Journal Issue

Trade Policies and the Environment

International Monetary Fund. External Relations Dept.
Published Date:
January 1992
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How do current trading rules affect environmental policy issues?

The relationship between trade and environmental policies has recently emerged as a major topic of debate. In some circles, international trading rules are seen as a limit on the ability of countries to protect national and global environmental resources. Yet, trade policy analysts view trade restrictions for environmental purposes as a new form of protection. Further developing countries worry that industrial countries will rely on trade sanctions to force compliance with national and international environmental objectives.

Thus, while various aspects of these issues are being examined under the aegis of the General Agreement on Tariffs and Trade (GATT), a “green round” of trade negotiations has been suggested even before the Uruguay Round has been concluded. Preparations for the UN Conference on Environment and Development in June 1992 have included work on how trade and environmental policies can be mutually supportive.

Basic concepts

Underlying this controversy are some basic economic principles. Economic activities of private agents often entail positive or negative effects on others that may not be reflected in private costs or benefits but appear as “social” benefits or costs that affect others. When a factory, for example, pollutes a river, it may impose social costs. In such circumstances, public policy can play a role by correcting for the divergence between social and private costs or benefits. An example would be a tax on the polluting activity equal to the social costs. An efficient, or “first-best,” policy attacks that problem directly. For instance, an efficient energy tax to reduce carbon dioxide emissions to combat global warming would vary between types of energy depending on carbon dioxide content. However, it is possible for less efficient, or “second-best,” policies to be better than no policy at all.

When environmental damage crosses national borders, an efficient pollution tax would include the social costs imposed on other countries. However, such policies are difficult to implement because polluting countries may have little incentive to factor the social costs imposed on others in their own production or pricing policies. A country that imports a commodity from a neighbor using a production process that results in cross-border pollution might reduce the pollution by imposing a tariff, provided the tariff affects the terms of trade. This is not the most efficient policy since it does not attack the problem directly and introduces production and consumption inefficiencies associated with the tariff. Moreover, the importing country may or may not be better off with the pollution-reducing tariff, depending on whether the benefits derived from less cross-border pollution are more than offset by the costs of trade protection.

When pollution problems are global rather than local in nature, cooperative agreements might yield efficient solutions. A polluting country could agree, for example, to impose a pollution tax conditional upon receipt of a side payment from the countries suffering from the pollution.

Alternatively, cooperative agreements among polluters might incorporate trade sanctions against parties or nonparties to the agreement as an enforcement mechanism. In the presence of transnational environmental problems with many sources, there is incentive for countries to “free ride” on the pollution abatement policies of others. If some countries can agree to an abatement plan, however, a credible threat of trade sanctions against nonsignatories could induce a change in nonsignatory behavior. Several prominent multilateral environmental agreements contain trade measures either as enforcement mechanisms or as enabling mechanisms (see table). A major issue is how these trade measures are treated by GATT rules.

Basic GATT rules

Two basic principles of the GATT are nondiscrimination and national treatment. Nondiscrimination, or most-favored-nation (MFN) treatment, obligates all countries that are contracting parties (CPs) to the GATT to extend to all other CPs the terms extended to their most favored trade partner. National treatment obligates contracting parties to treat imports in the same way as “like products” produced within their own countries with respect to internal taxes, standards, and regulations. Parties to a dispute that cannot be settled through consultation may request a GATT panel of disinterested parties to arbitrate. However, panel decisions are not easily enforced, relying almost exclusively on peer pressure.

GATT permits a number of exceptions. For example, Article XX allows two uses of trade restrictions provided they are not “arbitrary or unjustifiable” methods of discrimination nor act as disguised trade barriers. Article XX(b) permits measures “necessary” to protect human, animal, and plant life and health. In 1987, a GATT panel ruled that a cigarette import ban by Thailand (without corresponding production limits on the state cigarette monopoly) could not be justified as “necessary” under Article XX(b). Article XX(g) allows trade measures “relating to” conservation of a country’s exhaustible natural resources provided they are primarily aimed at making effective domestic production or consumption restrictions. In 1987, the United States successfully challenged before a GATT panel a Canadian prohibition on the export of unprocessed salmon and herring. Canada had defended it as a conservation measure “relating to” domestic regulations. The panel held that, since Canada had not placed limits on domestic consumption of these products, the measure was not primarily aimed at making domestic regulations effective.

Trade provisions of selected international environmental agreements
AgreementsTrade-related provisions
Convention on International Trade In Endangered Species of Wild Fauna and Flora (CITES)

Entry into Force January 1975

Objectives. Protection of fauna and flora from overexptoitation and extinction.
CITES Appendix I lists species threatened with extinction and obligates parties to almost complete trade ban.

Appendix II lists species which may become threatened and obligates parties to regulate trade using permit system.

Appendix III lists species whose trade may be regulated by the countries in which they exist.

Article XXIII permits countries to exempt themselves from obligations on a case-by-case basis.
London Guidelines for Exchange of information on Chemicals In International Trade

Entry into force. Over 100 countries have indicated interest.

Objectives. Assist countries increase safe use of chemical products through exchange of information and regulation of trade.
Obligates countries to exchange information with each other and notify UNEP International Register of Potentially Toxic Chemicals (IRPTC) whenever action is taken to ban or severely restrict use of chemicals.

Chemicals on IRPTC list are subject to Prior Informed Consent (PIC) of importer, unless the chemical is already in use in the importing country.
Basel Convention on the Control of Transboundary Movements of Hazardous Wastes and Their Disposal

Entry into force Not yet in force. Requires 20 ratifications.

Objectives. Ensure hazardous waste importers are inlormed of risks and have proper disposal facilities.
Requires exchange of information on transboundary waste shipments with UN Secretariat, written informed consent from authorities of importing country prior to shipment, and adequate disposal facilities in importing country. Waste shipments to nonsignatories prohibited Parties not to export to developing countries if they suspect disposal facilities to be inadequate.
Montreal Protocol on Substances that Deplete the Ozone Layer

Entry into force. January 1989; amended, June 1990 (20 ratifications necessary)

Objectives. Elimination of production and consumption of stratospheric ozone- depleting chemicals
Production and consumption phaseouts of controlled substances by 2000 (2010 for developing country signatories) Imports from nonsignatories banned by end-1990; exports to nonsignatories banned by end-1993.

Signatories without objections to a list of products containing controlled substances (to be drawn up by January 1992 and agreed to) required to ban imports from nonsignatories. Signatories to study feasibility of banning imports of products from nonsignatories of products which use controlled substances as inputs in their production.

Exceptions under Article XX do not apply to measures taken to protect health, safety, or resources in other countries. In 1991, after Mexico challenged a US law that banned the import of tuna caught in nets that killed dolphins, a GATT panel ruled that Article XX(b) and (g) exceptions did not apply because the ban was a unilateral effort to pursue environmental objectives outside US territorial jurisdiction. Mexico and the US have since agreed to pursue a multilateral solution to the issue.

Nondiscrimination and national treatment apply to “like products,” independent of production methods, so as to encourage trade based on each country’s comparative advantage. Discrimination in trade on the basis of the environmental effects of a country’s production processes is not generally permitted. However, border taxes may be allowed, provided similar domestic indirect taxes exist on a product or its inputs. For example, US legislation that imposed border charges on imported substances derived from certain chemicals, to raise revenue for clean up of waste disposal sites, was permitted by a GATT panel when challenged by the EC, since the chemicals were subject to similar domestic taxation.

Major questions remain about how these GATT rules might affect independent environmental agreements. A 1989 trade ban on products from endangered African elephants under the Convention on International Trade in Endangered Species of Wild Fauna and Flora (CITES) has been criticized as inefficient. It has been argued that controlled culling of herds for ivory and other products provides more incentive for some countries to conserve the species. This raises the question of whether a trade ban could be defensible if subjected to a GATT challenge, given the disciplines against trade measures for extraterritorial environmental objectives. Whether the trade provisions in the Montreal protocol to protect the ozone layer (see box in this article), that discriminate against nonsignatories could be justified in the GATT as necessary for the protection of life and health is also uncertain.

Other important issues

Some domestic measures ostensibly for health, safety, or environmental reasons —particularly technical standards—can act as disguised trade barriers. One case, never considered by a panel, is a European Community ban on beef raised with growth hormones to protect public health as perceived by its citizens, which has been challenged by the United States based on a lack of scientific evidence to justify it. Efforts in the GATT have been made to discipline the use of standards as nontariff barriers.

The Tokyo Round Standards Code and current Uruguay Round negotiations to modify and extend it, obliges signatories to make use of international norms when possible. Deviations are permitted for various reasons, including environmental protection, provided they are transparent and have a scientific basis. Similarly, Uruguay Round negotiations on sanitary standards for plant and animal products have sought to ensure that such measures are based on international standards when possible, with deviations not contrary to scientific principle and evidence.

Standards harmonization entails potential benefits and costs. It may reduce inefficient differences and permit increased trade, yet allowances must be made for differing standards when they reflect, for example, more stringent national risk tolerances. In the case of environmental protection standards, different countries may be capable of the same levels of abatement using different standards making harmonization inefficient. Further, purely local environmental problems would be most efficiently handled through national policies, whereas global problem may require cooperative solutions that may entail some standards harmonization.

Another issue involves the effects on “competitiveness” of differing costs of environmental protection on traded goods. Pollution-intensive industries in countries with costly abatement policies may claim to suffer from the “unfair” trade advantages of countries with lower costs. For this reason, it has been suggested that imports from countries with low abatement costs be considered unfairly subsidized and subject to countervailing duties. However, countries may be capable of achieving similar levels of environmental quality at different costs. In that case, a country levying countervailing duties against products from a country with lower abatement costs would be protecting an inefficient domestic industry. Further, when environmental effects are local and standards and abatement costs differ, such measures may be seen as encroaching on national sovereignty.

Peter Uimonen

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