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Trade and the environment with pre-existing subsidies: A dynamic general equilibrium analysis

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  • Bajona, Claustre
  • Kelly, David L.

Abstract

Countries that wish to erect trade barriers have a variety of instruments at their disposal. In addition to tariffs and quotas, countries can offer tax relief, low interest financing, reduced regulation, and other subsidies to domestic industries facing foreign competition. In a trade agreement, countries typically agree to reduce not only tariffs but also subsidies. We consider the effect of a free trade agreement on pollution emissions. We show that while reducing tariffs may indeed increase output and pollution, reductions in some subsides required by the trade agreement reduce pollution in general equilibrium for reasonable parameter values. Reducing subsidies has three effects on pollution: (1) reducing subsidies to firms reduces pollution-causing capital accumulation, (2) if subsidized firms are more pollution intensive, then reducing subsides moves capital and labor from more to less pollution intensive firms, and (3) reducing subsidies concentrates production in more productive firms, increasing output and thus pollution. We derive straightforward conditions for which (1) and (2) outweigh (3). We then calibrate the model to China in 1997, and find that pollution has a more elastic response to reducing subsidies than to reducing tariffs. While a 5% reduction in tariffs increases all pollutants by approximately 1%, a 5% reduction in subsidies reduces pollution by 1.8–11.6%, depending on the pollutant. The reductions in pollution occur without any environmental side agreements or abatement policy changes.

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Bibliographic Info

Article provided by Elsevier in its journal Journal of Environmental Economics and Management.

Volume (Year): 64 (2012)
Issue (Month): 2 ()
Pages: 253-278

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Handle: RePEc:eee:jeeman:v:64:y:2012:i:2:p:253-278

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Web page: http://www.elsevier.com/locate/inca/622870

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Keywords: Perverse Subsidies; Pollution Emissions; China; State Owned Enterprises; WTO Agreement; Applied General Equilibrium; Emissions Intensity;

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Cited by:
  1. Heutel, Garth & Kelly, David L., 2013. "Incidence and Environmental Effects of Distortionary Subsidies," Working Papers, University of North Carolina at Greensboro, Department of Economics 13-5, University of North Carolina at Greensboro, Department of Economics.
  2. Wei, Wenjie, 2014. "Welfare and Environmental Effects of Subsidies and Tariffs in North-South Trade in Renewable Energy Equipment," 2014 Conference (58th), February 4-7, 2014, Port Maquarie, Australia, Australian Agricultural and Resource Economics Society 165887, Australian Agricultural and Resource Economics Society.
  3. David Kelly, 2009. "Subsidies to Industry and the Environment," NBER Working Papers 14999, National Bureau of Economic Research, Inc.

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