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There is an inherent conflict between free trade and environmental protection through market mechanisms. This conflict resides in the contradictory objectives of internalising the costs of environmental externalities and the pursuit of comparative advantage within free trade.
Economic externalities are created where the activity of one person or entity affects the welfare of other persons or entities who have no direct means of control over those activities, and the costs of this interference are not reflected in the price of the good that creates this intrusion.[1] In essence this means that the effect the product had on the third party goes unnoticed. The inequitable result of this is that the person or entity that causes the externality is receiving a public (or “neighbourhood”) subsidy for the product. Thus, the price of the product does not reflect its true cost.[2]
This problem has traditionally received only peripheral attention. However, in the area of environmental policy, these externalities have become so obvious with many international environmental problems that they can no longer be ignored.[3]
The solution to the problem is believed to lie in making the polluter internalise the cost of the externalities. Internalisation creates an incentive to reduce the activity that produces the external cost, as the prices paid for the item in question rise to reflect the full value of all the sacrifices made to produce it.[4] This argument has now been extended to cover environmental externalities. For example, Principle 16 of the 1992 Rio Declaration on the Environment and Development states:
National authorities should endeavour to promote the internalisation of environmental costs and the use of economic instruments, taking into account the approach that the polluter should, in principle, bear the cost of pollution, with due regard to public interest.[5]
In response to the problem of externalities, new methods have been devised to correct the market failure.[6] The primary method is through taxation, which is a popular idea in both Green theory[7] and contemporary political debate.[8]
This idea of taxes to counter environmental externalities is typically ascribed to Arthur Pigou. He devised a series of taxes and subsidies to account for the social costs which were not incorporated in private decision-making.[9] Crudely, a tax is placed on polluters to bring their cost function into line with what it would have been had they faced the true social cost of their production. Thus, environmental taxes are a way of incorporating the indirect costs into the economy, correcting the shortcoming of the market.[10] This ideal is also broadly consistent with the Polluter Pays Principle. This is a guiding principle of the OECD’s environmental policy, which recognises:
when the costs of [environmental] deterioration are not adequately taken into account in the price system, the market fails to reflect the scarcity of such resources ... the costs of these measures should be reflected in the costs of goods and services which cause pollution and/or consumption.[11]
This concept is intuitively attractive, as it embodies the idea that environmental externalities should be internalised by those who cause them.[12]
Adam Smith opened the door for international economic integration. His thesis of laissez-faire was embodied in his influential work The Wealth of Nations.[13] Smith disagreed with domestic protectionist ideals, and sought to end mercantile institutions by moving towards the “free laws of commerce” in an international setting which would allow the free market system and societies within them to find their true balance, and thus create economic efficiency via specialisation, which would benefit all of those involved.[14] David Ricardo elaborated upon this idea with his thesis of comparative advantage. He postulated that:
Under a system of perfectly free commerce, each country naturally devotes its capital and labour to such employments as are most beneficial to each. This pursuit of individual advantage is admirably connected with the universal good of the whole.[15]
The idea that all benefit from free trade has reappeared in the international environmental arena. For example, Section 2.5 of Agenda 21 states:
An open, equitable, secure, non-discriminatory and predictable multilateral trading system that is consistent with the goals of sustainable development and leads to the optimal distribution of global production in accordance with comparative advantage is of benefit to all trading parties.[16]
The use of comparative advantage is believed to be in accordance with sustainable development. This is because free trade is expected to improve the environment through international competition which is alleged to be environmentally beneficial because of the efficient use of resources, higher productivity and increasingly efficient technologies. These factors are all deemed necessary for sustainable development.[17]
In this context, the ideal of comparative advantage involves an important assumption, namely, that the environment can be used to achieve comparative advantage. In essence, this means that low environmental standards are seen as part and parcel of a country’s comparative advantage to be exploited through trade.[18] Thus, as the Secretariat of the GATT stated:
in principle there is no difference between the competitiveness implications relating to different environmental standards and the competitiveness consequences of many other policy differences between countries - tax, immigration and education policies for instance.[19]
Thus, as the OECD suggested earlier, “[d]ifferent national environmental policies, for example, with regard to the tolerable amount of pollution, are justified”.[20] Consequently, the international trading system ought not to apply to redress or harmonise the different environmental approaches that different countries are willing to tolerate.[21] Therefore, trade advantages gained by countries willing to accept lower environmental standards are treated as part of the “efficient reallocation of production internationally”.[22] Under this theory, Southern countries should take advantage of the fact that their environmental standards are lower than in Northern countries, as a means to attract more investment.[23]
A conflict arises between internalising environmental externalities and comparative advantage when one nation chooses to internalise environmental costs, through for example the creation of taxes, whereas another does not, and, in contrast, actively externalises environmental costs in an attempt to obtain comparative advantage.[24] In such settings, the externalising nation will be actively exploiting a malfunctioning market place, as it is in effect claiming an environmental subsidy by not insisting that the correct price, that takes into account the externality considerations, be paid.[25]
This problem comes to a head when two nations allow their products to compete in an international open economy. Indeed, as the Business Council for Sustainable Development recognised:
The question remains - and to which we have no convincing answer nor indeed know of one - is how can a ... nation charge a price for exports that reflects their environmental costs, and compete against other nations willing to absorb such costs for short term profits?[26]
The difficulty is that there is an imbalance in price, as any product that does not incorporate the costs of externalities, as opposed to a product that does, will be cheaper. This means that a country that chooses to internalise its environmental costs will be at an economic disadvantage in an open market place.[27]
In such a setting, the most obvious solution, if the objective is to internalise the costs of environmental externalities, is to be found in unilateral or regional actions between like-minded countries in an effort to create level economic playing fields.[28] To do this, it is primarily necessary to impose restrictions upon products which do not incorporate the costs of environmental externalities in the same manner that a domestic producer may.
Despite the possibility of averting the conflict through unilateral actions which may create level economic playing fields by making all competitors internalise environmental costs, a further impediment stands in the way. This is the prima facie rejection of unilateral actions in international trade policy when dealing with environmental concerns. In such settings the emphasis is that all actions on environmental issues which could affect differing nations’ exports should be based upon international consensus. This belief stems from an established fear that individual domestic environmental protection justifications which are unilaterally introduced into free trade arenas could act as potential barriers to products that are produced in different, and in this instance, environmentally unfriendly ways. [29] This fear has been particularly acute with Southern countries.[30] Consequently, they are strong advocates of “environmentally unhindered” free trade.[31]
This idea was forcefully brought out at the 1992 United Nations Conference on Environment and Development (UNCED), where the use of unilateral trade distorting measures designed to protect the environment was explicitly and repeatedly rejected.[32]
This outlook reflects the 1991 ruling by a GATT panel of the “Mexican Tuna” issue, where the United States unilaterally restricted the importation of tuna which was caught by Mexican fishermen using fishing methods that are detrimental to dolphins.[33] There it was held that environmental protection considerations extending beyond a country’s jurisdiction could not be used to restrict imports. This would be acceptable only if action was required by international law, such as the Convention on International Trade in Endangered Species of Flora and Fauna[34] or the Montreal Protocol on Substances that Deplete the Ozone Layer,[35] but not if it was required only by domestic law.[36]
Thus, the application of tariffs to the products of other countries which do not attempt to incorporate the costs of environmental externalities may be struck down if there is no pre-existing international agreement dictating the needs for such policies.
Comparative advantage, which works upon externalising environmental costs, is not only an oversight in pricing, it also provides a subsidy by discounting the cost of environmental destruction. However, the Subsidies Code of GATT[37] encourages parties to eliminate subsidies as a form of domestic trade regulation because they are trade distorting.[38] Nevertheless, despite this general appearance of GATT and its inherent dislike for subsidies, certain subsidies continue to be tolerated within free trade agreements (such as for defence industries.)[39]
This is a political choice. If this type of trade distorting subsidy is accepted, there should be an equal or more compelling reason for the elimination of environmental subsidies, through externalities, which openly distort free trade. Yet ironically the definition of subsidy is often stated in very broad terms, and environmental protection, not environmental destruction, can be classified as such.[40] Additionally, the preference in times of conflict is for the capture of comparative advantage, rather than the internalisation of environmental costs. For example, point five of the OECD’s Guiding Principles on the Environment notes that the correct pricing of the environment:
Should be an objective of member countries ... provided that they do not lead to significant distortions in international trade and investment.[41]
This perspective is in accordance with the view that a willingness to destroy the environment should be openly tolerated to achieve comparative advantage. However, this comparative advantage works upon a manipulation of market pricing. Hence the contradiction of free trade in a manipulated market.
There are three possible responses to this problem. One, the nations that internalise environmental costs protect their markets and risk retaliatory measures in the international trade arena. Two, comparative advantage is retained in its classical sense, and environmental costs are willingly incurred and the environment is increasingly destroyed in a race to the bottom for environmental concerns, in the absence of international agreements. Finally, environmental costs are internalised and the market is corrected, consequently increasing environmental protection, and comparative advantage is rightfully orientated to mean free trade, in a free market, in a more sustainable manner.[42]
[*] LLB, LLM (hons) (Auckland), PhD (Nottingham), Lecturer in Law, University of Waikato.
[1] See Ruff, “The Economic Common Sense of Pollution” in Dorfman, R D & N S (eds) The Economics of the Environment (1977) 3, 16.
[2] Daly, H E and Cobb, J For the Common Good: Redirecting the Economy Towards the Community, the Environment and a Sustainable Future (1989) 53.
[3] Ayers, “Industrial Metabolism and Global Change” (1989) 41 International Social Science Journal 365; and Daly and Cobb, supra note 2, 37, 55.
[4] Cairncross, F Costing the Earth (1991) 46-47; Breslaw, “Economics and Ecosystems” in Barr, J (ed), The Environmental Handbook (1971) 83, 84-86.; Dorfman, supra note 1, xviii; and Daly and Cobb, supra note 2, 56.
[5] Principle 16, Rio Declaration on Environment and Development, A/Conf 151/5/Rev 1, 13 June 1992.
[6] See, for example, Dudek, “Energy and Environmental Policy: The Role of Markets” in (1991) 6 Natural Resources and the Environment 22, 25.
[7] Kemball-Cook, D The Green Budget (1991) 15-45; Goldsmith, E/Ecologist, Blueprint for Survival (1972) 37; O’Riordan, T Environmentalism (1981) 105; Goodin, R E Green Political Theory (1992) 196-197; Lewis, M W Green Delusions: An Environmentalist’s Critique of Radical Environmentalism (1992) 180-187; and Lang, T and Hines, C The New Protectionism: Protecting the Future Against Free Trade (1993) 143-145.
[8] See, for example, Brown, L R (ed) Vital Signs: The Trends That Are Shaping Our Future (1993) 21-22; Barrett, “Global Warming: The Economics of a Carbon Tax” in Pearce, D (ed) Blueprint 2: Greening the World Economy (1991) 31, 32; Hutton, “The Penalty for Pollution” Guardian, December 6, 1991; Brown, “Market Forces Key to Greener Britain” Guardian, October 2, 1992; Ghazi, “Car Use to be Curbed in U-Turn on Transport” Observer, September 27, 1993; and “Gummer Moots Greening of Taxes” (1994) 231 ENDS Reports 5-6.
[9] Pigou, A C The Economics of Welfare(1920) 17.
[10] Jacobs, M The Green Economy (1991) 150; Daly and Cobb, supra note 2, 142-143; and Dorfman, supra note 1, i, xxxviii.
[11] See principles 2 & 4 of the OECD’s Guiding Principles on the Environment US Dept of State Release, No 130, June 1, 1972 ((1972) 11 International Legal Materials 1172). See also Pearce, “The Practical Implications of Sustainable Development” in Ekins, P and Max-Neef, M (eds) Real Life Economics: Understanding Wealth Creation (1992) 403, 409.
[12] The idea of environmental taxes is also attractive because of the possibility of redistributing finances, their flexibility to adjustment, and their ability to apply them in situations where there are multiple sources of externality creation. See Tietenberg, “Economic Instruments for Environmental Protection” in Helm, D (ed) Economic Policy Towards the Environment (1991) 86, 105; Brown, “Launching the Environmental Revolution” in Brown, L R (ed) State of the World (1992) 179; Ruff, supra note 1, 1, 17; Jacobs, supra note 10, 153; Lewis, supra note 7, 183-186; and Kemball-Cook, supra note 7, 6-7, 19-23.
[13] Smith, A An Inquiry Into the Nature and Causes of the Wealth of Nations (1776).
[14] Ibid, Book iv, chapter 1. See also Kittrell, “Laissez-Faire In English Classical Economics” (1966) 27 Journal of the History of Ideas 610-620; Sabine G H and Thorson, T C A History of Political Theory (1973) 623-625. For a discussion of this approach as a modern ideology, see Warnock, J W Free Trade and the New Right Agenda (1987) 72-81; and Hagelstam, “Mercantilism Still Influences Practical Trade Policy at the End of the Twentieth Century” (1991) 25 Journal of World Trade Law 127.
[15] Ricardo, D Principles of Political Economy and Taxation (1817) 133-134. Note, Adam Smith also realised that “both may find it more advantageous to buy of one another, than to make what does not belong to their particular trade (supra note 13, Volume 1, 280).
[16] Section 2.5, Agenda 21 UNCED Doc A/CONF 151/4. See also Johnson, S P (ed) The Earth Summit (1993).
[17] Schmidheiny, S and Business Council for Sustainable Development, Changing Course (1992) xi - xii; World Bank, World Development Report 1992: Development and the Environment (1992) 67; and Bergeikj, “International Trade and the Environmental Challenge” (1991) 25 Journal of World Trade Law 105, 106.
[18] Jackson, “World Trade Rules and Environmental Policies: Congruence or Conflict“ (1992) 49 Washington and Lee Law Review 1227, 1243-44.
[19] GATT Working Group, Trade and the Environment, 4 World Trade Materials (1992) 20. See also Jackson, supra note 18, 1227, 1243-44.
[20] See principle 6 of the OECD Guiding Principles on the Environment. U.S. Dept of State Release, No 130, June 1, 11 International Legal Materials (1972) 1172.
[21] See Low, P (ed) International Trade and the Environment (1992) iii. See also Jackson, supra note 18, 1227, 1249; and Schmidheiny, supra note 17, 70.
[22] Pearson, “The Environment and International Economic Policy” in Joint Economic Committee, The United States Role in a Changing World Economy (1989) 114-115.
[23] Porter, G and Brown, J W Global Environmental Politics (1991) 139. The implicit assumption in this is that eventually, after a country has absorbed a set level of environmental damage, and has enough economic strength to choose otherwise, it will adopt a path that is less environmentally damaging. See Anderson, K and Blackhurst, R (eds) The Greening of World Trade Issues (1992) 3, 16-17, 19-20, 167, 241-42.
[24] For the problems of the proposed European carbon tax, see Persaud, “More Hot Air on C02 Emissions: The Community Proposal for An Energy Tax” (1991) 6 Oil and Gas Taxation Law Review 200; Porritt, “Will The World Save the Earth ?” (1992) 10 (5) BBC Wildlife 5; Marshall, “European Challenge to Britain on Energy Tax” Independent, March 24, 1993; Carvel, “Britain Alone in Barring EC Energy Tax” Guardian, April 24 1993; Palmer, “EC Waivers Over Plan To Tax Carbon Dioxide Emissions” Guardian, April 30, 1992; Palmer; “EC Chief To Boycott ‘US-Led Cocktail Party’” Guardian, May 28, 1992; and Spinks; “Multinationals Get Hot Under the Collar Over Europe’s Carbon Tax” Guardian, March 17, 1992. 28. See also the ENDS Reports, in 1992, volume 214, 1, volume 205, 23-24, volume 206, 25, volume 211, 30-31; and in 1993, volume 218, 35-36, volume 219, 37-38, volume 220, 23, volume 222, 12-13, 40-42, volume 25, 35-36; and in 1994, volume 230, 39-40.
[25] Kramer, “The Single European Act and Environmental Protection” (1987) 24 Common Market Law Review 659, 676, 678; Carrol, S The Single European Dump: Free Trade in Hazardous and Nuclear Wastes in a New Europe (1991) 9; Lomas, “Environmental Protection, Economic Conflict and the European Community” (1988) 33 McGill Law Journal 507, 531, 533; Ritchie, “GATT, Agriculture and the Environment: The U.S. Double Zero Plan” (1992) 22 Ecologist 214, 216; Goldman, “Resolving the Trade and Environment Debate: In Search of A Neutral Forum and Neutral Principles” (1992) 49 Washington and Lee Law Review 1279, 1291; and Persaud, supra note 24, 200.
[26] Schmidheiny, supra note 17, 80.
[27] Fish and South, “Industrialised Countries and Greenhouse Gas Emissions” (1994) 6 International Environmental Affairs 14, 34-36; Buckley, “International Trade, Investment and Environmental Regulation” (1993) 27 Journal of World Trade 101,123; Susskind and Ozawa, “Negotiating More Effective Environmental Instruments” in Hurrell A and Kingsbury, B (eds), Global Environmental Politics (1992) 142, 162; MacNeil, J Winsemius, P and Yakushiji, T Beyond Interdependence: The Meshing of the World’s Ecology and the World’s Economy (1991) 74-75, 106; Shrybman, “How Free is Free Trade?” 22 Ecologist 174; Persaud; supra note 24, 200; Spinks, supra note 24, 31; Kemball-Cook, supra note 7, 30; and Cairncross, supra note 4, 77.
[28] Goldman, supra note 25, 1279, 1290; Lang and Hines, supra note 7, 51-53, 89-91; and Buckley, supra note 27, 101, 104, 121, 123.
[29] Porter and Brown, supra note 23, 140.
[30] See Whalley, “The Interface Between Environmental and Trade Policies” (1991) 101 The Economic Journal 180, 187; and Pearce, “A GATT To Our Heads” BBC Wildlife (1992) 58.
[31] This position can be traced back to the 1971 Founex report which stated some of the fears Southern countries had of international environmental regimes: (1) Fear that the developed nations will create rigorous environmental standards for products traded internationally and generate “neo-protectionism” excluding non-conforming goods from poor lands. (2) Fear that the developed lands will unilaterally dictate environmental standards to the developing lands without considering how to relate those standards to the conditions of the developing lands (Founex Report, Environment and Development (1971), reprinted as Annex 1 to UN Doc A/CONF 48/10, December 10, 1971, or International Conciliation No 586, 1972). These fears partly found their way into Recommendation 103 of the 1972 Stockholm Conference on the Human Environment, which states: “All countries present at the Conference agree not to invoke environmental concerns as a pretext for discriminatory trade policies or for reducing access to markets, and recognise further that the burdens of the environmental policies of industrialised countries should not be transferred either directly or indirectly to the developing countries” (UN Doc A/Conf 48/14, 1972). This ideal was earlier recognised in principle 4 (e) of the UNGA Res 2849 (XXVI) Dec 7, 1970 on Development and the Environment which suggested that the 1972 Stockhom Conference should “avoid any adverse effects of environmental pricing on the economies of developing countries, including [through] international trade”.
[32] See Article 2 (5) of the United Nations Framework Convention on Climate Change, UNCED A/AC 237/18 (PART II) Add 1, May 5, 1992; article 13 (a) & 14 of the Statement of Principles for a Global Consensus on the Management, Conservation and Sustainable Development of All Types of Forests UNCED, Doc A/CONF 151/6/ Rev 1, Principle 12 of the Rio Declaration, supra note 5; and sections 2.8, 2.22, 11.24, 17.6 and 39.3 (d) of Agenda 21, supra note 16. See also Paragraph 152 of the Cartagena Commitment from the Eighth UNCTAD (1992) 22 Environmental Policy and the Law 189, 190.
[33] Tuna/Dolphin Panel Report GATT Doc DS 21/R, September 3, 1991.
[34] See Article 1 (c), II (2) & (3) of the Convention on International Trade in Endangered Species UNTS 973 (No 1, 14537) 243-438.
[35] See Articles 4 (2) & (3) of the Montreal Protocol on Substances that Deplete the Ozone Layer ( 1987) 26 International Legal Materials 1541. For discussions of this and the above Convention in this area, see Housman and Zaelke, “Trade, Environment and Sustainable Development: A Primer” (1992) 15 Hastings International and Comparative Law Review 535, 578-82. See also Saunders, “Legal Aspects of Trade and Sustainable Development” in Saunders, J O (ed) The Legal Challenge of Sustainable Development (1990) 370, 383.
[36] See “Update: Summary of Panel’s Decision” (1991) 21 Environmental Policy and the Law 214; “Marine Mammal Protection Act” (1991) 21 Environmental Policy and the Law 214; McDorman, “The GATT Consistency of U.S. Fish Embargoes” (1991) 24 George Washington Journal of International Law and Economics 477, 505-506; and Hooley, “Resolving Conflict Between GATT and Domestic Environmental Laws” (1992) 18 William Mitchell Law Review 483, 489-98.
[37] See Article VI, XVI & XXIII of GATT 55 UNTS 187.
[38] Agreement on Technical Barriers to Trade GATT Doc L/4907, BISD (26th Supp) 56 1980.
[39] Ritchie, “Free Trade Versus Sustainable Agriculture: The Implications of NAFTA” (1992) 20 Ecologist 221, 225; and Shrybman, “International Trade and the Environment: An Environmental Assessment of GATT” (1990) 20 Ecologist 30, 32.
[40] See Pearce, D and Warford, J J World Without End: Economics, Environment and Sustainable Development (1993) 307, 309-312; Ritchie, “GATT, Agriculture and the Environment: The U.S. Double Zero Plan” (1990) 20 Ecologist 214; Jackson, supra note 18, 1227, 1247-48; Housman, supra note 35, 541, 555; Shrybman, supra note 39; Warnock, supra note 14, 159-162; and Ritchie, supra note 39, 225.
[41] Point 5, OECD, supra note 11.
[42] Note that certain important commentators such as David Pearce (supra note 40, at 299-300) suggest that it is better to adopt “corrective policies” such as international financial assistance and technology transfers to Southern countries, rather than distort international trade in an attempt to incorporate environmental externalities. The problem with this is that while it may encourage Southern exporters to adopt better environmental policies it neither economically protects countries that do incorporate the costs of environmental externalities, nor encourages Southern countries to work directly towards incorporating environmental costs. A better approach would be to protect the entities which internalise environmental costs, and redistribute a portion of the increased tariffs that are incurred by non-internalising countries (depending upon their economic position) to parties which do attempt to internalise their costs.
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