The Political Economy of Trade Liberalization and Environmental Policy

The global trading system is currently undergoing another round of trade liberalization (the Uruguay Round), and regional economic integration is occurring in several parts of the world (e.g., EU, NAFTA). A surge in the interest in the environment has made the trade-environment link a part of trade talks. Following trade reform, it has become commonplace that industry representatives argue that less stringent environmental regulations in LDCs give these countries a comparative advantage in pollution intensive commodities, and that industries with high abatement costs will migrate to LDCs. This prediction is a political pressure on industrialized countries' environmental regulations in order to restore "competitiveness". Environmentalists argue that international differences in environmental laws and regulations may be reduced to their lowest common denominator through industry political pressure. This is thus not a fear of trade liberalization itself but of the effects of lower trade barriers on the political determination of environmental regulation. This paper focuses on the political economy effects of trade regime on environmental tax policy. First, we show that the politically determined tax may be inefficiently high or low depending on the relative political pressures in equilibrium. A positive tariff tends to increase the tax rate, since this increases tariff revenues. Second, we show the effects of trade liberalization on lobbying incentives. Both lobby groups are found to reduce their lobbying. This is because the marginal returns to a change in the tax fall. Thus, the lobby groups' political polarization on the environmental tax policy issue is reduced through tariff liberalization. Next, if the pollution tax falls sufficiently, pollution increases through the political channel. Fourth, we study the effect of tariff liberalization on pollution tax revenues. Several OECD countries are considering implementing or increasing pollution taxes in order to raise revenues. Tax revenues may fall due to political economy effects on the pollution tax rate. This implies that the environmental policy reforms proposed may lead to lower revenues than expected if the support from environmental lobby groups decreases faster than the opposition from industry interests. Furthermore, we find that pollution may increase simultaneously as tax revenues decrease. Finally, we discuss the case when the polluting good is exported, and is subject to an export tax. A reduction in the export tax increases the political polarization between the lobby groups, and depending on the relative increase in lobby group pressures, the pollution tax rate, pollution and pollution tax revenues may increase or decrease. An implication is that tariffs do not only distort domestic consumption and production, but also stimulate lobbying activities in other areas such as environmental regulation. Our findings also have a policy implication. Multilateral trade agreements that incorporate restrictions on changes in environmental policy would make it harder for domestic policy makers to mitigate the effects of trade liberalization. Environmental regulation would then not become a trade policy tool