International Trade - Theory and Policy, 2010a

noneconomists, providing permits that allow pollution seems anathema. However, because these
programs attempt to correct for problems related to the measurement of environmental costs, they may
be even more efficient even than using domestic taxes.
In the end, we must recognize that our theoretical analysis can only suggest the possibility that trade
liberalization will make a country worse off due to increases in pollution. The model shows that this is
logically possible. However, the model also shows it is logically possible for trade liberalization to raise
national welfare despite increases in pollution. It then becomes an empirical question of what the effect of
trade liberalization will be. For this reason, many environmental groups, such as Sierra Club, have
proposed that an environmental impact statement (EIS) be prepared for every trade agreement. An EIS
would assess the environmental costs of the agreement and thereby make environmental concerns a
criterion in the decision process. Presumably, these studies could prevent environmentally unfriendly
trade agreements from being ratified.
Many proponents of freer trade have objected to this proposal. Jagdish Bhagwati, for one, in his book In
Defense of Globalization, suggests that the ability to measure the environmental costs may be as difficult as,
or perhaps more difficult than, measuring the economic effects of a trade agreement.
KEY TAKEAWAYS
Environmental problems generally correspond to negative production or consumption externalities. Thus
these issues represent market imperfections.
This section presents a model in which domestic consumption of an import good causes environmental
pollution (e.g., gasoline consumption). This is the case of a negative consumption externality.
The model is used to show that trade liberalization may cause a reduction in national welfare if the
additional pollution caused by increased consumption is greater than the efficiency benefits that arise
from freer trade. Thus concerns that trade liberalization may cause environmental damage are consistent
with economic theory.
However, the theory of the second best suggests that when market imperfections exist, trade policy
corrections may be second-best, not first-best, policy choices.
Both an import tariff and a domestic consumption tax will reduce domestic consumption of the import
good and lead to a reduction in pollution. However, the domestic consumption tax achieves the result at a
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