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Unformatted text preview: L Karp International Trade December 7, 2005 5 Environmental policy and comparative advantage Stricter environmental policies (e.g. an increase in emissions taxes or a decrease in allow- able emissions) increase the costs of production in sectors that use environmental services. Most (if not all) economic models imply that stricter environmental policies decrease output in environmental-intensive sectors. It might seem from this statement that stricter environmental policies reduce a countrys comparative advantage in environmental-intensive goods, because stricter polices reduce the supply of the dirty good. This chapter explains why that conclusion might be either true or false. The pollution haven hypothesis is based on the idea that weak environmental protection promotes a comparative advantage in environmentally intensive industries. The corollary to this idea is that increased domestic environmental protection risks causing industries that use environmental services intensively to relocate to other countries. The view that stricter environmental standards decrease the comparative advantage of the environment-intensive sector may appear to be obviously true. It is probably based on intuition from a partial equilibrium setting, where factor prices are taken as given. The logic behind the belief is clear in a model with two commodities, where the "dirty sector" creates pollution and the "clean sector" does not, and both sectors have constant returns to scale. In a competitive equilibrium profits in both sectors are zero. In a partial equilibrium model, where factor prices are fixed, a higher pollution tax has no effect on costs in the clean sector, but it raises (tax- inclusive) costs in the dirty sector. Since profits in the dirty sector are initially zero, continued operation of the sector (after the tax increase) requires an offsetting increase in the price of the commodity produced by the dirty sector. Since the price of the dirty good has increased and the price of the clean good has not changed, the relative price of the dirty good has increased. That is, the higher tax reduces the countrys comparative advantage in the dirty good. Although this conclusion may be correct, the reasoning behind it is not valid in a general equilibrium setting, where factor prices adjust. The next section presents elements of the general-equilibrium model in chapter 2 of Copeland and Taylors Trade and the Environment . 106 There, a stricter environmental policy does reduce a countrys comparative advantage in the environmentally intensive sector. The following section discusses Chaus general equilibrium model (Oxford Economic Papers, 55 (2003) pages 25 - 35 "Does tighter environmental policy lead to a comparative advantage in less polluting goods?"). In this setting, the relation between environmental policies and comparative advantage can be ambiguous....
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- Fall '07
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