divergent environmental regulations and trade liberalization · divergent environmental regulations...

Divergent Environmental Regulationsand Trade Liberalization

by Mary Bohman1 and Patricia J. Lindsey2

1 Department of Agricultural Economics, University of British Columbia, Vancouver, B.C.2 Department of Agricultural and Resource Economics, Oregon State University,

Corvallis, Oregon.

Received 20 December 1995, accepted 23 January 1997

The market and nonmarket consequences of environmental regulations and of trade liberalization underdifferent regulatory regimes are explored in the context of the NAFTA through simulation modeling ofthe North American sheep and lamb markets. Producers are able to shift much of the cost of regulationto domestic and foreign consumers and thus gain from regulation. In the cases investigated, nonmarketeffects are unlikely to reverse the sign of market gains or losses, and “level playing field” regulationsmay or may not be preferred.

Les conséquences économiques et environnementales de la réglementation en matière d’environnementet de la libéralisation des échanges dans le contexte de l’accord de libre-échange nord-américain sontexaminées en modélisant le marché nord-américain de l’agneau et du mouton. Les producteurs réus-sissent à transférer aux consommateurs nord-américains la plupart des coûts dus à la réglementationet donc à en retirer des gains. Dans les cas étudiés, il est peu probable que les impacts environnemen-taux changent les gains en perte et vice-versa. Une réglementation n’affectant pas la compétitivité despartis ne serait pas nécessairement préférable.

Canadian Journal of Agricultural Economics 45 (1997) 17–38

17

INTRODUCTION

In the debates surrounding proposals to liber-alize trade within North America via theCanada–U.S. Trade Agreement (FTA) andthe North American Free Trade Agreement(NAFTA), the potential for conflict betweentrade and environmental policies was raised.In an international trade context, the sensibil-ity that more output is not invariably pre-ferred to less translates into questions regard-ing interactions between trade and environ-mental policies and outcomes.

Prominent in these discussions is theissue of policy differences. “Vive la differ-ence!” may be a rallying cry for some, butcalls for a so-called “level playing field” areapt to be heard where there are differences inenvironmental regulations among tradingpartners. In the United States, for example,Senator Frank Lautenberg proposed an

amendment “to make the failure to adopteffective pollution standards an unfair tradepractice.” This was justified on the basis that“countries which allow the exploitation oftheir environment are reaping the benefits oflower production costs” (CongressionalRecord: S4817). Where countries’ effectiveenvironmental policies are the same, tradeliberalization is unlikely to trigger charges ofenvironmental dumping and loss of competi-tiveness, despite any discrepancies in theinherent costs of compliance. Rather, it is thedifferences in regulation among trading part-ners that give rise to a set of concerns. Inmany important respects, the situation andissues mirror those pertaining to other poli-cies and technical standards: Do the policydifferences serve as intentional or uninten-tional trade barriers? Does the policy providea hidden subsidy to (or tax on) local produc-

ers? Will further easing of tariffs underminethe effectiveness of existing policies? Is pol-icy harmonization, as is increasingly the casein the European Union, desirable from a wel-fare standpoint? Or is the public good betterserved by mutual recognition of each coun-try’s own standards?

There is still much to be learned aboutthe interplay between trade liberalization andenvironmental protection measures, both ingeneral terms and with respect to particularpolicies and industries. This paper exploresthe effect of environmental policies in anopen economy framework and of trade liber-alization when there are production external-ities. To this end, we formulate a partial equi-librium model that includes producerresponse to environmental policies for NorthAmerican trade in a selected sector. Themodel is calibrated to actual trade flows andthen is employed to explore quantitative trade,environmental and welfare effects ofNAFTA liberalization under a variety ofenvironmental policy assumptions. Our mainfindings are generally consistent with thoseof other empirically based studies of the rela-tionship between trade liberalization andenvironmental policies: North Americantrade liberalization has the expected marketeffects with or without environmental poli-cies in place, and environmental policiesretain their effectiveness following trade lib-eralization. Also, as expected, environmentaleffects serve as a partial offset to market-based gains from trade liberalization for theexporter and enhance the gains (or reducelosses) for the importing countries.

SPECIFIC OBJECTIVES

The two main objectives of this paper are toexplore the effect of environmental policiesin an open economy framework and to inves-tigate the effect of trade liberalization whenthere are production externalities. The firstobjective responds to the concern that envi-ronmental policies serve as a tax on produc-ers in the imposing country. Our focus withinthis broader objective is divergent policies. Inthe markets studied we pose two questions:

• To what extent do environmentalrestrictions affect the expected marketoutcomes?

• Does a level playing field — in thesense of equal restrictions — increasesocial welfare relative to divergent pol-icy situations?The second objective arises from the

concern that nonmarket effects will negatethe benefits from trade liberalization. Theclassic welfare results that support econo-mists’ arguments regarding the desirability offree trade rest on the assumption that marketprices reflect the full costs of production andthat market welfare represents social welfare.Relaxation of this assumption calls into ques-tion the desirability of free trade (Pethig1976). A secondary concern is whether or notenvironmental policies can remain effectivefollowing trade liberalization.

The empirically based simulation modelis constructed to yield results that allow us toaddress the specific questions outlined above.While the methodology is necessarily appliedto a particular set of related markets, thisresearch is not intended as an in-depth analy-sis of those markets per se. We use the mar-ket situation as it existed in 1990 as the basisfor comparison and then perform two sets ofsimulations. In the first, unilateral and bilater-al imposition of environmental regulationsare modeled as the basis for addressing ques-tions regarding their market and nonmarketeffects. In the second, trade liberalization issimulated across regulatory scenarios in orderto look at the market and nonmarket tradeoffsfrom tariff removal under a variety of condi-tions. Formal hypothesis tests are beyond thescope of this type of model, yet the results arecapable of yielding insights conditional uponthe assumptions and parameterization.Sensitivity of the results to the specific para-meterization is investigated.

THEORETICAL AND EMPIRICALANTECEDENTS

Over the past two decades, a series of theo-retical explorations of trade and environmen-tal interactions has yielded a wealth of

18 CANADIAN JOURNAL OF AGRICULTURAL ECONOMICS

propositions whose factual significance hasyet to be conclusively established.Depending upon the particular assumptionsemployed and/or parameters involved, it canbe demonstrated that trade liberalization canhelp, harm or have little net effect upon thenatural environment. Similarly, environmen-tal regulations can be shown to alter geo-graphic patterns of production and trade, ornot, depending upon the assumptionsemployed.

Concerning the issue of environmentalregulations’ influence on the location of pro-duction, the possibility for significant effectscan be demonstrated theoretically, but empir-ical verification has not been forthcoming.Some early theoretical studies such asSiebert et al (1980) and Pethig (1976) estab-lished a potential link between environmen-tal regulations and reduced internationalcompetitiveness, with correspondingchanges expected in production and tradeflows. However, to date, little empirical sup-port has been found for such competitiveeffects (von Moltke 1993; Jaffee et al 1993).Similarly, evidence that differences in envi-ronmental compliance costs have causeddirect or indirect shifts in the location of pro-duction of “environmentally intensive”goods appears to be inconclusive at most.Low (1993) and others (e.g., Tobey 1993;Jaffee et al 1993) have found little statisticalevidence that divergent environmental regu-lations play a significant contributory role inindustrial migration decisions, or that so-called “environmental dumping” is morethan an anecdotal phenomenon.

One recent example of an empiricalstudy should serve to give the typical flavorof such efforts. Grossman and Kreuger(1993) examined potential environmentaleffects of the NAFTA, concentrating primarilyon U.S.–Mexico issues. Their analysis of therelationship between per capita gross domes-tic product (GDP) and air pollution suggest-ed that NAFTA-induced increases in percapita GDP are likely to improve Mexico’senvironmental protection efforts. Grossmanand Krueger also were unable to find statisti-cal evidence of industrial flight to Mexico to

avoid high U.S. pollution abatement costs.On the contrary, the relevant coefficient hadthe opposite sign to what was expected andwas statistically significant. The authors sur-mised that compliance costs are too smallrelative to total costs to drive the decisionbetween U.S. and Mexican production loca-tions. Using a computable general equilibri-um model together with data on U.S. toxicreleases, Grossman and Kreuger generatedpredictions about post-NAFTA electricitygeneration and toxic releases in the partnercountries, concluding that changes in thescale and composition of manufacturing maylead to a worsening of industrial pollutionand increased electricity generation in allthree countries. Nevertheless, the authorsspeculate that Mexico’s comparative advan-tage lies in relatively less polluting sectorssuch as agricultural and labor-intensive man-ufactures, so that North American trade lib-eralization may yield an overall reduction inpollution for that country.

Another set of studies has taken up opti-mality and social welfare issues. Relativelyearly, Pethig (1976) took issue with theproposition that countries enjoying relativelylarge assimilative capacities (environmentalendowments) should specialize in the pro-duction of environmentally intensive goods,and rigorously showed the necessary and suf-ficient conditions for a welfare loss fromtrade given a set of initial assumptions. Morerecently Krutilla (1991) presented a theoreti-cal approach to identifying first-best and sec-ond-best optimal trade and environmentalpolicy combinations when there are produc-tion externalities. Feenstra and Rose (1993)explored first- and second-best policies in thecontext of California’s agricultural waterrequirements and U.S.–Mexico trade liberal-ization. Some special assumptions (e.g., thatwater now used to produce crops that arereplaced by Mexican imports will be sold tourban consumers, and horizontal supplycurves) yielded sizable social welfare gainsfor California following liberalization. Inthese works, it can be seen that the welfareimplications of free trade cannot be signed apriori in the presence of externalities.

DIVERGENT ENVIRONMENTAL REGULATIONS AND TRADE LIBERALIZATION 19

The absence of definitive answers tomost questions regarding the interaction oftrade and environmental outcomes and poli-cies is frequently mentioned in the literature.In Copeland and Taylor’s (1995) review oftheoretical contributions to the dialogue, itquickly becomes apparent that specific con-ditions and assumptions about countries, sec-tors, preferences and institutions determinethe eventual conclusions regarding the envi-ronmental and welfare outcomes of special-ization and trade. Indeed, the body of theo-retical results has led to observations thatempirical analyses are needed to verify thetheoretical propositions and to ascertainwhich assumptions should be included in theset of those corresponding to particularobserved outcomes. Yet, as pointed out byPerroni and Wigle (1994), quantitative sup-port for the various propositions emergingfrom the theoretical literature on trade andthe environment is both scarce and generallynot particularly robust. The relationshipsappear to be sufficiently complex and depen-dent upon specifics that they confound easygeneralizations. Robustness may ultimatelybe obtained through a preponderance of evi-dence garnered from multiple studies, eachutilizing a somewhat different approach orset of assumptions or applied to a differentset of markets.

LIVESTOCK INDUSTRY, POLICIESAND EXTERNALITIES

The livestock industry is selected for thiscase study because of its readily identifiableand potentially significant environmentalexternalities, the existence of trade flowswithin the North American countries and theexistence of import tariffs for Canada andMexico. The extent and nature of livestockexternalities and the cost of alleviation varyaccording to species, intensity of production,and geography. Such considerations makegeneralizations risky. The live sheep andlamb markets are chosen to represent theissues in the simplest possible way. A rela-tively minor component of the livestockindustry in North America, its modest size

facilitates partial equilibrium analysis andthe trade flows are almost entirely containedwithin the continent. The sheep and lambmarkets are bilateral markets restricted pri-marily by tariffs, further simplifying themodeling. The straightforward trade rela-tions and the comparatively minor govern-ment support for these industries allow theUnited States to focus on the externalityeffects.

Pollution caused by manure disposalfrom intensive livestock production is theleading environmental issue in agriculture inmany regions. Manure pollutes the environ-ment through leaching of excessive nitratesinto groundwater and through runoff, whichcan cause eutrophication of streams andwaterways. European countries, notablywithin the European Union (EU), have iden-tified nitrates as a significant contributor towater pollution, and livestock as a majorcontributor to the nitrate problem. Leuck(1993) has investigated the responsiveness oflivestock supply in the EU to policies intend-ed to reduce nitrate-related water pollution,and Haley (1993) further examined the poli-cy-production-environmental-trade nexus forEU agriculture.

Within North America, environmentalexternalities as a consequence of livestockproduction have also been recognized,although there has not been a policy such asthe EU Nitrate Directive to serve as a focalpoint for public opinion and economic analy-sis. In Canada and the U.S. regulationsregarding the location of livestock produc-tion and the storage and spreading of manureare in effect. In Richardson and Mutti’s(1976) study of the effects of U.S. environ-mental controls on international competitive-ness, livestock and livestock products rankedwith the “pollution-intensive” manufacturingindustries in terms of pollution abatementcosts and market effects.

Canadian regulation of externalitiesfrom agriculture is largely conducted on aprovincial basis. Similarly, the Clean WaterAct in the U.S. directs states to identify andremedy water quality problems such as thosecaused by manure. Hence there are geo-


graphic policy differences within as well asacross countries.1

Even in the relatively simple cases ofsheep and lambs, the externalities havecomplex interactions, and the indirect con-sequences of production differ by location.Sheep herds are generally small acrossCanada, with the largest herds having only afew hundred animals and found with theHutterite colonies in Alberta. Hobby farmsaccount for most production in allprovinces. At current levels of output, sheepmanure is not concentrated and is unlikely tohave any significant negative environmentaleffects, particularly in view of the environ-mental regulations, although local overgraz-ing or grazing too near streams remains apossibility.

Sheep (and lamb) production in theUnited States generally involves extensivegrazing. Manure runoff into streams andwaterways is a potential source of negativeexternalities, as is leaching into groundwaterof nitrates from manure as a result of over-grazing. Overgrazing can also contribute tosoil erosion problems. In both BritishColumbia and the U.S. Pacific Northwestregion, sheep grazing is sometimes used incombination with silviculture (tree farming)to reduce the need for herbicides. In Oregon,sheep are also grazed on grass seed fieldsduring the winter months, again reducing theneed for chemical applications. These desir-able production externalities may or may notbe monetarily rewarded.

Mexican sheep production is extensiveand small, and may result in improved soilconditions. Nonetheless, overgrazing in anyone location may contribute to soil erosionand eutrophication of streams. Thus, in eachof the three countries, the possibility existsfor both positive and negative externalities.

MODELING ISSUES

Empirical models of trade and environmentalinteractions have employed a variety ofapproaches, each with its strengths andweaknesses for the purposes of addressing anumber of related questions. One common

approach is to utilize an existing model ofinternational trade (e.g., Anderson 1992;Grossman and Kreuger 1993) in conjunctionwith separately estimated or available rela-tionships between the economic activity rep-resented by the trade flows and environmen-tal outcomes. Our approach shares some fea-tures with these and other empirically linkedstudies. In common with Abler and Shortle’s(1995) analysis of agricultural pollution con-trol policies, optimizing producers in ourmodel are assumed to substitute amonginputs, and their choices alter the environ-mental consequences of production at anygiven level of output. The model shares withAnderson (1992) the approach of calculatingmarket-based welfare gains from trade liber-alization using the solution of a sectoral priceequilibrium model and then considering theeffect on the natural environment as a poten-tial adjustment to the measured market wel-fare gain or loss.

A critical component of pre- and post-trade liberalization welfare comparisons isthe measurement, including the valuation, ofnonmarket effects of such liberalization. Ourapproach to the welfare question is to esti-mate the value of nonmarket effects requiredto exactly offset the market effects of liberal-ization under different environmental policycombinations. This approach is not too dis-tant from Ballenger, Beattie and Krissoff’s(1994) analysis of western hemisphere freetrade in fruit juice. In their study, Ballenger,Beattie and Krissoff calculated the level ofregulation the exporting countries wouldaccept in order to obtain free trade for theseproducts. We make welfare comparisonsamong scenarios without searching for opti-mal policy combinations in any absolutesense.

EMPIRICAL MODEL

The key issues can be illustrated using a par-tial equilibrium model of international trade.As alluded to above, the model simulatestrade (tariff removal) and other stylized (envi-ronmental) policy changes to the situation


existing in 1990, facilitating evaluations ofthe questions posed rather than searching foroptimal outcomes in the Krutilla sense. Oursimulation model is developed and calibratedfor 1990 North American trade in live sheepand lambs. The U.S. and Canada trade lambs,with Canada a net importer in 1990. Mexicoimports cull ewes from the U.S. Canada andMexico trade neither live sheep nor lambswith one another, and virtually all of NorthAmerican trade in these two markets is intra-regional. The essence of North American livesheep and lamb trade therefore is captured bya pair of bilateral trade models. While theparameters differ, the sheep and lamb modelsare conceptually identical.

The trade segment of the model is illus-trated by the three panel diagram in Figure 1,which shows the market level supply anddemand curves for an importing and export-ing country and their interaction throughtrade. Key features and underlying assump-tions include:

• products geographically homogeneous• border prices (in U.S. dollars) are used• tariffs are assumed to be the only trade

barrier in effect2

• both countries are large in the sense thatprice is determined through interactionof the excess supply and demandcurves, which are the horizontal differ-ence between each country’s domesticsupply and demand curve.

The quantity traded (center panel) corre-sponds to the equilibrium price(s). The quan-tities produced and consumed in the import-ing and exporting countries are determinedby the intersection of the equilibrium priceline(s) with the supply and demand curves.

The ambiguous effects of environmen-tal policy in an open economy is illustratedfor the imposition of environmental policy inboth countries with tariffs in place. The twoequilibrium solutions shown are for traderestricted by tariffs only, and with environ-mental restrictions on production as well. Forthe case with tariffs and no environmentalregulation, the domestic supply and demandcurves (S and D) are given by the solid lines.

In Figure 1, the exporting country’sdomestic supply and demand curves withoutregulation and the corresponding excess sup-ply curve are given by S, D and ES. For theimporting country, the unregulated supply,demand and excess demand curves are givenby S, D and ED. The imposition of a tariff bythe importing country causes the excessdemand curve to shift down by the amount ofthe tariff and the tariff inclusive excessdemand curve is shown as EDt. The tariffinclusive equilibrium price for the exportingcountry is pe and the price in the importingcountry equals pe plus the tariff and is shownas pm.

Regulation causes the supply curve inboth countries to rotate leftward to Sr and the


Figure 1. Trade effects of environmental restrictions

regulated excess supply and demand curvesare derived as ESr and EDr. The restrictionon supply caused by the regulation causes theexporter to sell less on world markets at anyprice and leads to increased demand onworld markets from importing countries. Theregulation causes world prices to increase,but the effect on the volume of trade isambiguous. Keeping the tariff in place, theprices in the exporting and importing coun-tries increase to pe′ and pm′, respectively.Figure 1 shows a decrease in the volume oftrade from qt to qt′.

In both countries, consumer surplusdeclines following regulation due to higherprices and lower quantities: pedb > Pe′db′(exporter) and pmhe > pm′he′ (importer). Theeffect of environmental regulation on pro-ducer surplus is given by pm′f′gpm – f0g forthe importer and pe′a′c′pe – a0c′ for theexporting country. This cannot be signed apriori. The empirical model treats all possi-ble combinations. Note that neither producersurplus nor total market welfare can besigned and that changes in tariff revenue andnonmarket welfare effects must also be con-sidered to find the change in total welfare.

Environmental and Trade PolicyScenariosTrade liberalization is modeled as removal ofthe tariffs prevailing in 1990 as specifiedunder the NAFTA provisions. The 1990Canadian per-head tariff on live lambs wasequal to $0.60 or approximately 1% of thevalue, while Mexico had a 10% ad valoremtariff on live sheep imports.

Three different environmental policyscenarios are simulated to allow for bothmultilateral and unilateral imposition ofenvironmental policies. Since most policiesto regulate livestock waste have beenimposed recently, the data used to calibratethe model are assumed to reflect no regula-tion (or a lower level of regulation than cur-rent standards). The first scenario assumesthat the regulation implicit in the dataremains the same (No EnvironmentalRegulation or NOER). The second scenarioassumes that both countries impose a stan-

dard (Both Environmental Regulation orBER). The final two scenarios represent uni-lateral environmental regulation by theexporting (Exporter EnvironmentalRegulation or EER) and importing country(iMporter Environmental Regulation orMER), respectively.

The model is solved in two rounds,starting from the base case with the import-ing country levying a tariff with no environ-mental regulation. In the first round, environ-mental regulation is imposed. In the secondround, tariffs are removed for each of theenvironmental policy scenarios. The two-step process shows both the effects of theenvironmental regulations and the way inwhich the impact of trade liberalizationvaries with different assumptions about envi-ronmental regulation. The full solution setincludes market and nonmarket outcomes forboth countries under each policy combina-tion.

Figure 2 shows the effects on quantitytraded and prices of trade liberalization(international market panel in Figure 1) forthe environmental scenarios modeled. Thefirst set of simulations corresponds to theequilibrium pairs as follows:

• a,a′ = NOER• b,b′ = BER• c,c′ = EER• d,d′ = MER.

Tariff removal leads to a movement fromeach equilibrium pair to its correspondingstarred value, e.g., from a,a′ to a*. The rangeof resulting price and quantity outcomes isshown on the axes. Pure trade liberalizationhas the expected market effects. The changestransfer back to domestic markets as illus-trated previously in Figure 1. Comparison ofselected equilibrium prices for the importingcountry serves to illustrate the potential fortrade liberalization to ameliorate the priceeffects of environmental regulation. If theimporter combines the two policy changes, itmoves from a′ to d* (exporter does not regu-late) or c′ to b* (exporter regulates). In eachcase, imports increase, but there is little priceeffect compared with standalone environ-


mental restrictions (points d′ or b′). At thesame time, the price drop normally associat-ed with tariff removal (a′ → a* or c′ → c*)does not materialize.3 Again, many of thewelfare effects from these combinations areindeterminate, even on a market basis, andmarket effects can be outweighed by non-market effects.

Model FormulationThe model for an individual country isbriefly described, followed by the worldequilibrium conditions.

The supply curve is derived from a prof-it maximization problem at the farm level.Producers respond to relative prices withinregulatory limits, if any, to choose the opti-mal combination of inputs and outputs.Producers are assumed to be price takers inall markets. The pollution externality is treat-ed as an input in the production process.4 TheCobb-Douglas form is chosen as the simplestproduction function that allows for substitu-

tion between inputs. Two inputs are mod-eled, x1, a composite input of variable factorsto produce output, qs , and the pollution, x2.5

qs = Ax1αx2

β (1)

The assumptions made regarding pro-duction externalities are deserving of atten-tion. Two relationships are used, one varyingand one fixed. Producers are assumed to havesome scope to adjust the mix of external andmarket inputs for any given level of produc-tion according to the production function.The amount of the external “input” is equal tothe externality associated with the output.Starting at an arbitrary value for the basecase, proportionate policy-induced changes inthe externality are then calculated.

In this industry, sheep or lamb manureis considered the primary source of produc-tion externalities. In the model, x2 representspollution from components of manure suchas nitrates and phosphates, not the quantity


Figure 2. Trade liberalization and environmental restrictions

of manure. The model allows other inputs(e.g., storage facilities, composting equip-ment) to abate the pollution from compo-nents of the manure.6

The aggregate supply curve, Qs, isderived by assuming that farmers maximizeprofits subject to exogenous output, p, andinput, w1, w2, prices. Market supply isassumed to be the sum of individual farmersupply curves:

Qs = A1/(1–k)(w1/α)–α/(1–k)(w2/β)–β/(1–k)pk/(1–k)

(2)where k = α + β.

The supply curve has a constant elastic-ity form with the constant equal to {A1/(1-k)

(w1/α)-α/(1-k) (w2/β)-β/(1-k)} and the elasticityequal to {k/(1 – k)} and can be used directlyin the trade model. The Appendix on modelcalibration describes the specific linkages.

Typical regulations for livestock wastemanagement consist of limits on the amountthat can be discharged on a given parcel ofland. The regulations are a type of standardand are modeled as a constraint on the totalamount of the externality that can be pro-duced, ( x2), independent of the total amountof output. The restricted supply curve isgiven by Eq. 3:

Qsr = A–1/(α–1)(w1/α)α/α–1) x2

–β/(α–1)p–α/(α–1)

(3)

The elasticity for the restricted supply curve,εr, equals [–α/(α – 1)]. It can easily beshown that the restriction reduces the supplyelasticity (for α, 0 < α < 1) relative to theunrestricted elasticity. The restricted supplyelasticity works through the trade model toalter the outcome of trade liberalization withenvironmental regulation in one or morecountries.

If, instead, environmental regulationtakes the form of an input (or effluent) tax,the price of x2, w2, becomes (w2 + t) where tis the per-unit tax rate. This expression is sub-stituted into Eq. 2 and shifts the unrestrictedsupply curve without changing the elasticity.

Like the supply curves, the marketdemand curves are assumed to be an aggrega-

tion of individual utility maximizing con-sumers, and the market demand curve can alsobe thought of as the marginal social benefitcurve. By exclusion, it is implicitly assumedthat the income effects of the policy changeson demand for sheep and lambs are negligible.

A constant elasticity demand curvecompletes the domestic market. The differ-ence between domestic supply and demandequals the countries’ excess supply ordemand relationships. Domestic supply, Qs,demand, Qd and net trade, T, for each coun-try are given by constant elasticity functionsstated in Eqs. 4 to 6. Eqs. 4a and 4b give theregulated and unregulated supply curves,respectively. The notation indicating a spe-cific country has been suppressed:

Qs = aPε; a = A1/(1–k)(w1/α)–α/(1–k)

(w2/β)–β/(1–k) and ∈ = k/(1 – k) (4a)

Qsr = aPε; a = A–1/(α–1)(w1/α)α/(α–1)

x2–β/(α–1) and ∈ = –α/(α – 1) (4b)

Qd = cPη (5)

T = Qs – Qd (6)

Equilibrium is found by solving for the pricewhere world trade balances. The modeldescribed in this paper contains only twocountries: an importer M and an exporter E.The equilibrium condition is given by Eq. 7

TM + TE = 0 (7)

Trade is assumed to equalize prices exceptfor tariffs. In the two trade models used inthis paper, the importing country is assumedto have a tariff and the exporting country hasneither a tariff nor an export subsidy. Theprice linkage equation is given in Eq. 8,where the tariff is given by tM:7

PM – tM = PE (8)

The solution set for this model yields theequilibrium price(s), quantities supplied anddemanded, net trade and production external-ity level for each country.


Measurement of Nonmarket ValuesCritical to meaningful comparisons of thefull social welfare implications of trade andenvironmental policy changes is the ability tomeasure the nonmarket effects of thosechanges. A frequent stumbling block for wel-fare assessments in the presence of nonmar-ket effects is the absence of market values forthe nonmarket component, which leaves ana-lysts at best comparing quantity changes withvalue changes — an “apples and oranges”comparison. In order to make the problemanalytically tractable in the absence of valuesfor marginal changes in lamb or sheepmanure, we solve for threshold nonmarketvalues that leave welfare at the same level asbefore the policy change. The problem isformulated as follows, where ∆w representsthe change in social welfare:

∆w= ∆wM + ∆wNM

where∆wM = ∆producer surplus +

∆consumer surplus +∆government revenues

∆wNM = ∆environmental effects. Setting ∆w = 0 implies that ∆wNM |∆w=0 =–(∆wM). In the present context, there areknown coefficients for the per-head produc-tion of manure for sheep and lambs. Thesecoefficients are then combined with the pro-jected changes in Qs to convert the total∆wNM|∆w=0 into its per-ton equivalent. Thecalculation in terms of specific model vari-ables is given by:

$ per ton of manureNM ∆w=0 =[1/(Qs

r–Qs)(ton/head)][∆wM] (9)

In Figure 3, the relationship between thequantity of manure, m, and the quantity ofoutput, q, is given by the line m(q). Thisfixed relationship is used in Eq. 9 to calculatea value per ton of manure that offsets themarket-based welfare gains. The actual envi-ronmental effect associated with any givenquantity of output is given by x(q) and x(q)′for the unrestricted and restricted cases, andis measured along the right axis. The type ofregulation imposed in the model is shown by

the move from x(q) to x(q)′ to the right ofoutput q, reflecting the restriction to no morethan x2*. Note that it is possible for a policy-induced change in technology to change theshape of x(q) to the left of point q as well.

The functions x2(q) and x2(q)′ representthe input demand functions and can bederived from Eqs. 2 and 3, respectively. Aspreviously explained, sufficient data do notexist to measure the initial amount of x2, andthe model assumes a base level and calcu-lates changes in the externality from thisbase. However, this does not produce a valueof the externality that can be compareddirectly with the market-based welfare gains.

Model Specification and CalibrationThe model is constructed utilizing 1986SWOPSIM elasticities of supply and demandfor mutton and lamb (meat) (Sullivan,Wainio and Roningen 1989). These are con-verted to (live) sheep and lamb elasticitiesthrough use of the derived demand and sup-ply elasticity relationships; i.e., demand forlive lambs is derived from the demand forlamb meat, and mutton supply is derived fromlive sheep supply (assuming constant mar-keting per-unit margins). The price ratiosused in the conversions are border prices asreported by the United States (Fant 1992).Actual production, consumption and tradefigures for 1990 are used in combinationwith the elasticities to calculate the constantof the supply and demand curves.8

As other researchers have found (Ablerand Shortle 1995; Peronni and Wigle 1994),there is a severe shortage of data on the link-ages between output and environmental pol-lution. Part of the solution is to use the theo-retical linkages between the trade and pro-duction models to reduce the number ofrequired parameters. Details on these calcula-tions and data sources for production functionparameters are contained in the Appendix.

MODEL RESULTS

Recall that the purpose of the modeling exer-cise is to explore the market and nonmarketeffects of environmental policies and trade


liberalization, separately and in combination.First, we examine the effects of environmen-tal regulation (restriction on amount of pollu-tion)9 with tariff protection in place. What isits ability to shift production? How do theoutcomes differ when both countries regulateversus unilateral regulation by the importingor the exporting country? The next set ofresults concerns the effects of trade liberal-ization. Having simulated trade liberalizationunder each of the environmental regulatoryscenarios, we ask a set of related questionsconcerning the market and nonmarket effectsof trade liberalization with environmentalpolicies in place. Attention is then given tosocial welfare effects, allowing inferences tobe drawn regarding the desirability of freetrade, environmental regulation and “levelplaying fields” from several vantage points.

Environmental Regulation with TariffProtectionThe simulated market effects of imposingdifferent combinations of environmental pol-icy regimes with tariff protection are present-ed in Table 1. Environmental regulations

decrease the supply elasticity and rotate thesupply curve to the left, reflecting in part ahigher marginal cost for producing a givenlevel of output (supply curve correspondingto Eq. 4b rather than Eq. 4a). The increase inmarginal cost leads to a decrease in produc-tion, and the fall in output changes both thetraded quantity and price.

The first two columns of Table 1 pre-sent the change in price in both the sheep andlamb markets under the various environmen-tal policy regimes.10 In all scenarios, thereduction in output has the expected effect ofincreasing the world price, with the largestincrease taking place when both countriesimpose regulations. The relative magnitudeof the price increase between importing andexporting countries imposing regulationsdepends on the trade elasticities (equal to aweighted sum of domestic supply anddemand elasticities with weights equal to theratio of the domestic supply (demand) to thequantity traded). In the sheep market, thelargest price increase occurs when theimporting country, Mexico, regulates. This isbecause the U.S. excess supply is relatively


Figure 3. Nonmarket effects of regulation

inelastic and can meet the increase indemand only at relatively higher prices.Regulation by the exporting country causesthe largest change in the lamb marketbecause the import demand is relativelyinelastic. Note that in this case the regula-tions are sufficiently restrictive to cause atrade reversal. On the other hand, whenCanada regulates, the highly elastic excesssupply for the U.S. leads to an increase inU.S. exports and only a small increase in theworld price.

The changes in net trade depend on thepattern of regulation. When both countriesregulate, the change in net trade cannot bepredicted a priori because the reduction insupply causes an increase in excess demandand a decrease in excess supply. The resultsillustrate the two possibilities: in our simula-tions, regulations cause an increase in nettrade in the sheep market and a decrease inthe lamb market. When the exporting coun-

try regulates, the decrease in excess supplyshould result in less trade, as illustrated in thesheep market where trade falls by 21,500head. The unexpected result in the lamb mar-ket occurs because of a trade reversal, whichmakes Canada a larger exporter thanimporter. Regulation by an importing coun-try should increase excess demand and nettrade, and the regulation turns the U.S. intoan importer.

The welfare effects of environmental reg-ulation are measured in part by changes in pro-ducer surplus, consumer surplus and net mar-ket welfare, which is the sum of changes inproducer surplus, consumer surplus and tariffrevenue. In all but one case (Canada, lambs)the increase in price caused by the regulationdominates any higher costs, and producer sur-plus increases. The exception in the lamb mar-ket for Canada when it imposes regulationsshows the differences between small and largecountries. Canada faces a highly elastic excess


Table 1. Changes caused by environmental regulation with tariff protection

Scenario Price Net trade Producer surplus Consumer surplus Net market welfare

(US$/head) (1000 head) (US$000) (US$000) (US$000)Sheep Mexico U.S. Mexico U.S. Mexico U.S. Mexico U.S.

Base 32.91 29.92 430.0 27,287 20,511 48,154 10,566 76,727 31,077BER 13.86 12.60 1.7 10,639 8,776 –18,480 –4,152 –7,292 4,624EER 3.62 3.29 –21.5 3,360 1,801 –4,877 –1,093 –1,447 709MER 8.40 7.64 24.1 5,835 5,906 –11,260 –2,526 –5,005 3,380

Lambs Canada U.S. Canada U.S. Canada U.S. Canada U.S.Base 63.39 62.79 11.0 21,211 251,537 43,484 401,087 64,701 652,625BER 9.64 9.64 –8.9 2,845 34,970 –4,232 –50,680 –1,393 –15,710EERa 8.87 8.27 24.7 3,702 30,964 –3,642 –46,665 53 –15,701MER 0.64 0.64 27.1 –921 3,441 –289 –3,426 –1,194 16

Initial supply elasticities used: Canada lambs = 0.312; U.S. lambs = 0.331; Mexico sheep = 0.113; U.S.sheep = 0.112 Supply elasticities with regulation: Canada lambs = 0.295; U.S. lambs = 0.314; Mexico sheep = 0.091;U.S. sheep = 0 .1007 Demand elasticities used: Canada lambs = –0.344; U.S. lambs = –0.167; Mexico sheep = –0.076; U.S.sheep = –0.057Initial trade elasticities: Excess demand: Canada lambs = –26.5; Mexico sheep = –0.48Excess supply: U.S. lambs = 241.2; U.S. sheep = 0.24a Environmental regulation causes a trade reversal.

supply and is nearly a small country in thismarket. In this case, the reduction in Canadianoutput causes only a slight increase in price(64 cents), and producers must absorb thehigher costs. One might expect greater resis-tance to regulation from producers in indus-tries that face strong competition on worldmarkets. Consumer surplus decreases in everycase because of higher prices.

Changes in net market welfare illustratethe linkages between optimal trade and envi-ronmental policy that have been discussed inthe literature (Krutilla 1991). In the sheepmarket, the net market welfare of the U.S.increases when it imposes environmentalregulation because the decrease in supply

causes an increase in the terms of trade. TheU.S. had not previously imposed an exporttax to take advantage of its market power,and the environmental policy partially sub-stitutes for the optimal trade policy.11

The simulated impact of divergent envi-ronmental policies on the location of produc-tion, changes in nonmarket values, and exter-nality changes are given in the top half ofTable 2. Changes in production are shown inthe first two columns and are all small whenexpressed in percentage terms. The largestchange, 7%, occurs for Canada in the lambmarket when it unilaterally imposes regula-tion and corresponds to conditions thatapproximate a small exporting country.


Table 2. Changes in production, threshold nonmarket values, and externality

Scenario Change in production Threshold nonmarket value Externality change

(1000 head) (%) (1000 head) (%) ($/ton manure) (%) (%)Environmental regulation with tariff protection:Sheep Mexico U.S. Mexico U.S. Mexico U.S.

Base 922 763 — — — —BER –37.4 4 –4.9 1 –163 791 — —EER 10.8 1 –23.5 3 111 25 +12.3 —MER –47.3 5 19.9 3 –88 –142 — +28.8

Lambs Canada U.S. Canada U.S. Canada U.S.Base 439 5332 — — — —BER –12.5 3 –134.4 3 –224 –234 — —EERa 17.1 4 –151.8 3 –6 –207 +18.6 —MER –28.7 7 18.0 0 –83 –2 — +1.4

Pure trade liberalization:Sheep Mexico U.S. Mexico U.S. Mexico U.S.

NOER –3.3 0.3 5.5 0.7 –209 –129 –3.5 +7.3BER –2.6 0.3 4.8 0.6 — — — —EER –3.1 0.3 4.9 0.6 –246 — –3.2 —MER –2.8 0.3 5.3 0.7 — –166 — +6.9

Lambs Canada U.S. Canada U.S. Canada U.S.NOER –1.2 0.3 1.7 0.03 0 –1 –1.1 +0.1BER –0.9 0.2 1.3 0.02 — — — —EERa — — — — — — — —MER –1.0 0.2 1.6 0.03 — –3 — +0.1

a Environmental regulation causes a trade reversal. Consequently, trade liberalization is not relevant,given the absence of U.S. tariffs.

Given that environmental policy isimplemented in response to nonmarket con-cerns, a complete analysis includes somemeasure of nonmarket benefits. Presumably,a country would not impose environmentalrestrictions in the absence of negative exter-nalities. Thus we assume that the environ-mental regulation, where imposed, is justi-fied, and any reductions in the amount of theenvironmental input serve to increase socialwelfare. Table 2 gives the calculated thresh-old nonmarket values for each regulationscenario. The case where both countriesimpose regulations is discussed to interpretthe results. Recall that the threshold nonmar-ket value is calculated as the per-ton non-market value for manure required to restorewelfare to the pre-regulation level given byEq. 9. In the sheep market, Mexico experi-ences a fall in both net market welfare andproduction. If production causes pollution,then the threshold value represents the cost(negative value) of pollution required to off-set the regulation-induced fall in market wel-fare. Environmental regulations lead to adecrease in sheep production but an increasein net market welfare for the U.S. The posi-tive threshold nonmarket value is consistentwith a positive externality associated withsheep manure. A per-ton value of $791would be required to eliminate the positivewelfare gains. Obviously, if manure causespollution, then the nonmarket gains increasethe total benefit from regulation. In this case,the terms of trade benefits provide somecompensation to producers, facilitating theimplementation of environmental regulation,as suggested by Krutilla.

The last piece of the puzzle is the simu-lated changes in the production externality.These are presented in the last two columnsof Table 2 as percentage changes from thebase amount for the country that does notimpose regulation. As expected, unilateralregulation by the trading partner leads to anincrease in the level of externalities for theother country ceteris paribus. The increasesrange from a low of 1.4% for the U.S. whenCanada regulates, to a high of 28.8% for theU.S. when Mexico regulates. The changes

for the importers when the U.S. regulates areless diverse: 17.4% for Canada and 12.3%for Mexico. These values are driven both bythe relative size of production and the elas-ticities of demand and supply.

Three conclusions emerge from the sim-ulation results where environmental policy isimposed with tariffs. First, environmentalpolicy can be effective even with trade barri-ers. Second, domestic producers gain fromenvironmental regulation because of theincrease in price. This result presumes alarge country in world markets. Producers insmall countries would have to bear the fullcosts of regulations without any benefit ofhigher prices. The MER scenario for lambsshows results for a case where the importingcountry imposing the environmental policyhas almost no ability to affect prices, and isthe only case where producer surplus falls.Third, the failure to match the regulationsimposed by one’s trading partner has thepotential to increase a country’s own level ofproduction externalities. In the lamb market,social welfare may well decline for the non-regulating partner, given the small size of thenet market welfare gains. In the sheep mar-ket, the increased externality would add toMexico’s simulated loss in net market wel-fare and provide a full or partial offset toU.S. market welfare gains. In all cases, theheightened externality levels serve to exacer-bate the consumers’ losses.12

Trade LiberalizationThe model results from trade liberalizationunder different environmental regulationscenarios are given in Table 3. The calcula-tions assume that the same environmentalpolicy exists before and after trade liberaliza-tion. With regulations in place, trade liberal-ization has the expected effects. Tariffremoval causes prices to fall for the import-ing country and increase for the exportingcountry, and net trade increases.

Trade liberalization induces smallchanges in prices, quantities and welfareacross scenarios. The small tariffs and inelas-tic supply and demand curves drive the sizeof the changes. The results obtained by our


model are representative of most commodi-ties where pre-NAFTA tariffs were small. Asexpected, trade liberalization without envi-ronmental regulation leads to a decrease inproduction externalities for the importer andan increase for the exporter (Table 2).

In addition to producing small marketeffects, a striking similarity in the results isobserved across scenarios. Once environ-mental regulation is in place, trade liberaliza-tion involving the elimination of small tariffsproduces similar results, even if only onecountry imposes regulations. In NorthAmerica, pre-liberalization tariffs are mostcommonly either small or absent. Therefore,for most commodities, the removal of tariffscan be expected to have a small direct envi-ronmental effect.

The results from the trade liberalizationscenarios reinforce the conclusion that tradeliberalization does not render environmentalpolicy impotent. With some types of policies,such as standards that place absolute restric-tions on the amount of pollution, there maybe no damage to the environment from tradeliberalization, even for the exporting country,as illustrated in Figure 3. The bottom half ofTable 2 reports the changes in output andthreshold nonmarket value in the absence of

regulation. The environmental standardimposed in our model allows a country tohave complete control over externalities irre-spective of changes in output.13

Sensitivity AnalysisThe sensitivity of our model to elasticity val-ues is examined for both sets of scenarios.The analysis focuses on the supply elasticitybecause:

• the low values in the available data raisequestions about their accuracy

• increasing the demand elasticity wouldhave a similar effect on world markets

• supply is directly related to concernsabout pollution.

In each set of experiments, the supply elas-ticity in both countries is increased by anequal percentage from the base (in fixedincrements). The related regulated elasticityis calculated for each elasticity value follow-ing Eq. 3. The unit increases are 50% and10% for the sheep and lamb markets, respec-tively. A larger increment is used to generatea wide range of possible outcomes in thesheep market because of the low value of thebase lamb/mutton elasticity. The constantunit increases from the base result in increas-ingly smaller percentage changes from the


Table 3. Changes caused by pure trade liberalization

Scenario Price Net trade Producer surplus Consumer surplus Net market welfare

(US$/head) (1000 head) (US$000) (US$000) (US$000)Sheep Mexico U.S. Mexico U.S. Mexico U.S. Mexico U.S.

NOER –1.05 +1.95 6.6 –961 1490 1414 –647 –833 843BER –1.51 +2.74 5.9 –1337 2083 1995 –892 –1178 1191EER –1.07 +2.25 6.1 –997 1670 1437 –744 –916 926MER –1.44 +2.31 6.4 –1260 1817 1920 –759 –1046 1058

Lambs Canada U.S. Canada U.S. Canada U.S. Canada U.S.NOER –0.54 0.06 2.5 –237 316 244 –315 0 1BER –0.54 0.06 2.0 –231 306 232 –306 0 0EERa – – – – – – – – –MER –0.54 0.06 2.3 –223 300 244 –298 –2 2

aEnvironmental regulation causes a trade reversal. Consequently trade liberalization is not relevantsince the U.S. has no tariffs.

previous value, and this causes the graphs ofthe sensitivity analysis calculations to dis-play a concave function.

Figure 4 presents the changes in thresh-old values per ton of manure for the sheepmodel for the trade liberalization scenariowith no environmental regulation, and forthe divergent regulation scenario when theexporting country (U.S.) imposes regulation.Under the trade liberalization scenarios, U.S.output and net market welfare increase.Therefore, a negative externality effect isrequired to offset the welfare increase. Theper-tonne value falls as supply becomesmore elastic for two reasons. First, theincreased supply response translates intomore manure and the damage per tonrequired to offset the welfare gain falls.Second, the change in market welfare isinversely related to the supply elasticitybecause quantity traded adjusts more and thechange in terms of trade required to bring themarket back into equilibrium is smaller.Mexican output decreases and there is a fallin net market welfare. Therefore, if manureharms the environment, the lower output willimprove welfare from nonmarket effects.The threshold per-ton value decreases as sup-ply becomes more elastic for the same rea-sons given for the U.S. In neither scenario isthe sign of the change in net market welfareor the threshold value reversed.

The sensitivity experiments for the EERscenario illustrate the possibility of changesin the sign of the welfare effect and relatedthreshold nonmarket value. Using the base-line data, Mexico has an inelastic excessdemand curve, and unilateral regulation bythe U.S. increases market welfare by takingadvantage of a previously unexploitedopportunity for an export tax. The change inwelfare becomes negative exactly at thepoint where the increase in the supply elas-ticity makes excess demand elastic. Thethreshold value for Mexico decreasesbecause of the increase in supply response,similar to the U.S. results.

Figure 5 shows the effect in the lambmarket of trade liberalization with no envi-ronmental regulation and the MER scenario

as the supply elasticity for the importingcountry, Canada, increases. In the MER sce-nario, the negligible change in U.S. welfareresults from the fact that Canada has almostno impact on the North American marketprice. The fall in Canadian welfare reflectsthe loss in producer surplus (consumers paythe North American market price) as largerchanges in output occur in response to regu-lation. In the trade liberalization scenarios,similar to the sheep market, the per-tonnenonmarket values fall because of anincreased quantity over which to spread wel-fare effects and a smaller change in the termsof trade.

Other Modeling IssuesAs is always the case, our results are deter-mined in important ways by the generalmethodological approach employed and thespecific assumptions invoked. The modelconsiders only aggregate production andmay not capture large regional changes inenvironmentally sensitive regions. Thisweakness is to some extent ameliorated forevaluation of nonmarket effects, since ourapproach has the potential to support dis-parate regional comparisons of costs andbenefits relative to the threshold per-tonlevels calculated. The threshold values alsohave the advantage of pertaining only to themarginal environmental effects due to thechanges in production levels, rather than rep-resenting some average over all production.One of the well-known drawbacks to usingpartial equilibrium models for this type ofanalysis is the absence of consideration ofalternative uses for the resources. This can beparticularly troubling when external effectsare one of the focal points of the analysis. Inthe present case, arbitrary values areassigned to the initial environmental input,and they can be considered to incorporate thenet environmental input, taking into accountalternative uses at different output levels.The use of a static framework allows for onlylimited changes in technology, and thuslong-run implications cannot be addressed.Through the border price equalizationassumption, it is implicitly assumed in the


model that live sheep and lambs are geo-graphically homogeneous. This may or maynot be an adequate simplification if, forexample, one country exports feeder lambswhile importing fed lambs. One desirablefeature of the approach used is the fact thatthe environmental consequences are not heldconstant across borders or across policy sce-narios, and the level of environmental inputis not fixed with respect to output.

While only one type of environmentalregulation is simulated in this model, it hasbeen established in other research (Bohmanand Lindsey forthcoming) that results are notqualitatively different when pollution taxesare included as an alternative to directrestrictions.

CONCLUSION

Returning to the questions motivating thisresearch, several conclusions are suggestedby the models’ results. These are presentedwith full cognizance of their dependence

upon the parameterizations employed. Thefirst set of questions concerns the extent towhich environmental restrictions affect pro-duction and trade outcomes, and whether ornot environmental regulations remain effec-tive following trade liberalization. One infer-ence that may be drawn from the simulatedmarket outcomes is that, beyond importerversus exporter status, relative size matters tothe effect on production and trade outcomes.In the lamb market, Canadian production isso small relative to U.S. production thatCanadian regulations have no significanteffect on U.S. market outcomes, althoughtrade volumes are affected by the drop inCanadian production. As expected, it makesa difference whether the exporter, theimporter or both regulate, with productiondeclining where regulations are imposed andincreasing when they are imposed by thetrading partner. If price changes are unfet-tered, price increases of varying sizes can beexpected for both trading partners associated


Figure 4. Sensitivity analysis for sheep model: Threshold values as a function of supply elasticities

with the imposition of environmental regula-tions. Net trade increases if the importer uni-laterally imposes regulations, but mayincrease or decrease when the exporter regu-lates, depending on other factors. Some sup-port is found for the concern that unilateralenvironmental regulations may lead to achange from exporter to importer status, asdemonstrated in the lamb market. Finally, ourresults provide no evidence to support con-cerns that environmental policies will be ren-dered ineffective following trade liberaliza-tion. In neither of these North American mar-kets is trade liberalization in the form of tariffremoval shown to make any appreciable dif-ference in the outcomes across regulation sce-narios. In fact, trade liberalization appears tobe remarkably neutral in this regard.

The more significant changes are foundin the various welfare results. Environmentalregulations in this open market frameworkfor these markets lead to sometimes substan-tial shifts in market welfare from consumers

to producers, as producers are able to passalong the costs of environmental regulationsto consumers even in an open economy.Shifts in market welfare among countries arealso found to occur. The importing countryexperiences a market welfare loss when itregulates, and may or may not lose when theexporting country unilaterally regulates. Theexporting country gains when the importerunilaterally regulates, and may gain or losewelfare otherwise. Trade liberalization haslittle effect on overall welfare, but may exac-erbate the shift among countries.

Turning our attention to the desirabilityof a “level playing field” in the sense ofequal restrictions (harmonization), ourresults support the conclusion that combinednet market welfare, not taking into accountexternalities, is highest without additionalenvironmental regulations in both the sheepand lamb markets and lowest when bothcountries regulate. Thus the two “level play-ing field” scenarios form the endpoints, with


Figure 5. Sensitivity analysis for lamb model: Threshold values as a function of supply elasticities

the divergent regulation (mutual recognition)scenarios in between. Nonmarket and distri-butional consequences come into play. Whennonmarket welfare is considered, it wouldrequire implausibly high per-ton nonmarketcosts to turn the welfare loss into a gain inthe lamb market under bilateral regulation,with or without trade liberalization. In thesheep market, the threshold nonmarket val-ues suggest that the U.S. is apt to gain andMexico apt to lose from bilateral “level play-ing field” regulations. Our results also sug-gest that producers are likely to benefit frombilateral regulation, with producers in largecountries gaining more from bilateral regula-tion than from regulations imposed only ontheir trading partner. Consumers of theseproducts foot the bill while society as awhole is presumed to gain from environmen-tal protection.

There is little evidence in these resultsto support the view that environmental poli-cy divergence meaningfully affects the desir-ability of free trade or that free trade condi-tions make a significant difference to thedesirability of harmonized environmentalregulations. To be sure, the threshold non-market values differ across trade liberaliza-tion scenarios, but in one market they aretrivial, while in the other the range is bound-ed by the values from the two level playingfield scenarios.

The contribution of this research to thebody of evidence concerning the interplay ofenvironmental and trade policies and out-comes is enhanced by our relaxation of theassumption that environmental externalitiesare rigidly linked to output levels andthrough calculation of the threshold externalper-unit values necessary to maintain a givenlevel of social welfare. The fruitfulness interms of its contribution to the policy dia-logue is thus linked to the methodologicalcontribution herein, particularly in view ofthe scarcity of data and measurement diffi-culties surrounding nonmarket valuation.Additional explorations of these questionsfor other markets will take our professionfurther down the path of empirically sortingout which are the key parameters.

APPENDIX: CALIBRATION METHOD

The direct linkage of the producer profitmaximization problem to the trade modelfacilitates imposing environmental regula-tions in a theoretically consistent model. Thecalibration method for the base case isdescribed first, followed by the method toimplement the regulated scenario.

The elasticity of the supply curve andthe production function coefficients, α and βare linked by the relationship ε = k/1 – k(recall that k = α + β). Therefore, if data existfor the supply elasticity, then only one freeproduction function exponent remains. Weassume a common value for the environmen-tal input coefficient, β, and derive the com-posite input exponent, α, such that α = ε –εβ – β / (1 + ε). The calibration strategyallows for the productivity of the compositeinput to vary across countries as a function ofthe output elasticity. A positive relationshipexists between ε and α. With this model, dif-ferent values of β across countries could beused to analyze differences in levels of exter-nalities. For example, the proximity to urbanareas or ground or surface water changes theexternality per unit of manure for livestock.However, given the data limitations, we haveassumed a common externality effect acrosscountries.

The relationship between the constantin the production function and the constant inthe supply function is exploited to calibratethe production function. Note that the con-stant for the aggregate supply function isderived following the well-known calcula-tion using data on the supply elasticity anddata on price and quantity. From Eq 4., a =A1/(1-k) (w1/α)-α/(1-k) (w2/β)-β/(1-k). The valueof a can be derived with existing data andinformation about the input price ratios. Datafor relative cost of environmental inputs rel-ative to total costs are available from severalsources. For the livestock industry, theBEA’s Pollution Abatement and ControlExpenditures Statistics, estimate the costs foragricultural businesses (= feedlot operations)for 1990 totaled $12 million ($3 million forcapital expenditures and $9 million for


operating costs). Capital expenditures havefallen since a peak in the mid-1970s. UsingUSDA data for livestock on feed (cattle,sheep and lambs and hogs/pigs), this worksout to 0.2% of the value of the animals. Thismay overestimate costs, since most of theregulations only apply to operations with atleast 100 head.

Ingo Walter’s I-O-based calculations ofdirect and overall environmental control“loadings” for livestock and products enter-ing international trade flows is 1.28% directand 1.98% overall (percentage of final sales).The data are for 1968–70. Jaffe et al (1993)estimated that the 1991 gross annual pollu-tion abatement and control costs as a per-centage of value of shipments for all indus-tries was 0.62%, those with “high” abate-ment costs include paper and allied productswith 1.27%, chemical and allied productswith 1.38%, petroleum and coal with 1.8%and primary metal with 1.51%.

We estimate the relative price of envi-ronmental inputs to other inputs equal to 2%in the base period. The composite inputprice, w1, is set equal to 1. As discussed inthe text, environmental regulations for thelivestock industry have been tightened sincethe base period in the model. The new regu-lations impose limits on the amount of pollu-tion that can be discharged and have beenmodeled as a restriction on the amount of thepollution input. The new elasticity value iscalculated based on Eq. 3 and is used in placeof the observed elasticity value in the regu-lated scenarios. At the margin, we wouldexpect the restricted elasticity (and the priceof the externality) to alter both the mix ofinputs and the quantity supplied to the mar-ket at any given output price.

NOTES1The regulations in British Columbia illustrateone approach to regulation. The British ColumbiaCode of Agricultural Practices legislates thatmanure disposal must not exceed an amount suchthat the soil can absorb the nutrients. The amountthat can be spread depends on both the weatherand the soil. The long rainy season provides thelargest constraint to spreading, and most farmers

had approximately three months’ manure storage,which is less than that implied by the regulations.In British Columbia, construction of four monthsof additional storage for a 100 cow dairy herdcosts between C$12,000 for a clay pit in favorablesoil conditions to C$120,000 for a concrete-lined,covered pit. Thus the costs differ according toenvironmental conditions, even with the sameregulations in place. Note that these same vari-ables affect the amount of externality associatedwith production of a unit of manure.2While this study singles out environmental regu-lations, it should be kept in mind that the livestockindustries of North America and their related mar-kets operate under a complex set of rules and reg-ulations. Hillman (1991) lists an array of nontariffmeasures for Canada and the U.S. These are like-ly to have complex market effects, even withoutthe inclusion of water quality or other environ-mental regulations. Should true harmonization ofnontariff measures be completed, the assumptionrepresents an understatement of the extent of tradeliberalization.3The extent of the offset is determined by the sizeof the tariff relative to the magnitude of the envi-ronmental policy-induced shift in the excessdemand curve and the slopes of the excess supplyand demand curves.4The same result would be obtained were it treat-ed as an output (Copeland and Taylor 1994), butthe model would be more complicated.5The same formulation has been used as the basisfor modeling technology as a pollution controlpolicy by Abler and Shortle (1995).6In the model, manure is assumed to be producedin fixed proportions to output, but does not enterthe production function directly. When the levelof production changes, the manure output changesby this proportion, although the associated exter-nality can vary. To illustrate, assume that manureis equal to γ qs and the nitrogen content is equal toΓ manure (i.e., nitrogen is equal to γ Γ qs ). Thepollution, x2, is related to output by the productionfunction and is less than the fixed proportionsrelationship because the composite good is a sub-stitute input for pollution (x2 = (qsAx1

α)1/β).7The model could easily be extended to accommo-date additional countries and domestic policies.8The data for 1990 are representative of prices andquantities in a typical year for live sheep andlambs in North America.9We also simulate imposition of a 100% environ-mental tax. The main qualitative difference in theresults from those presented here are to be foundin the government revenue figures, which reflect


changes in production as well as import levels.Tables of results for this set of simulations areavailable upon request from the authors.10The changes in price for the sheep market differbetween the U.S. and Mexico because Mexico hasan ad valorem tariff. Canada imposes a per-unittariff that, by definition, remains constant whenprice increases.11Note that U.S. law prohibits export taxes.Related to this point, while an optimal export taxmay increase welfare for a individual exportingcountry (assuming no retaliation) it lowers worldwelfare. Keep in mind that environmental policyis a second-best solution to achieve trade policyobjectives.12These statements are made presuming negativeexternalities. If, instead, the production externali-ties are desirable, the welfare effects would be inthe opposite direction.13Copeland and Taylor (1995) discuss this case.

ACKNOWLEDGMENT

Technical paper number 11122, OregonAgricultural Experiment Station. Authorship isjointly shared. The authors would like to thankparticipants of the workshops and plenary confer-ence of the North American Agricultural PolicyResearch Consortium, and Journal reviewers forhelpful comments.

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