Effects on Trade after Improve Environmental Quality

Effects on Trade after Improve Environmental Quality, What happens to the output of a nation and its effect on trade when it decides to improve environmental quality?

Some goods and services are simply not traded internationally. It is certainly true of intangibles such as environmental quality. Pollution control aims at internalizing environmental externalities.

In so doing, pollution control draws off resources from other sectors of the economy. This is turn, is bound to affect a country’s comparative advantage and international trade.

Environmental damage avoidance (or environmental quality; E) as a third possible “Output” of society. Using a three-dimensional space. We can draw an XME transformation surface with the standard transformation function for tradable goods and services lying in the XM plane.

If social preferences now shifts in the direction of environmental control loss of goods X and M can be produced as resources are increasingly devoted to pollution control. “Small Country” pollution control means that we can produce less of both the exported and imported goods.

The terms of trade can either improve or deteriorate, depending on which effect is stronger. If pollution control hits X more strongly than M, the offer curve will shift to the left and the terms of trade of the “large country” will improve and vice versa.

 

environmental damage avoidance
environmental damage avoidance

 

In this diagram, we assume that the terms of trade are given by the slope of TT and that the XM price ratio is equal to the marginal rate of transformation at A.

In production, the mix is OX1 (of which X2X1 is exported) and OM1 whereas the consumption mix is OM2 (of which M1M2 is imported) and OX2.

The XM transformation curve “shrinks” inward and a new production equilibrium such as C would produce an improvement in environmental quality (E1).

But with unchanged terms of trade, the tradable production mix may now be OX3 (of which X4X3 is exported), along with OE1 of (non-traded) environmental quality improvement.

Effects on Trade after Improve Environmental Quality explaining by theoretically and diagrammatically.

Resources diversion into non-tradable environmental quality has in this example,

  • Reduced output of tradable by X3X1+M3M1
  • Reduced consumption of tradable by M4M2+X4X2 (this is the real cost of pollution control to society)
  • Reduced exports by X3X1-X4X3
  • Reduced imports by M1M2-M3M4
  • Increased production and consumption of environmental quality of OE1.

Suppose finally, that our exports good X is capital intensive and our imports good M is labor-intensive, and that pollution control activities in the form of increased E are also capital intensive.

Then the inward shift of the equilibrium X and M production level in the diagram will likewise not be symmetrical, the country’s comparative advantage will be undermined the productive factor that gives rise to its comparative advantage is being disproportionately drained off into pollution control. Even though the terms of trade are then likely to improve.

Our point is, of course, to show that the basic trade model we have used inadaptable to the analysis of nontrade goods and services even something as complex as pollution control.

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