Does Trade Liberalization Cause a Race-to-the-Bottom in Environmental Policies? A Spatial Econometric Analysis

This chapter explores the impact of openness to trade, and the size of trade flows, on the determination of environmental regulations. Some authors argue that as a result of global trade liberalization countries are likely to relax domestic environmental policy standards in order to increase (or maintain) “competitiveness” (see Esty, 1994; Dua and Esty, 1997; Esty and Geradin, 1997). This could potentially lead to a “race to the bottom,” where countries continually undercut the competitors’ regulations, or refrain from enacting new environmental policies altogether, a “regulatory chill.” Fredriksson (1999) shows in a political economy model that the effect of trade liberalization on politically determined pollution taxes depends on the size of the relative shifts in political power of producer and environmental lobby groups that occur as a result of the liberalization (see also Bommer and Schulze, 1999). Others argue that “ecological dumping” may occur, where environmental policies are set at suboptimally lax levels for strategic reasons (Barrett, 1994; Kennedy, 1994; Rauscher, 1994). Industry and union interests join the environmentalists in their fear that trade liberalization will create “pollution havens” with low stringency of environmental regulations and a comparative advantage in polluting sectors. These fears have given rise to calls for harmonization of environmental policies in regional free trade areas, e.g., across the EU or NAFTA members (Esty and Geradin, 1997).