Environmental and Trade Policies: Some Methodological Lessons

This paper describes the results of using a new computable general equilibrium model for the European Union that incorporates local and transboundary externalities to evaluate the effects of trade policy reform. In contrast to all past theoretical and empirical research, this model includes the morbidity effects of three criteria air pollutants as nonseparable arguments of household preferences. The model is based on the Harrison-Rutherford Wooton model that identifies 11 regions, six aggregate commodities and three factor inputs. Three modifications were made to the model: (a) Stone Geary utility functions were used to characterize preferences for each consumer; (b) nine morbidity effects due to the three air pollutants were introduced as translating effects; and (c) pollution generation and dispersion models were introduced and calibrated to the model's base solution. General equilibrium welfare effects are evaluated with a balance of trade function. Overall, the evaluations of policy suggest that incorporating environmental effects as nonseparable influences on preferences can have a marked impact on the evaluation of trade policy reforms.