In debates over the recent extensions of trade liberalization (the Uruguay Round, the Single European Market and NAFTA), a number of competing claims were made, two of which are the focus of this paper. The first concerns the fear of environmentalists that, in the absence of trade policy instruments, governments might seek to give their domestic producers a competitive advantage by relaxing environmental policies imposed on them. The second is that, instead, governments might seek to toughen environmental policies to provide an incentive for their domestic producers to innovate green technologies ahead of their rivals. An appropriate framework for testing these claims is the world of imperfectly competitive international markets, where governments may indeed have incentives to manipulate the markets through their environmental policies, and producers may have incentives to manipulate the markets through their R&D policies.

In Discussion Paper No. 1063, Research Fellows Alistair Ulph and David Ulph provide a more general treatment of the issues than most previous literature. They allow governments to set environmental policies strategically and consider cases where governments use emissions taxes or emission standards as their instruments. They also allow producers to engage in both environmental and process R&D. Three main results emerge. First, when governments use emission taxes, allowing for both process and environmental R&D does not change qualitative results relative to those that arise when producers use only environmental R&D. Second, neither of the claims noted at the beginning holds in general. Lastly, in the model used here, governments are more likely to set too tough environmental policies when they use emission standards than when they use emission taxes.

Trade, Strategic Innovation and Strategic Environmental Policy – A General Analysis
Alistair Ulph and David Ulph

Discussion Paper No. 1063, November 1994 (IM)