Environmental Policy and Strategic International Trade

Abstract

Policy-makers frequently express concern about the possible impact of environmental policy in raising production costs and lowering international competitiveness, yet empirical studies suggest that such effects are small. However, these findings are from models in which international trade is modelled as being perfectly competitive. In earlier theoretical work I have shown that if trade is modelled as imperfectly competitive with scope for strategic behaviour by producers, then the choice of environmental policy instrument can have a marked impact on the incentives for producers to act strategically, with environmental standards reducing significantly the incentives for strategic overinvestment relative to environmental taxes, or no environmental policy at all. In this paper I present a simulation model which is based on the earlier theoretical work to try to assess how significant these arguments might be in practice. The parameters of the model are calibrated on data for the world fertiliser industry, though the model does not pretend to be a realistic description of that industry. These empirical results show that the impact of environmental policy on strategic behaviour can be at least as important as the more usual impact of environmental policy operating through induced changes in costs of production above.

This paper is based on work carried out as part of a study commissioned by the U.K. Department of Environment (DoE) and Department of Trade and Industry (DTI) (Horton, Rollo and Ulph, 1992). I am grateful to Nick Hartley and Jonathan Fisher for comments on earlier versions, but I am solely responsible for all the results, opinions and mistakes contained in this paper. I am indebted to Alan Young for expert computing assistance with the simulations.