Protectionism and Pollution

It is already a fact that economists overwhelmingly support free trade. It is really Ricardo’s simple and intuitive ‘comparative advantage’ that makes it abundantly clear. More than that further research in trade theory, à la Paul Krugman has made this abundantly clear. Yet, the intuition is lacking amongst the public. More so, it is lacking among fellow students in my class and colleagues in the other social sciences (political science, sociology for example). There are two hold ups. One is the consideration for ‘Infant industries’, or rather what I see as their bias against free trade that gives infant industries a weight too large for even its own findings as an economic concept. There is a methodological issue that individuals fall into when they give excessive weight to a relationship. I’ll leave infant industries for another post but for this post I want to discuss the idea that free trade increases environmental degradation.

The common phrase is actually a “Race to the Bottom”. This concept means certain policy, mostly deregulation, attracts foreign business leading to increasing environmental damage. You usually see this phrase in the context of lower tariffs among a Western and developing country, so that rich polluting firms can take advantage of cheap labor and lax regulation elsewhere and damage the environment. This works well as a story with a very basic economy where we assume that polluting is associated only with cheap and dangerous industries. This story, however, breaks down when forced to face economic theory and data.

Tim Harford’s The Undercover Economist has a really good discussion (pg. 202) of this that uses a piece of pollution and FDI data I’ll show, though arguably his discussion shows the economic intuition much better. I recommend his book in general due to its focus on intuition and lack of technicality for non-economics people.

David Wheeler, for the World Bank, very simply plotted pollution and foreign direct investment (FDI).

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In these three cases increases in trade from abroad coincides with falls in air pollution. This trend extends further to today, for instance around the 2008 Olympics China enacted environmental regulations. So, this begs the question, why does the trends above occur. And why can’t we actually experience widespread affects of “Race to the Bottom” in general. I have been to developing nations, in fact I have been to the same countries at different times and they hadn’t reached the supposed “bottom”.  There are two things to consider to why free trade decreases pollution. The first is the comparative advantage of developing nations doesn’t attract the heavily polluting industries, like ones in production of heavy chemicals which occur mostly in large developed nations, which have the human capital and technology for such industries to become a comparative advantage. The second cause is what is summarized in the Environmental Knutz Curve. To summarize, societies get richer and through various institutional changes both regulatory and efficiency in industry lead to fall in pollution (what has occurred in China very recently).

When it comes to the reasoning based on efficient industry, Wheeler points out something very important that every anti-free trade and “race to the bottom” proponent forgets:

Research in both high- and low-income countries suggests that pollution control does not impose high costs on business firms. Jaffe (1995) and others have shown that compliance costs for OECD industries are surprisingly small, despite the use of command-and-control regulations that are economically inefficient. These results suggest that differential pollution control costs do not provide OECD firms with strong incentives to move offshore.

(pg. 6)

Firms don’t take advantage of the initial lack of environmental regulation in whatever developing nation. The costs of complying with standards is not extremely high or a weighty cost. Wheeler finds that inefficiency is linked to poorly run state-run enterprises in China before death of Mao as an example. Also, the assumption that poor countries don’t care about the environment is not true. And certainly, many multinational corporations find it in their interests to comply with regulations more so than native or state-run firms. I really do recommend reading Wheeler’s World Bank report. Personally, my experience with environmental economics was zero before this paper.

The reasons stated above deal with the poor assumptions about how the “race to the bottom” plays out in international trade. There are other considerations to consider. The Knutz Curve. Countries that become affluent and richer tend to have changes politically through access to education and new needs and wants. The Knutz Curve for the environment is relatively noisy. Plotted data shows a slight inverted-U trend but it certainly doesn’t explain the specific differences in pollution amongst countries. Certainly institutional effects, such as type of regulation, existing political ideology, strength of government in imposing laws or type of regulatory regime might explain differences among countries more. But certainly the increase in living standards lead to less pollution and increased political action. Again, “race to the bottom” reveals to be a poor concept in every way. In a universe where the race to the bottom holds, the Knutz curve would have the poor world at a high level of pollution in a free trade regime and the developed world at a lower level of pollution. That trend is non-existent.

What is interesting is that this doesn’t mean intra-country liberalization should also be immediate. China is an excellent example where in the 1980s deliberate and controlled liberalization lead to limited pockets of pollution, mostly state industries were polluting at a level that created permanently damaging ecological effects. If on one day the polluting industries were liberalized without time for the public to react to liberalization there would be high levels of pollution but in limited pockets. However, again it won’t be permanent or any worse than state enterprises. But add free trade and possibly the opposite occurs. No more race to the bottom. But before one reasons that the pollution occurs in large populace western nations as non-polluting industries leave for poor nations, consider figure 5 in the Wheeler paper. The trend continues even into today. There are many reasons, from regulatory to technological improvements. As well, Pigouvian taxation has been remarkable successful (see sulfur pollution in the US), much better than outright bans or regulation. It helps correct market failures and shows that complaints by firms concerning costs to avert pollution were exaggerations, the market shows the truth of their actions. This was noted by Wheeler.

Coming back to Tim Harford’s book, which I hate to steal from. Even though I read the book years ago, one observation he shares from OECD data is that countries that practice protectionism in agriculture tend to have higher levels of fertilizer use. The intuitive reason of course is that if your comparative advantage for natural reasons is not agriculture but you still subsidize and protect it then your industry will rely on possibly high and unnecessary levels of fertilizer use. This can have an effect on soil quality in the future. This protectionism occurs in rich, developed countries. Think of South Korea, Japan, USA, EU, etc. Race to the Bottom only occurs in protected industries. Why this argument still remains prevalent against TPP for instance, I am unsure. I can only haphazardly assume it has to do with certain individuals’ political priors.



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