Chapter 27 International Trade, Foreign Investment, and the Environment

The 1990s produced a large literature on foreign trade and the environment, including both theoretical and empirical contributions. The paper surveys this literature. It starts by looking at the traditional Heckscher–Ohlin type models of international trade and then moves to noncompetitive models and the strategic use of environmental policy in open economies. A shorter section is devoted to public-choice approaches to environmental policy. Moreover, the paper deals with factor mobility and interjurisdictional competition, with intertemporal issues such as renewable resources and foreign indebtedness, with the empirical evidence, and with institutional issues related to the World Trade Organization and international environmental agreements. Basically three questions are addressed from different points of view: – Are trade liberalisation and increased factor mobility good or bad for the environment? – Are there larger incentives to relax environmental policies if economies are more open? – Do we have to expect a race towards the bottom in environmental regulation if trade and international factor movements are liberalised? The answers to all these questions are ambiguous. Since many of the recent contributions to the theoretical literature model second-best worlds, in which the environmental externality is only one of several distortions of the economy, the results depend crucially on the nature of the other distortions. This survey paper gives an overview of this literature and explains the contradictory results. On the empirical side, the results are inconclusive as well. The link between environmental policies on the one hand and international trade and factor movements on the other is much weaker than one might have expected given the intensity and controversy of the policy debate at the turn of the century. Based on the theoretical results and on the empirical evidence, the paper finally tries to identify promising areas of future research. In spite of much progress made in the last decade, much remains to be done.