An argument against free trade

A few posts ago, starting from the fact that non-OECD countries are for the first time in history producing more CO2 than their wealthier cousins, I wondered about the implications of global warming for free trade:

I expect another reason to be important (for the rise in CO2 emissions from non-OECD countries) and that's the migration of 'dirty industries' to the countries with the least stringent environmental standards and the lowest taxes on fossil fuels.

Can global warming in a world with widely varying taxes on CO2 emissions provide an argument against free trade? Trade is beneficial when a country has a comparative advantage in producing a certain good, but what if that advantage is borne out of differences in energy taxes? Is trade in private goods as beneficial as mainstream models suggest in the presence of global externalities?

Wikipedia has a good article, accessible to everyone, on comparative advantage. The cornerstone of trade theory and one of the most fundamental insights economics has to offer, the theory of comparative advantage powerfully demonstrates that everyone can gain from trade in the presence of different relative costs of production.

Picture a world with only two counties (let's call them USA and China) where only two goods are produced and consumed: call them 'services' and 'manufactures'. Asssume that there are no barriers to trade, so that eventually we reach an equilibrium where all gains from trade are exhausted.

Enter global warming. We now know that production of 'manufactures' also involves social costs and the free market is not efficient. The US takes immediate steps to rectify the situation and imposes a pigouvian tax on the production of manufactures. If the Chinese follow suit, the problem is solved. But what if they don't?

In the presence of taxes on US production, the relative cost of producing 'manufactures' in China goes down and production shifts away from the US to reflect the change in comparative advantage.

Under this scenario, some of the gains from trade are transferred from the US to China, as China can only emerge better off from this change in US costs of production. And the planet suffers too: with production of manufactures shifting from the US to China, the effect that a tax on the US production of manufactures has on global CO2 emissions can be as low as non-existent.

In this situation, and if the US is serious about achieving a more socially efficient outcome, it has only one option: to impose an indirect pigouvian tax on Chinese production of manufactures by introducing import duties.

In other words, to the extent that CO2 emissions are taxed at a socially inefficient level in some jurisdictions, free trade means that those that tax CO2 the least will enjoy a larger share of the gains from trade than would have been the case under a global pigouvian taxation regime. Furthermore, under a plausible set of assumptions, local taxes can be next to completely ineffective in reducing CO2 emissions, and import tarrifs and duties can lead to welfare increases in a county worried about global warming.

How long until global warming starts featuring prominently in trade negotiations?


  1. Keith Says:

    Surely just a special case of Harding's 'tragedy of the commons'.

    I do take issue with the idea of comparative advantage being to everyones' benefit (though of course, you said it may, be not it is). Things like the dis-benefit of atmospheric carbon are a fashionable example of market failure, but there are many and substantial social costs to 'free trade' that remain under the radar. Do we really want to work in a human monoculture? Is economic efficiency really the only thing that matters in people's lives? I think we would all be a lot happier if we returned to the 18th century idea of harnessing the economy to work as our servant, rather than the 20th century idea of us all being the servants and tools of the economy.