The limits of cross-border environmental policies: Trade diversion as leakage

Global environmental externalities are one of the most pressing policy challenges of the modern era. Unilateral policy options to address global externalities are limited, however, by sovereignty and a general difficulty in achieving environmental objectives across national borders. We study an emerging trade policy tool used in cross-border environmental policies—environmental standards for imports—using a European Union program aimed at mitigating illegal timber harvesting in tropical timber exporting countries. Through bilateral agreements with partner countries, the program established de facto import restrictions through supply chain transparency and certification requirements on forest products. We find that the policy led to a diversion of partner country exports away from the EU towards other markets, particularly in Asia, and had no discernible impact on reducing forest loss. Our findings highlight the role that trade diversion can play as a leakage mechanism in such cross-border environmental policies.