Trade and the Environment

1. Trade and the Environment Jeffrey Frankel Harpel Professor Harvard Kennedy School Thinking Ahead on International Trade Geneva,June18, 2009

2. The anti-globalization movement • Ten years ago some protestors at the Seattle WTO Ministerial meeting, launching the first of the big anti-globalization demonstrations, wore turtle costumes. • Why? • They felt that a WTO panel had, in the name of free trade, negated the ability of the US to protect sea turtles, • simultaneously undermining national sovereignty & • the international environment.

3. Central questions • Is trade good or bad for the environment? • Does globalization help or hurt in achieving the best tradeoff between environmental and economic goals? • Do international trade & investment allow countries to achieve more economic growth for any given level of environmental quality? • Or do they damage environmental quality for any given rate of economic growth? • Do the WTO & environment conflict? • How can globalization best be harnessed?

4. Symmetric fears Free traders fear that talk of environmental protection will be used as an excuse by some industries to gain protection for themselves against competition from abroad. Environmentalists fear that talk of free trade will be used as an excuse to give inadequate weight to environmental goals and excessive weight to GDP.

5. Widely agreed: openness to trade & other international activity is good for economic growth • In theory: classical comparative advantage (e.g., Ricardo) & more modern theories of trade based on imperfect competition (e.g., Krugman). • Empirically: many studies. • E.g., one estimate: every .01 increase in a country’s trade/GDP ratio raises income 3 ½ % (over next 20 yrs) -- Frankel-Romer

6. But what about effect of opennesson environmental quality,which is not capturedin GDP statistics?

7. Is trade itself good or badfor the environment? There are many possible effects of trade. They can be categorized according to Whether they (i) operate via GDP, just like investment, technology, or other sources of economic growth, or (ii) are peculiar to trade alone, and hold for a given level of GDP. Within each category, there are effects both beneficial for the environment, and detrimental.

8. Is growth per se good or bad for the environment? Environmentaldamage • EnvironmentalKuznets Curve:Grossman and Krueger (1995) Economic growth (whether trade-led or not) is good for the environment above a peak level of income. • EKC is confirmed for some pollution measures, e.g., SO2, • But generally rejected for CO2 . • Democracy matters too => need effective national regulation, not just demand for clean environment.

9. Is trade itself good or badfor the environment, in theory?

10. RACE TO THEBOTTOM The impossible trinity of global environmental regulation Protectionism National sovereignty Environmental standards Unregulated emissions Multilateral governance Globalization

11. Some examples of trade helping environment • Imports of environmentally friendly products (fuel-efficient autos, sugar-based ethanol…) • Trade brings technological innovation, which can, for example, save energy. • MNCs bring global standards to where the local alternative is environmentally less friendly. • Consumers can express enviro preferences via buying habits, e.g. “dolphin-free” labeling on tuna achieved its purpose. • Multilateral agreements • Potential for trade sanctions, as in Montreal Protocol on ozone depletion • Kyoto Protocol • International trade in emissions permits: a win-win feature • Russia ratified as quid pro quo for EU supporting its WTO accession.

12. Which tend to dominate in practice: • The effects of trade that are detrimental to the environment (e.g., race to the bottom)? • Or the effects of trade that are beneficial (e.g., US imports of fuel-efficient autos)? • It depends on what measure of environmental quality is at stake.

13. SO2 concentrations tend to fall with openness,especially after controlling for democracy, cross-country Low-democracy High-democracy = Trade/GDP

14. CO2 emissions/cap tend, if anything,to rise with openness

15. But these rough correlations tell us little. • To isolate the effect of trade on a country’s environment, we need to control for other determinants, such as • income • democracy • population density. • Econometric analysis • Frankel and Rose, 2004

16. Environmental quality equationSource: Frankel & Rose, R.Ec.& Stats., 2004 IV for GDP/cap: investment, education… IV for openness: geographically-based prediction of trade

17. Is trade itself good or badfor the environment, statistically?Source: Frankel and Rose, R.Ec.& Stats., 2004

18. Do harmful or beneficial effects of trade dominate for environmental goals? Bottom lines: For SO2 at low incomes, harmful effects (EKC) work against beneficial effects at high levels of income, trade helps through both channels. For CO2 Even at high levels of income, trade continues to hurt. <= Absent an effective multilateral treaty, the popular will cannot be enacted.

19. I have now updated this econometric analysis • in a 2009 paper for the Swedish Globalisation Council -- putting together data for 1990-2004, • for 158 countries. • EKC (the inverted U) shows up for PM10 , and water pollution. • Trade still appears to worsen CO2. • Again, the obvious explanation: the lack of a comprehensive global climate agreement.

20. The anti-globalization movement:the first big protests in Seattle, 1999

21. Why did they march together in Seattle?

22. What do the anti-globalizers meanwhen they say the WTO is an intrusive undemocratic bureaucracy? • Its governance? = the member-country governments. • Technically one-country one-vote. • True, US & EU have disproportionate weight.But making it more democratic would mean giving more weight to India. Result: Policy would give much lower priority to the environment. • The Articles of Agreement? Hard to object to, as we will see. • The WTO staff? A few thousand powerless technocrats working in a house on Lake Geneva. • WTO panel rulings that interpret the rules? That must be it.

23. Typical WTO panel cases • Tariffs or other measures that discriminate against producers in some trading partners, • either in favor of other trading partners (potential violation of MFN principle of Article I)or • in favorof “like products”from domestic producers (potential violation of national treatment provision of Article III).

24. Typical WTO panel cases,continued • If targeted country files a WTO complaint alleging such a violation, the question is whether the measure is permissible under Article XX • which allows for exceptions to the non-discrimination principles for environmental reasons (XXb), • provided that the measures in question are not “a means of arbitrary or unjustifiable discrimination” or a “disguised restriction on international trade.”

25. Kyoto &Geneva Will the Global Climate Change Regime Come Into Conflict with theGlobal Trade Regime?

26. Mutual respect Drafters in Kyoto and Geneva showed more consideration for each other than the rank & file of environmentalists and free traders. The Kyoto Protocol text: Parties should “strive to implement policies and measures...to minimize adverse effects on international trade...” ; UNFCCC features similar language

27. Mutual respect,continued • WTO regime is equally solicitous of the environment: • Article XX allows exceptions for health & conservation • Preamble to 1995 Marrakesh Agreement establishing WTO seeks “to protect and preserve the environment;” • 2001 Doha Communique starting new round of negotiations: “the aims of ... open and non-discriminatory trading system, and acting for the protection of the environment ... must be mutually supportive.”

28. The Kyoto Protocolis in my view a useful foundation. But it lacks: • Provisions for emission targets in future years • Targets for US, China & other developing countries • An enforcement mechanism • including an incentive for holdouts to join, and • enforcement of the agreement. • Could trade sanctions be the mechanism?

29. Possible application of trade barriersby US climate change legislation: The serious Climate Change billsintroduced in the 110th Congress called for some border adjustment: energy-intensive imports require permits or tax applied to fossil fuel imports. Washington may not realize that the US is likely to be the victim of legal sanctions before it is the wielder of them.

30. Possible application of trade barriersby EU:Directive of the European Parliament & of the Council, Paragraph 13,amending Directive 2003/87/EC so as to improve and extend the EU greenhouse gas emissions allowance trading system; Brussels, Jan. 2008: “Energy-intensive industries which are determined to be exposed to significant risk of carbon leakage could receive a higher amount of free allocation, or an effective carbon equalization system could be introduced with a view to putting EU and non-EU producers on a comparable footing. Such a system could apply to importers of goods requirements similar to those applicable to installations within the EU, by requiring the surrender of allowances.”

31. Would carbon-import penalties be compatible with the WTO? Question (1): GHG emissions are generated by so-called Processes and Production Methods (PPMs). Does that rule out trade measures against them? Question (2): What specific trade control design is appropriate?

32. Precedent (1): Montreal Protocol on stratospheric ozone depletion Trade controls had two motivations: (1) to encourage countries to join, and (2) if major countries had remained outside, would have minimized leakage, the migration of production of banned substances to nonparticipating countries. In the event (1) worked, so (2) not needed.

33. Precedent (2): The true meaning of the 1998 WTO panel shrimp-turtle decision • New ruling: environmental measures can target, not only exported products(Article XX),but also partners’ Processes & Production Methods (PPMs), • subject, as always, to non-discrimination (Articles I & III). • US was able to proceed to protect turtles, without discrimination against Asian fishermen. • Environmentalists failed to notice or consolidate the PPM precedent.

34. Precedent (3): In case there is any doubt that Article XX, which uses the phrase “health and conservation,” applies to climate change, … • a 3rd precedent is relevant: • In 2007, a WTO Appellate Body decision regarding Brazilian restrictions on imports of retreaded tires confirmed the applicability of Article XX(b): • Rulings “accord considerable flexibility to WTO Member governments when they take trade-restrictive measures to protect life or health… [and] apply equally to … measures taken to combat global warming.”

35. Central message: border measures to address leakage need not necessarily violate sensible trade principles or the WTO, but there is a great danger that they will in practice. The big danger: If each country imposes border measures in whatever way suits national politics, they will be poorly targeted, discriminatory, and often disguisedly protectionist; they will run afoul of the WTO, and will deserve to. We need a multilateral regime to guide such measures. Some subjective judgments as to principles that should guide design of border measures…

36. Appropriate border adjustments could be tariffs or, equivalently, a requirement that importers surrender tradable permits.Guiding principles include: • Measures should follow guidelines multilaterally-agreedamong countries participating in the targets of KP & its successors. • Judgments as to findings of fact(who is complying, etc.)should be made by independent expert panels. • Measures should only be applied by countries that cut their own emissions in line with the KP & its successors,against countries not doing sodue to either refusal to join or failure to comply. • Import penalties should target fossil fuels, and a half dozen of the most energy-intensive major industries: aluminum, cement, steel, paper, glass, and perhaps iron & chemicals.

37. Conclusions • Has globalization damaged the environment? • either among open countries in general (through a “race to the bottom” in environmental regulation) or • in certain countries (“pollution havens”). • Such effects are plausible in theory, but empirical studies of cross-country data find no detrimental effects of trade on some measures of environmental degradation such as SO2 air pollution, controlling for income.

38. Economic/environmentalwin-win examples • Remove barriers to imports of environmental goods • US ended restrictive 80s tariffs & quotas on Japaneseauto imports, benefiting both consumer pocketbook & air quality • USG proposal for Doha round: liberalize capital equipment and services used in environmental sector • US could let in imports of Brazil’s sugar/ethanol, again hitting all 3 goals. • A global ban on subsidies to fossil fuelswould achieve both enviro goal of reducing carbon emissions and economists’ goals of reducing deficit spending& an economic distortion.

39. Summary of conclusions,continued • Thus globalization and the environment need not necessarily be in conflict. • Trade & growth give countries the means to clean the air, • provided they have effective institutions of governance in place. • For local air pollution, the appropriate governance is at the national level.

40. Summary of conclusions,continued • But the evidence does suggest that trade & growth can exacerbate other measures of environmental degradation, particularly CO2 emissions. • The difference can be explained by the observation that CO2 is a global externality • which cannot be addressed at the national level due to the free rider problem. • We need institutions of governance at the multilateral level. • These have not been in place, at least until recently.

41. The solution • Greater international cooperation on environmental and trade issues, • so that we can get the best of both. • Very specifically, the Copenhagen Conference of Parties should agree guidelines for penalties on carbon-intensive imports that countries are allowed to impose on each other.

43. The author acknowledges • capable research assistance by Danxia Xie; • valuable input from Joseph Aldy, Scott Barrett, Jagdish Bhagwati, Thomas Brewer, Steve Charnovitz, Arik Levinsohn, Gary Sampson & Robert Stavins; • useful comments on the first draft from Pontus Braunerhjelm, Prasanth Regy, Rob Stavins, Helena Svaleryd, and Danxia Xie; • and support from • the Harvard Program on International Climate Agreements • a Faculty Grant in Sustainability Science from Harvard’s Center for International Development, • as well as from the Government of Sweden.

44. Writings underlying this lectureavailable at http://ksghome.harvard.edu/~jfrankel/currentpubsspeeches.htm#Trade%20and%20Climate%20Change • “Environmental Effects of International Trade,”A Report for the Swedish Globalisation Council, Government of Sweden, 2009. HKS RWP 09-006.   • "Global Environment and Trade Policy," March 2009 for the Harvard Project on International Climate Agreements, directed by Joe Aldy & Rob Stavins; forthcoming, Cambridge University Press.RWP08-058.  HPICA paper no.08-14.   • The Leakage/Competitiveness Issue In Climate Change Policy Proposals,” in Climate Change, Trade and Investment: Is a Collision Inevitable?, forthcoming, Brookings Institution Press, Washington, DC, 2009, Lael Brainard, ed..WCFIA WP 4792. • "Is Trade Good or Bad for the Environment?  Sorting out the Causality" with Andrew Rose, Review of Economics and Statistics, 87, no.1, 2005.NBER WP No. 9201

45. Appendices • Frankel-Rose econometrics • Characteristics of carbon-intensive import penalties • Possible conflicts between Climate Change regime and WTO other than border measures.

46. Appendix 1: Frankel & Rose paper • Equations estimated: • Growth equation (using gravity variable as IV for trade openness) • Environmental quality equation (using factor endowments as IV for growth)

47. Construction of IV for openness First-stage regression of gravity equation • log(Tradeij/GDPi) = - .94 log(distanceij) + .82 log(popj) + .53 Langij (.05) (.02) (.11) + .64 Borderij - .27 log(AiAj) - .47 # Landlockedij + uij (.21) (.01) (.08) • Equation estimated for 1990. • Number of Obs. = 4052. • R2 = .28 (Robust standard errors in parentheses.) Computation of Instrumental Variable • Take exponent of fitted values of bilateral trade and sum across bilateral trading partners: j exp [Fitted log(Tradeij/GDPi) ] . • Correlation (trade ratio, generated IV) = .72

48. Measures of environmental damage • SO2: sulphur dioxide, mean (in micograms per cubic meter), 1995 • NO2: nitrogen dioxide, mean (in micograms per cubic meter), 1995 • PM: Suspended Particulate Matter, mean total (in micograms per cubic meter), 1995 • Water: Rural Access to Clean Water • Def: annual deforestation, average percentage change, 1990-95 • Energy: Energy depletion, in percent of GDP (“genuine savings”)[1] • CO2/capita: Carbon dioxide emissions, industrial, in metric tons/cap [1] Energy depletion is a measure computed for the World Bank’s World Development Indicators. It is equal to the product of unit resource rents and the physical quantities of fossil fuel energy extracted (including coal, crude oil, and natural gas). Table 3.15, http://www.worldbank.org/data/wdi2001/pdfs/tab3_15.pdf.

49. Appendix 2 – I classify characteristics of possible border measures into 3 categories, named by color: (1) “White” category: those that seem reasonable & appropriate. (2) “Black” category: those that seem dangerous, in that they are likely to become an excuse for protectionism. (3) “Grey” category: those that fall in between.

50. French President Sarkozy: “…if large economies of the world do not engage in binding commitments to reduce emissions, European industry will have incentives to relocate to such countries…The introduction of a parallel mechanism for border compensation against imports from countries that refuse to commit to binding reductions therefore appears essential, whether in the form of a tax adjustment or an obligation to buy permits by importers. This mechanism is in any case necessary in order to induce those countries to agree on such a commitment.” letter to Barroso, January 2008