Environmental Policy
Market conduct

One of environmentalists' concerns about the impact of recent extensions of trade liberalization on the environment is that, in the absence of trade policy instruments, governments might manipulate their environmental policies for trade reasons. In Discussion Paper No. 1065, Research Fellow Alistair Ulph analyses the interactions between strategic behaviour by governments and producers when governments use either emission standards or emissions taxes He uses a model of Bertrand competition contrasted with Cournot outcomes. The purpose is to test the importance of market conduct in predicting the incentive for governments to distort environmental policy. Strategic behaviour by governments takes the form of distortions to their environmental policy from the first-best rule of equating marginal damage and marginal abatement costs. Strategic behaviour by producers implies inefficient investment in R&D.

The main finding is that when only governments act strategically, they will set too tough environmental policies, and the distortion will be greater if governments use emission standards rather than emission taxes. When only producers act strategically, they underinvest in R&D, but it is not possible to give a universal ranking of policy instruments. When both governments and producers act strategically, this reduces the extent of government distortion of environmental policy. This is the same result as with Cournot competition but for very different reasons: when governments use emission taxes with Bertrand competition, they set taxes below the first-best level, the reverse of what happens when only governments act strategically.

Strategic Environmental Policy and International Trade – The Role of Market Conduct
Alistair Ulph