Wednesday, April 7, 2010

About the impact of environmental product regulation on the environment in the North and the South

Imagine that the world is separated in two: a more developed North that cares about the environment, and a less developed South that does not. The North imposes restrictions on the consumption of goods that pollute. Conventional wisdom tells us the environment should be improving in the North and deteriorate in the South.

Jota Ishikawa and Toshihiro Okubo tell us the opposite could happen. The crucial aspect here is that firm can relocate. The producer of a polluting good could just stop serving the North and then relocate to the South. This is what all those against environmental regulation are afraid of. As long as the remaining goods are still polluting, and if there is going to be more production and consumption of those, one could get more pollution in the North. For this to happen, though, one needs some particular circumstances: pollution is only global, competition is monopolistic, compliance costs are low, and standards are lax. To make sure the environment is improved this calls for perfect competition (getting rid of protectionist measures), high compliance costs and rigorous standards. Easy.

The reason for the counter-intuitive result is, not unexpectedly, rather twisted. Once the North introduces regulation, firms producing affected goods move South. There is less competition in the North, which attracts firms not affected by regulation from the South. But there is less good variety in the North, and the goods of the newcomers cost less than before because trade costs are dropped, thus consumers buy more. The opposite happens in the South. Kind of hard to believe, but I cannot see where the argument would go wrong.

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