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Is Trade Good or Bad for the Environment? NBER Digest

November 2002

Opponents of globalization claim that international trade harms the environment. They

believe that in open economies a "race to the bottom" in environmental standards will

result from governments' fears that enhanced environmental regulation will hurt their

international competitiveness. In Is Trade Good or Bad for the Environment? Sorting

out the Causality (NBER Working Paper No. 9201), NBER Research Associates Jeffrey

Frankel and Andrew Rose examine the environmental effects of openness to trade in a

statistical cross-section of countries in 1995. They find that the impact of trade on at

least three kinds of air pollution appears to be, if anything, beneficial, not adverse, for a

given level of income. Openness, measured as the ratio of trade to income, appears to

reduce air pollution. The level of statistical significance is high for Sulfur Dioxide (SO2),

and moderate for Particulate Matter and Nitrogen Oxides (NO2).

Correlation need not prove causation. The observed correlation between trade and

pollution could arise in other ways. It is possible that countries that are more

democratic tend to be both more open to trade and more responsive to environmental

concerns. Also, higher levels of income can interact with trade and the environment in

all sorts of ways. This paper tries to disentangle the causality between trade and the

environment by first testing for the effect of openness on the environment while

controlling for income. Then the authors focus on exogenous variation in trade

attributable to geography (for example distance from major trading partners), and on

variation in income per capita attributable to standard growth determinants (for

example population, investment, and education).

How could trade be good for the environment? Trade allows countries to attain more of

what they want, including environmental protection (the authors call this proposition

the gains-from-trade hypothesis). Trade might lead to international pressures to

increase environmental standards, or to beneficial technological and managerial

innovations. Multinational corporations tend to bring clean state-of-the-art production

techniques from higher-standard countries of origin to host countries where such

standards are not yet known. Furthermore, trade economists believe that openness to

trade encourages continual innovation both in technology and in management practice;

such innovation likely will be applied to environmental concerns as well as to pure

economic goals. In other words, Frankel and Rose suggest, environmental improvement

may well accompany globalization.

Even if openness to trade does not raise air pollution worldwide, it may give rise to

"pollution havens": that is, some countries that specialize in dirtier production and

export their products to others who specialize in cleaner production. In this way, the

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geographical distribution of pollution might change, even if the average level did not. In

one version of the pollution haven hypothesis, poorer countries are predicted to have a

"comparative advantage" in pollution. But Frankel and Rose test the proposition that

the combination of being poor and open makes for higher levels of pollution, and they

find no evidence of it at all. Similarly they are able to reject the versions of the pollution

haven hypothesis that say that low-density countries or capital-intensive countries have

a comparative advantage in pollution.

The authors also document for the three measures of air pollution the "Environmental

Kuznets Curve" for the three measures of air pollution. This widely tested relationship

says that growth harms the environment at low levels of income, but helps at high levels.

At higher levels of income per capita, growth stimulates the public's demand for

improving environmental quality, which in democratic societies is brought about

through environmental regulation. Frankel and Rose estimate that SO2 pollution, for

example, peaks at income levels of about $5,770 per capita, and thereafter starts to

decline. All of this squares with economic theories that suggest that growth yields air

and water pollution when industrialization is being introduced, but eventually results in

reduction of reduced pollution as countries become prosperous enough to afford

cleaning up their environments. In other words, production technology inevitably

pollutes, but the rising income that results from this same production technology just as

inevitably increases the demand for environmental quality.

A final finding is also familiar from studies of trade and income: globalization is good for

growth. The authors find that every .01 increase in the ratio of trade to GDP raises

income by 0.4 percent over the following 20 years. The effects of trade that operate via

growth -- worsening pollution at first, and then reducing pollution later -- may be larger

than the effects of trade that operate independently of growth.

In sum, Frankel and Rose find that after an initial adverse effect in the relationship

between growth and environmental damage at low levels of income, a pattern emerges

showing that growth eventually has a beneficial effect on air pollution. Still, the

researchers caution that the results are less consistently positive in regard to broader

measures of environmental quality. Some environmental problems such as emission of

greenhouse gases are truly global and not local, they point out. A "free rider" problem

prevents national governments from translating the demand for environmental

improvement into reality, even when they collectively have the economic means to do

so. Thus the authors are not surprised to find statistically that trade and growth do not

seem to have beneficial effects on emissions of these gases. In such cases, say Frankel

and Rose, international cooperation and not just local regulation is needed.

From NBER