An Alternative Base Case for Modeling Trade and the Global Environment

Abstract

The trade-and-environment literature concentrates on a generic base case, focused on the production side of general equilibrium, with consumption "neutralized" by assuming homothetic preferences. I offer a simple alternative base case, neutralizing the usual production features instead. I focus on the demand side of general equilibrium, introducing nonhomothetic preferences where environmental quality has an income elasticity of demand exceeding one. I contrast cooperative and noncooperative outcomes between two countries, showing that the poor country makes lower abatement efforts under either assumption. A poor country may be worse off when the large country abates (reversing the usual argument on free riding) and cooperative bargaining over abatement levels may offer no gains. I identify "policy leakage" and show that border taxes are counterproductive. Free trade is good for the environment for several reasons. Finally, I briefly examine "issue linking" in bargaining to assess the benefits of linking trade and environment negotiations.