Three essays in trade and the environment

This thesis comprises of three papers on various aspects of trade and the environment.
The first paper takes a closer look at the interplay of international environmental
agreements (IEAs), trade and welfare. It is well known from the literature
of strategic environmental policy that governments bound by WTO-rules that
preclude direct trade intervention may use environmental policy as a substitute
for trade policy. Studying a third-market model with imperfect competition and
global emissions, we first show that the strategic rivalry between exporter countries
causes a welfare loss for both countries. Such a loss represents a motivation
for the countries involved to conclude an IEA that internalizes the external effects.
Welfare of the exporter countries increases as a consequence of such an
IEA. However, we show that, taking into account the accompanying loss of consumer
surplus in third countries, the overall welfare effect might be negative, so
that the world as a whole is worse off with than without the IEA. The main conclusions
drawn from the first paper are that IEAs are a useful tool to internalize
environmental externalities, but that (i) malign welfare effects can arise in the
presence of pre-existing distortions such as imperfect competition; (ii) an evaluation
of the recent proliferation of regional IEAs has to take into account impacts
on non-members; and (iii) regional IEAs may not be a fruitful way of addressing
global environmental challenges such as climate change.
The second paper analyzes the impact of decisions made by governments that
are not strict welfare maximizers on strategic and cooperative environmental policy making. Again we analyze a version of the third-country model of strategic
trade policy including pollution and, inspired by the public choice view on governments
and bureaucrats, we show that decisions made by policy makers that
have incentives diverging from pure welfare maximization can lead to quite distinct
outcomes both from a positive as well as from a normative point of view.
In particular, we show that even a fully cooperative IEA between governments
that maximize tax revenue rather than welfare may lead to a welfare loss for the
signatory countries. Furthermore, we demonstrate that tax revenue-maximizing
governments may lead to a higher welfare than welfare-maximizing governments,
because the former can credibly commit to higher emission tax levels. Finally, a
delegation game between governments is used as an illustration to show that the
strategic situation between the two exporter countries does not always correspond
to the Prisoner’s Dilemma but might be of several other game-theoretic types.
These results expose the sensitivity of many of the conclusions from the strategic
trade and environmental policy literature to variations of the arguably optimistic
assumption that governments are strictly welfare-maximizing.
The third paper, which was written jointly with Prof. Frank Krysiak, is an
attempt to find strategies of reducing the costs and increasing the effectiveness of
unilateral climate policy. As a global climate agreement encompassing all major
emitters of GHGs is unlikely to be forthcoming in the near future, but nonetheless
some countries such as the EU and Switzerland have decided to pursue reduction
targets independently, the question arises as to how such unilateral policies should
be optimally designed. For the case of emitting intermediate goods sectors, this
question has not been thoroughly addressed in the literature. Using a three-sector
general equilibrium model it is shown that, if the production of an intermediate
good, such as electricity or transportation services, causes GHG emissions, it can
be optimal to (partially) contain the effects of climate policy to that sector. Containment
consists of a subsidy or tax on the intermediate good and is a second-best
policy in the presence of WTO rules for the cases of carbon leakage and market
power; through containment, also climate policy-induced unemployment can be reduced. The results of this paper suggest ways in which countries that wish to
be frontrunners could design climate policies that achieve reduction cuts at lower
costs and thus also reduce domestic political pressure against unilateral action.