bhagawati and

Srinivasan argue that antidumping actions are selective: they can target down to the level of the firm, not just a specific foreign country! Besides, compared to tariffs,
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they are also elastic: the duties will be set at rates that are decided during litigation and therefore are a function of litigation expenditure, impartiality of the procedures governing the litigation, and the bilateral game played between the complainants and their targets. Further, in playing the game, the rules are set in favour of litigants, relative to what the rules would be if the objective of antidumping actions were truly to avoid economically defined predation. In particular, the usual game of reconstructing the true costs, against which prices charged are compared to determine dumping margins, has been played to the hilt to get these margins to be as high as possible in litigation The eco-dumping margins would have to be necessarily estimated on the basis of reconstructed costs of meeting the pollution standards of the complainant country (p.80). Environmental requirements have the potential of being turned into non-tariff barriers. The environmental requirements with potential effects on market access include regulations, standards, labelling requirements, packaging requirements, and certain SPS measures. Regulations and standards refer to product content, recycled content, energy efficiency, degradability and product characteristics. Many of them require proof of compliance through conformity assessment, including certification. Some countries emphasize integrated product policies and producer responsibility, based on instruments such as take-back obligations, non-regulatory measures (including information-based requirements and self-regulation) and lifecycle analysis. See UNCTAD Note (2004). The private sector and NGOs are also using voluntary standards, codes and benchmarks often as part of corporate social responsibility or risk management initiatives. The UNCTAD Note points out that the ability to enter a market is a function of both the competitiveness of the export (determined by the relative cost and quality of the product) and the characteristics of the supply chain and the structure of the markets. The exporting countries can do by themselves to improve the competitiveness of the exports, but market exigencies (including voluntary environmental requirements and codes) and the characteristics of supply chain are to a large extent exogenous to the developing country exports.

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Eco-labels inform consumers that a labelled product is environment-friendly. It is preferred to non-tariff barriers, if it is voluntary, participatory, market-based and transparent. However, eco-labelling could be misused for the protection of domestic markets. Some common complaints about the eco-labels in developed countries are that (a) the labelling criteria tend to focus on the resource endowments and technologies available in developed countries, and their environmental concerns, and (b) poor participation by developing countries at the design stage and also insufficient time to adjust their production plans to meet the labelling requirements. See WTO (2004), and Nohani and Ghosh (2000). A thorny issue in the eco-labelling debate is about the use of criteria linked to PPMs, see WTO (2004). The WTOs position is that countries have the right to set criteria for the way products are produced, if a production method leaves a trace in the final product (e.g., fruit grown using a chemical pesticides, with there being pesticide residue in the fruit itself). However, measures based on unincorporated PPMs or non-product related PPMs i.e., PPMs which have no trace in the final product e.g. fruits grown using a chemical pesticide with there being no trace of the pesticide in the fruit are considered WTO-inconsistent. Developing Countries Concerns Many developing countries find that the environmental requirements with potential market access effects are proliferating and becoming more stringent and complex. They are also concerned that some of the standards fixed by some European countries are higher than the international standards. capacity constraints and structural problems. These countries face The See UNCTAD Note (2004).

capacity constraints include difficulties in identifying the relevant requirements, implementing the necessary technical, institutional and procedural changes, and demonstrating compliance in a creditable way. The structural problems identified are lack of awareness and management of information, poor institutional capacity, weak infrastructure, dominance of small and medium industries (SMEs) in the export sector, lack of finance, and insufficient access to technology. The UNCTAD Note suggests the following approaches to overcome the problems faced by developing countries: (a) active participation in pre-regulation and pre-

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standard setting consultations, (b) harmonization and equivalence, (c) proactive adjustment policies in developing countries, and (d) technical assistance to and capacity-building in developing countries. It proposes a Consultative Task Force on Environmental Requirements and Market Access for Developing Countries. We consider the market access and market entry problems, the capacity constraints and structural problems, the technical support and financial assistance available from developed countries, and the adjustment policies in responses to the external factors with respect to the exports of leather and leather products from developing countries to the developed countries, in later chapters, 3, 5 and 7. 5. Environmental Problems with Transborder Externalities We consider two cases. The first case is one where economic activity in one country creates negative externality in another country. The popular example is thermal power generation in the northern states of the United States causing acid rain in the southern states of Canada. In case of merchandise trade, the export of a good by one country may cause environmental problem in another country in the form of pesticide content or traces of certain banned items or non-biodegradability or nonrecyclability of used product or/and packaging materials. The GATT Article XX and the TBT Agreement in the WTO permit countries to use regulations and standards to solve environmental problems, provided the methods used do not violate the WTOs basic principles of MFN and NT. At the same time the developed countries have to take into consideration the special problems of developing and least developing countries. An alternative to trade measure is technical support and financial assistance to developing countries to enable them to attain the prescribed environmental standards of the developed countries. When an environmental problem is truly global e.g., emission of green houses, depletion of ozone layer, loss of biodiversity, collective action at the global level is needed to reach a cooperative binding solution. Agenda 21 stresses that environmental measures addressing global environmental problems should, as far as possible, be based on international consensus. At the end of 2004, there were 238 multilateral environmental agreements (MEAs) in force. About 30 MEAs contain trade measures to achieve goals of the MEAs. The main trade measures

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within the MEAs are trade ban, export/import license, and negotiation, packaging and labelling requirements. A possible conflict between the trade measures contained in a MEA and WTO rules could be the violation by a MEA of the WTOs non-discrimination principle. Such a violation could take place when a MEA allows trade between its parties in a specific item, but bans trade in the very same item with the non-parties. This policy is in violation of the WTOs MFN clause, which requires countries to grant equivalent treatment to like imported products. When one of the trading partners has not signed a MEA, it can bring the matter to the WTO Dispute Settlement Agency. Even though no dispute has come to the WTO regarding the trade provisions contained in MEAs, the WTO must be prepared for it when such a dispute is referred to it in the future. The Doha Ministerial Declaration [31(i)] asks the CTE to clarify the relationship between the WTO rules and MEAs, with respect to those MEAs, which contain specific trade obligations. partners to an MEA. While recognizing the problems of non-compliance by members of a MEA and freeriding by the non-members and the need for the trade sanctions to secure and enforce automatic compliance, Bhagwati and Srinivasan argue that such an agreement itself has to be legitimate in the eyes of those accused of free riding or non-compliance (p.98). The Rio Principle of common but differentiated responsibility recognizes the greater responsibilities of developed countries compared with the developing countries, because of their large contribution to current environmental problems, their access to environmentally sustainable technologies and ability to bear the financial burden. 6. Concluding Remarks Creation of the WTO on January 1, 1995 was a milestone in the evolution of the MTS for trade liberalization and promotion of world trade. The WTO is a democratic, transparent and rule-based organization with special provisions for developing and least developed countries.
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However, the outcome of those negotiations must be

limited to the applicability of WTO rules to conflicts between WTO members who are

Inclusion of environment in world trade agenda has created some tensions. The WTOs position is that the WTO is primarily a multilateral agency for promotion of world trade and it is not an environmental protection agency. But some developed countries who prefer high environmental standards, particularly green activists, feel that harmonization of environmental standards across countries is necessary to maintain their environmental standards, and if harmonization is not feasible, they must have the freedom to use trade measures to achieve their goals. Trade theorists argue that the WTO should not be burdened with environmental issues and trade measures are not the first best instruments to solve environmental problems. Developing countries view any attempt at harmonization of environmental standards and use of regulations and standards when harmonization does not occur as neo-protectionism. fulfilled. They complain that some of the promises made by developed countries at the UNCED and in the WTO Agreements have not been Compared with the expectation of 0.97 percent of GDP of developed countries in the form of Official Development Assistance, the actual level is now only 0.40 percent. Even with regard to the bound rates, compared with the average bound rates for all products of 3.9 percent in the USA and 4.1 percent in the European Union, the actual bound rates in sectors such as textiles and leather, which are of interest to developing countries, are much higher. As mentioned earlier, many developing countries face capacity constraints both at the participation stage when the regulations and standards are designed in developed countries and in coping up with the regulations and standards in the form of testing/certification. The problems are serious in sectors of export interest like textiles and clothing, leather and leather products, agricultural products and meat. Most production units in these sectors are small and some of them are in the unorganized sector. They face infrastructural problems and high transactions costs in complying with the importing countries requirements. What is needed is assistance from the developed countries in the form of transfer of environmentfriendly technologies at concessional rates and financial support towards capacity

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building efforts to enable developing countries to participate more effectively in the MTS. MTS can be made a global public good if equity considerations, Rio principles and the commitments for developing countries incorporated in the WTO Agreements are translated into reality. The WTO can become a global public good only when it meets three conditions - publicness in consumption, publicness in decision making and publicness in distribution of net benefit. See Mendoza (2003). Rodrik (2004) presents a case for making the trade regime work for development. He says that the WTO rules must recognize that poor countries need the space within which they can pursue development policies. This policy space would accept institutional diversity and the right of countries to erect and protect their own institutional arrangements so long as they do not seek to impose on others. He favours the introduction of a development box in the MTS so that in trade negotiations more emphasis could be given to developmental concerns than simply maximizing trade.

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ACRONYMS CTE CTESS EFTA EMIT GATT ISO MEA MTS NAFTA NIMBY PPM SPS TBT TRIPS UNCED UNCTAD USA WTO Committee on Trade and Environment CTE Special Session European Free Trade Association Group on Environmental Measures and International Trade General Agreement on Tariffs and Trade International Standards Organization Multilateral Environmental Agreement Multilateral Trading System North American Free Trade Agreement Not-in-my-backyard Processes and Production Methods Sanitary and Phyto-sanitary Technical Barriers to Trade Trade Related Aspects of Intellectual Property Rights United Nations Conference on Environment and Development United Nations Conference on Trade and Development United States of America World Trade Organization

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REFERENCES Bhagwati, J. and T.N. Srinivasan (2002), Trade and the Environment: Does Environmental Diversity Detract from the Case for Free Trade in K. Anderson and B. Hoekman (eds.), The Global Trading System, I.B. Tauris & Co., London. Chichilnisky, G. (1994), North-South Trade and the Global Environment, American Economic Review, September, 851-74. Copeland, B. and S. Taylor (1994), North-South Trade and the Environment, Quarterly Journal of Economics, August, 755-87. Copeland, Brian, R. and M. Scott Taylor (2003), Trade and Environment, Theory and Evidence, Princeton University Press, Princeton. Grossman, G.M. and A.B. Krueger (1993), Environmental Impacts of a North American Free Trade Agreement, MIT Press, Cambridge, Massachusetts. Levinson (1996), Environmental Regulations and Industry Location: International and Domestic Evidence, in J. Bhagwati and R. Hudes (eds.), Fair Trade and Harmonization, MIT Press, Cambridge. Low and Yeats (1992), Do Dirty Industries Migrate? in P. Low (ed.) International Trade and the Environment, World Bank Discussion Paper 159, The World Bank, Washington D.C. Neumayer, Eric (2000), Pollution Havens: An Analysis of Policy Options for Dealing with an Elusive Phenomenon, Journal of Environment and Development, Vol.10, No.2, June, 147-77. Nohani, B.N. and P. Ghosh (2000), Ecolabelling: Developing Country Apprehensions, Environment and Development Economics, 5, 506-10. Nordstrom and Scott Vaughan (1999), Trade and Environment A WTO Study, http://www.wto.org/english/tratop_e/envir_e/environment.pdf , Downloaded on October 10, 2003. Porter, M.E. and C.Van der Linde (1995), Towards a New Conception of the Environment-Competitiveness Relationship, Journal of Economic Perspectives, 9(4), 97-118. Sankar, U. (2001) Environmental Economics, Reader in Economics, Oxford University Press, New Delhi, Paperback fourth impression 2004. Sorsa, P. (1994), Competitiveness and Environmental Standards, Policy Working Paper No.1249, the World Bank, Washington, D.C.

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United Nations Conference on Environment and Development (UNCED) (1992), Rio Declaration and Agenda 21, Rio de Janeiro United Nations Conference on Trade and Development (UNCTAD) (2004), Environmental Requirements and Market Access for Developing Countries, http://ro.unctad.org/trade_env/test1/meetings/rio/TD_X1_BP_1.pdf Downloaded on November 10, 2004.

World Bank (1998), World Development Indicators, Washington, D.C. World Trade Organization (WTO) Environment, Geneva. (2004), Secretariat Note on Trade and

XU, Xinpeng (2000), International Trade and Environmental Regulation: Time Series Evidence and Cross Section Test, Environmental and Resource Economics, Vol.17, 233-57.

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