GEP 10/05: Liberalizing Trade in Environmental Goods

Summary

Trade liberalization in environmental goods and services, while making cleaner technologies available and allowing a country to increase its welfare, can paradoxically lead to an increase in pollution.

Abstract

Trade liberalization in environmental goods is high on the agenda of the current Doha round. We examine its effects in a model with one domestic downstream polluting firm and two upstream firms (one domestic, one foreign). The domestic government sets the emission tax rate after the outcome of R&D is known. The upstream firms offer their technologies to the downstream firm at a flat fee. The effect of liberalization on the domestic upstream firm's R&D incentive is ambiguous. Liberalization usually results in cleaner production, which allows the country to reach higher welfare. However this increase in welfare is typically achieved at the expense of the environment (a backfire effect). Thus our results cast doubt on the hoped-for "win-win-win" outcome of trade liberalization in environmental goods.

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Authors

Bouwe R. Dijkstra and Anuj J. Mathew

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