Product quality, consumption externalities, and the role of National Treatment

Article III of the WTO (National Treatment) limits domestic policy in an effort to curtail protectionist discrimination against foreign products. In this paper, we examine the role of National Treatment and prominent Article XX exceptions when goods are vertically differentiated and generate consumption externalities. We study the domestic policy choices of two countries (first-stage problem) and quantity and price equilibria in two product markets (second-stage problem) under a strict application of Article III and compare them to the policy choices and product market equilibria prevailing when countries can misrepresent external damages and discriminate. While one may expect that high externalities would lead to a greater need for exceptions to equal treatment, we show that this is often not the case and, furthermore, that non-discrimination can lead to a cleaner world environment.