Environmental Economies
Free trade effects

In general, a reduction in trade barriers will affect the environment by expanding the scale and altering the composition of economic activity and initiating a change in the techniques of production. Environmental advocacy groups in the US are concerned that such changes, as might follow a North American Free Trade Agreement (NAFTA), could be inimical to the goal of preserving a clean and sustainable global commons.

In Discussion Paper No. 644, Research Fellow Gene M Grossman and Alan B Krueger study the relationship between air quality and economic growth for a cross-section of urban areas in 42 countries. Using information about the site of the monitoring station, the characteristics of the city and the country's income level they find that concentrations of sulphur dioxide and smoke increase with per capita GDP at low levels of national income but decrease with GDP above a turning-point of about $5,000 per capita, while concentrations of suspended particulates decline monotonically with per capita income at all levels of development. Citizens passing this critical level feel able to afford higher standards of environmental protection and so demand stricter regulation. Trade liberalization that promotes growth in developing countries such as Mexico may therefore yield an environmental dividend.
Grossman and Krueger analyse the industrial composition of Mexican exports to the US and the value added of the `maquiladora' sector (mostly foreign-owned firms that import foreign components for assembly and re-export). They find no evidence of a `pollution haven', where lax environmental protection laws confer on Mexico a competitive advantage in industries that are subject to high pollution abatement costs in the US. A NAFTA may therefore be beneficial to the environment. They use a computable general equilibrium model to show that the Mexican utilities sector, which currently generates many air pollutants, will contract. There is an offsetting negative impact on the US, but the US uses more environmentally friendly production techniques, so the net effect may be positive. Mexico's production of toxic waste will decline, while that in the US will rise, although these effects will be less sanguine for Mexico if US direct investment increases substantially with a NAFTA.

Grossman and Krueger maintain that trading countries produce and export the goods that best suit their national capabilities, and trade liberalization accentuates this specialization. Since industrialized countries have a comparative advantage in many of the goods whose production poses the greatest threat to the environment and tend to employ cleaner technologies, liberalizing world trade may yield global environmental as well as economic benefits.

Environmental Impacts of a North American Free Trade AgreementGene M Grossman and Alan B Krueger

Discussion Paper No. 644, April 1992 (IT)