INTERNATIONAL AGREEMENTS: TRADE, LABOR, AND THE ENVIRONMENT

INTERNATIONAL AGREEMENTS: TRADE, LABOR, AND THE ENVIRONMENT
11 1 International Trade Agreements 2 International Agreements on Labor Issues 3 International Agreements on the Environment 4 Conclusions INTERNATIONAL AGREEMENTS: TRADE, LABOR, AND THE ENVIRONMENT

Introduction 1999 WTO trade negotiations in Seattle, WA were the first to be heavily protested, with protests sometimes turning violent. Past trade negotiations had focused on lowering tariffs in most sectors of members’ economies. Remaining barriers to trade, however, dealt with regulatory barriers, such as environmental regulations. The Uruguay Round (1986–1994) allowed for countries to bring disputes if they felt they were excluded from a market due to unreasonable environmental standards.

Introduction These new rules infuriated many groups who thought the WTO might threaten their environmental interests. Additionally, many felt it undesirable for a panel in Geneva to make rulings affecting domestic regulations. All these groups gathered in Seattle to voice their dissatisfaction with the WTO. The goal of this chapter is to examine why international agreements are needed, and how these agreements affect labor and environmental issues.

Introduction When a country imposes a tariff, the domestic producers receive a higher price which gives a terms-of-trade gain for the importing country. We will show that when two or more countries implement tariffs to try to achieve these terms-of-trade gains, they both end up losing. To avoid these losses, international agreements to reduce tariffs and move toward more free trade are needed.

Introduction The WTO is a multilateral agreement, involving many countries, with agreement to lower tariffs between all members. Regional trade agreements involve several countries, often located near each other, which offer free trade among the member countries. The North American Free Trade Agreement (NAFTA). NAFTA also included “side agreements” involving the rights of workers and the environment, as do other international agreements.

Introduction We will discuss the extent to which NAFTA and other labor agreements protect the rights of workers. We will also discuss international agreements on the environment. Rulings at the WTO have a direct impact on the environment, but other international agreements have a more direct impact. International agreements are needed to ensure that countries recognize the external environmental costs of their economic activities.

Learning Objectives To understand why international agreements like those negotiated under the WTO are needed. To examine how such agreements affect labor issues. To examine how such agreements affect environmental issues. To understand why international agreements to reduce tariffs and move toward free trade are needed. To understand what a regional trade agreement is.

Learning Objectives To understand the role of regional trade agreements in reaching the free trade goal. To understand the role of labor and environmental issues within regional trade agreements. To understand the extent to which NAFTA and other labor agreements protect the rights of workers and the environment. To be able to explain the indirect impact of the WTO on labor and environmental issues and the direct impact of regional agreements.

Learning Objectives To understand how countries do not recognize the true costs of their economic activity on the environment—negative externalities. To understand that for “global” pollutants, international agreements are needed to incorporate these negative externalities.

International Trade Agreements
Countries will often enter into a trade agreement to reduce trade barriers between themselves. A pact to reduce or eliminate trade restrictions. The WTO is a multilateral trade agreement, involving many countries, all with the goal of reducing tariffs between member countries. WTO has negotiated many trade agreements. Under the most favored nation principle, the lower tariffs agreed to in these negotiations must be extended equally to all WTO members. New members get these benefits, but must also agree to lower their own tariffs.

To demonstrate a multilateral trade agreement, we will assume there are only two countries. The important feature of a multilateral agreement is that NO member country is left out of the agreement. We will then analyze regional trade agreements occurring between smaller groups of countries. Implications from these are much different than those from multilateral trade agreements. There are over 200 free trade agreements worldwide. Some threaten the WTO as a major forum for multilateral trade liberalization.

The Logic of Multilateral Trade Agreements Tariffs for a large Country Figure 11.1 shows the effects of a tariff on a large country (Home). We found before that a tariff leads to a deadweight loss for Home: (b+d). We also saw a terms-of-trade gain for Home, e, which equals the reduction in Foreign price due to the tariff times the Home imports with the tariff. If Home applied the optimal tariff, then the terms-of-trade gain exceeds DWL, and Home gains overall. For Foreign, a DWL, f, exists from inefficient production levels. The Home gain comes at the expense of an equal terms-of-trade loss for Foreign, e, plus the DWL, f.

Figure 11.1 Figure 11.1 Tariff for a Large Country The tariff shifts up the export supply curve from X * to X * + t. As a result, the Home price increases from PW to P * + t, and the Foreign price falls from PW to P *. The deadweight loss at Home is the area of the triangle (b + d ), and Home also has a terms-of-trade gain of area e. Foreign loses the area (e + f ), so the net loss in world welfare is the triangle (b + d + f ).

The Logic of Multilateral Trade Agreements The Payoff Matrix We stated before that it is optimal for large countries to impose small tariffs, but that did not consider strategic interactions between multiple large countries. If every country imposes a small optimal tariff, is it still optimal behavior for these countries? We can use the payoff matrix to determine the Nash equilibrium outcome for each country’s tariff level. Figure 11.2 shows the payoff matrix between Home and Foreign, both large countries deciding to impose a tariff. Assume the two countries are the same size so payoffs are symmetrical.

The Logic of Multilateral Trade Agreements Free Trade The upper left hand quadrant is when neither country imposes a tariff. The payoff for the two countries is 0. Payoffs will be measured in any other situation as relative to free trade. Tariffs Suppose Home imposes a tariff but Foreign does not. Home payoff is e – (b+d), and Foreign’s is –(e+f). This is the lower-left quadrant. If the opposite occurs, the payoffs are exactly opposite, and this is the upper-right quadrant.

The Logic of Multilateral Trade Agreements Tariffs If both countries impose the optimal tariff, they are the same size. Terms-of-trade gain for each country is cancelled out by the terms-of-trade loss it suffers because of the other country's tariff. Both countries suffer DWL: -(b+d+f). Their own DWL, plus DWL from the other country’s tariff. This is the lower right quadrant of the matrix.

Figure 11.2 Figure 11.2 Payoffs in a Tariff Game This payoff matrix shows the welfare of the Home and Foreign countries as compared with free trade (upper-left quadrant in which neither country applies a tariff). Welfare depends on whether one or both countries apply a tariff. The structure of payoffs is similar to the “prisoner’s dilemma” because both countries suffer a loss when they both apply tariffs, and yet this is the unique Nash equilibrium.

The Logic of Multilateral Trade Agreements Prisoner’s Dilemma The pattern of payoffs we just saw has a special structure called the “prisoner’s dilemma”. This is a game where two accomplices are caught in a crime and each has to decide whether or not to confess, when locked in separate rooms unable to communicate. The best result for both is to not confess. However, since they cannot communicate and do not know what the other is doing, the best option for each is to confess. This is similar to our situation where each country acting on its own has an incentive to apply the tariff, but doing so makes both worse off.

The Logic of Multilateral Trade Agreements Nash Equilibrium The only Nash equilibrium in figure 11.2 is the lower right quadrant—both countries apply a tariff. To move from that point would increase the countries’ loss, (e+f) > (b+d+f), so the Nash equilibrium for both countries is to apply the tariff. The Nash equilibrium leads to an undesirable outcome for both countries, even though it is the best choice if the other country imposes a tariff.

The Logic of Multilateral Trade Agreements Free Trade Agreement The bad outcome can be avoided if the countries enter into some type of free trade agreement. The WTO provides a mechanism to eliminate the prisoner’s dilemma by giving an incentive to remove tariffs. Those who join the WTO must agree to remove some tariffs, but in return they get lower tariffs from other members. This allows us to move closer to free trade. It is then more likely to end up in the upper left quadrant of the payoff matrix instead of the lower right.

Regional Trade Agreements In this case countries eliminate tariffs among themselves, but keep tariffs against other countries. Article XIV of the GATT states regional trade agreements are acceptable as long as the group does not jointly increase tariffs against outside countries. They do, however, contradict the most favored nation principle. Countries in the regional trade agreement are treated better (no tariffs) than countries outside the agreement.

Regional Trade Agreements Sometimes they are called preferential trade agreements. This emphasizes that member countries are favored over other countries. Even though they violate this principle, they are permitted because they are a positive move toward free trade with a larger group of countries. Regional trade agreements are classified into two basic types: Free trade areas Customs unions

Regional Trade Agreements Free trade area A group of countries agreeing to eliminate tariffs (and other barriers to trade) between themselves, but keeping whatever tariffs they formerly had with the rest of the world. In 1989, Canada entered into a free trade agreement with the U.S. known as the Canada-U.S. Free Trade Agreement (CUSFTA). In 1994, Mexico was included to create the North American Free Trade Agreement (NAFTA). Each of these countries have their own tariffs with all other countries of the world, but have worked to eliminate trade barriers with each other.

Regional Trade Agreements Customs Union Similar to a free trade area, except that in addition to eliminating tariffs among countries in the union, the countries within a customs union also agree to a common schedule of tariffs with each country outside the union. Examples are the European Union (EU) and the signatory countries of Mercosur South America. All countries in the EU have identical tariffs with respect to each outside country, as does Mercosur.

Regional Trade Agreements Rules of Origin If China is looking to export a good to Canada, it will want to do so at the lowest cost. If Canada has high tariffs on that good, but Mexico has low tariffs, why not export to Mexico and then trade it freely to Canada? Free trade areas have complex rules of origin. Specifies what type of goods can be shipped duty-free within the free trade area. The good from China to Mexico would not get duty-free access to Canada in this example. The good would first have to be used in the production of another good giving it enough “North American content” to qualify for duty-free access.

Regional Trade Agreements Rules of Origin Specifies, for each and every product, how much of its production has been done in North America. These rules are clearly not needed in a customs union since all the countries have common tariffs with outside countries. So why not just create a customs union and make it easier? Because tariffs with outside countries are a political issue, of which many countries wish to maintain control. So what are the economic effects of regional trade agreements, in either case?

Trade Creation and Trade Diversion When trade agreements are made, the increased trade can be of two types. Trade creation occurs when a member country imports a product from another member country that it made for itself before. Gain in consumer surplus for importing country due to lower prices. Gain in producer surplus for exporting country due to increased sales. Same as opening trade effect in Ricardian or HO models. No other country is affected because the good was not traded at all before—welfare gains for both countries.

Trade Creation and Trade Diversion Trade diversion occurs when one member country imports a product from another member country that it was previously importing from an outside country. Trade is taken away from one country and moved to another country. This is not always the most efficient move since the former country might have been producing at lower costs, but due to changes in tariffs, it ends up cheaper to import from the member country.

A Korean-American Strand Enters Trade’s Spaghetti Bowl
The U.S. and South Korea are forming a free trade agreement. The agreement looks beneficial, especially for these two countries. Significant reduction in tariffs, liberalization for U.S. farm exports, greater protection for U.S. investors, greater protection of intellectual property, etc. So what are the problems?

This agreement essentially allows them to discriminate in favor of exporters or investors based in each other’s territory. This is likely to create significant trade diversion. Partners might shift from more competitive to less competitive suppliers. More importantly, given the increase in the number of preferential trade agreements, this being a significant one, other countries will be desperate to avoid the consequences for them. Could that mean even more agreements?

What are the economic consequences of that? A larger portion of world trade will be under the complex rules that govern many of these agreements, which means greater administrative complexity. Every new agreement changes the preferences for suppliers, which is likely to create uncertainty for businesses. Professor Jagdish Bhagwati of Columbia university has called this the “spaghetti bowl” of preferences.

There are important political consequences that go along with the economic ones. A company's access will depend more on the power of its government to open markets than on the competitiveness of the country. Governments with lots of power will compete to get more favorable terms for their producers. Many are starting to believe these effects are all far removed from what the founders of the GATT system were after.

Numerical Example of Trade Creation and Diversion Let’s consider an example from NAFTA where an auto part is now imported by the U.S. from Mexico instead of from China. We can keep track of the gains and losses for the countries involved. Asia loses export sales, loss in producer surplus. Mexico gains producer surplus from increased sales. Since Mexico is not the most efficient producer, there is potential social loss due to the trade diversion.

Numerical Example of Trade Creation and Diversion We can see the potential cost amount in Table 11.1. The table shows the costs to import the part from Mexico and Asia under three different tariff options: 0%, 10%, and 20%. In the first set, there is no trade agreement, so it is cheaper to import from Asia under a tariff of 0% and 10%, but cheaper to make it themselves (no trade) with a 20% tariff. However, in the second set, under NAFTA, there is no tariff for Mexico at any point, so it is cheaper to import from Mexico for tariffs of 10% and 20%.

Table 11.1 Cost of Importing an Automobile Part Table 11.1 Cost of Importing an Automobile Part This table shows the cost to the United States of purchasing an automobile part from various source countries, with and without tariffs. The numbers illustrate the idea of trade diversion, under which the United States could switch from buying the auto part from Asia before NAFTA (for $20.90 with a 10% tariff) to Mexico after NAFTA (for $20 with zero tariff). While the United States gains 90¢ on each unit from paying a lower price, it also loses $1.90 in tariff revenue from not purchasing from Asia.

Numerical Example of Trade Creation and Diversion Trade Creation Assume there is a 20% tariff. After NAFTA, the U.S. will import from Mexico for $20, since it costs more to import from Asia ($22.80) or to make it themselves ($22). The U.S. clearly gains from the lower cost of the part, Mexico gains through exports to the U.S., and Asia is unaffected since it was not exporting at that tariff level anyway.

Numerical Example of Trade Creation and Diversion Trade Diversion Now suppose the tariff was 10% instead. Before NAFTA, the U.S. imported the part from Asia for $20.90. After NAFTA, it will import from Mexico at a price of $20. Because of NAFTA, the U.S. switches the source of imports from Asia to Mexico—trade diversion. Producer surplus in Asia falls and producer surplus in Mexico increases. What about the U.S.? Although they gain $0.90 on each part, they lose $1.90 in tariff revenue from each import from Asia.

Trade Diversion in a Graph Figure 11.3 shows the free-trade price of the part from Asia, with the free-trade export supply curve for Asia. We assume the U.S. is a small country relative to the potential supply from Asia. Including the tariff, the cost of imported parts from Asia is Pasia+t and the supply curve is Sasia+t. The free-trade supply from Mexico is upward sloping, Smex and inclusive of the tariff is Smex+t. Before NAFTA, both Mexico and Asia face the same tariff.

Trade Diversion in a Graph Equilibrium is at A, importing a total of Q1 at a price of Pasia+t. Of total imports, Q2 comes from Mexico at B, since under perfect competition these imports have the same tariff-inclusive price as those from Asia. Tariff revenue is collected on imports from both Mexico and Asia as (a+b+c+d).

Trade Diversion in a Graph After Mexico joins NAFTA, it can sell duty-free to the U.S. The relevant supply curve is now Smex and imports from Mexico increase to Q2 at C. The price charged remains Pasia+t since Mexico’s MC has increased along its supply curve, so the price to U.S. has not changed. U.S. loses tariff revenue of (a+b+c). Mexico gains producer surplus of (a+b). The combined effect of NAFTA is a loss of c. The combined welfare actually falls due to NAFTA.

Figure 11.3 Net Loss After NAFTA, the relevant supply curve is Smex. Equilibrium imports from Mexico are now Q3 at C. MC for Mexico are higher so price stays at Sasia+t The price faced by the U.S. with the tariff, before NAFTA, is Pasia+t with Asia and Mexico supply curves of Sasia+t and Smex+t At this price, the U.S. equilibrium imports total Q1 at A. Of the total imports, Q2 will be from Mexico at B Price The U.S. loses tariff revenue of (a+b+c) Mexico gains producer surplus of (a+b) The combined effect of NAFTA is a net loss of c Smex+t The US gains tariff revenue of (a+b+c+d) Smex Q2 B C Q3 A Q1 Pasia+t Sasia+t b c d a Pasia Sasia MUS Import Quantity

Trade Diversion in a Graph Interpretation of the Loss This is one of the few cases where we have said that a move to free trade makes a country worse off. Why does this happen? Asia is the more efficient producer of the good for units Q3-Q2 with MC=Pasia. When production is diverted to Mexico, the extra exports from Mexico are produced at MC=Pasia+t. The combined loss c can be interpreted as the average difference between Mexico’s MC and Asia’s MC times the extra imports from Mexico. This is similar to the “production loss” or “efficiency loss” we saw with a tariff for a small country.

Trade Diversion in a Graph Interpretation of the Loss What we have to remember is that even though we moved to free trade between Mexico and the U.S., the tariff with China remained. It is really only a partial step toward free trade, which can clearly be bad for countries involved. This is an example of why some economists oppose regional trade agreements, but support multilateral trade agreements under the WTO.

Trade Diversion in a Graph Not all trade diversion creates a loss. The previous loss is only a possible outcome, depending on Mexico’s MC’s. There could be a gain to the importing country. In figure 11.3, suppose that after joining NAFTA, Mexico has significant investment into the auto parts industry, and its supply curve shifts to S’mex. Equilibrium is then at D at a price of Pasia and Mexico will fully replace Asia as a supplier of parts. In this case, the U.S. loses tariff revenue of (a+b+c+d). However, the import price drops to Pasia increasing U.S. consumer surplus by (a+b+c+d+e). Net change in U.S. welfare is then +e: a net gain. Clearly Mexico’s producer surplus still gains as well.

Figure 11.3 Net Gain If Mexico has significant investment in auto parts after NAFTA, supply could shift to S’mex increasing equilibrium imports to point D. Price U.S. still loses tariff revenue of (a+b+c+d). But gains consumer surplus of (a+b+c+d+e) for a net U.S. gain of e. Smex+t Smex S'mex Pasia+t Q2 B C Q3 A Q1 e Sasia+t b c d a Figure 11.3 Trade Diversion With Mexico and Asia facing the same tariff of t for sales into the United States, the equilibrium is at A with the quantity Q2 exported by Mexico and the remainder exported by Asia at a price of Pasia + t. U.S. tariff revenue is the area (a + b + c + d). Eliminating the tariff with Mexico under NAFTA leads to an expansion of Mexican exports to Q3. The United States loses the tariff revenue (a + b + c), which is the U.S. loss as a result of trade diversion from Asia to Mexico. Pasia Sasia D MUS Import Quantity

Trade Diversion in a Graph It is very possible for any particular case to have elements of trade diversion and trade creation. NAFTA and other regional trade agreements have the potential to create net gains for members. However, this is only true if the amount of trade creation exceeds the amount of trade diversion. Now we can use this information to see the effect on Canada and the U.S. of opening free trade.

Trade Creation and Diversion for Canada
In 1989 Canada formed a free trade agreement with the U.S. Five years later, they entered into NAFTA with the U.S. and Mexico. Professor Daniel Trefler at the University of Toronto has analyzed the effects of these free trade agreements on Canadian manufacturing industries. As part of his research, Trefler estimates the amount of trade creation and diversion for Canada in its trade with the U.S.

He finds the reduction in Canadian tariffs on U.S. goods increased imports of those goods by 54%. Trade Creation Purchasing those goods from the U.S. decreased their imports from other countries by 40%. Trade Diversion Note that 80% of all Canadian imports are from the U.S. and the other 20% are from the rest of the world, so the numbers above must be weighted appropriately.

54% of the trade creation is multiplied by the 80% of Canadian imports that come from the U.S. 40% of lost imports from the rest of the world is multiplied by the 20% that typically comes from the rest of the world. Taking the difference between trade created and diverted, we get: 80% x 54% - 20% x 40% = 35% > 0 Share of US imports Increase in US imports Share of other imports Decrease in other imports Since this number is positive, trade creation is greater than trade diversion. Canada gained.

International Agreements on Labor Issues
Regional issues often involve issues other than tariffs. The two big issues that are typically discussed are effects on the environment and on labor. Labor standards refer to all issues that directly affect workers, including occupational health and safely, child labor, minimum wages, etc.

Labor standards were included in NAFTA to satisfy two different groups. Consumers and policy makers are often concerned with working conditions, especially in developing countries, and want to avoid any worker exploitation. Unions in the developed countries are also concerned with these issues partly due to solidarity with foreign workers and partly due to increased competition for “home” workers. Imports are cheaper if businesses do not have to put costs toward these issues.

Economists are often skeptical about such concerns as they can be viewed as attempts to “protect” domestic interests in the developed country. Results in less competition if the foreign country has to increase their costs to the same level as the home country. Economics teaches us that we need to be careful that enforcing labor standards in other countries does not create a worse condition for those workers.

Labor Side Agreement under NAFTA NAFTA does not change the labor laws in countries, but is meant to improve enforcement. If one country believes another is not enforcing their own laws, the country can be brought before the North American Agreement on Labor Cooperation (NAACL). Many cases have dealt with the maquiladora plants in Mexico, but charges have been brought against the U.S. as well. Migrant workers picking apples in Washington state. 1998 case with resolution in 2000.

Labor Side Agreement under NAFTA Critics of NAALC argue that procedures for resolving disputes are slow and include major exceptions that render them ineffective. Others argue that the agreement has caused an institutional forum where labor unions and activists from the three countries can build solidarity.

Other Labor Agreements There are many other examples of international agreements that monitor the conditions of workers in other countries. Unions and other organizations are concerned about rights of workers to unionize, job safety, and work hours. Consumers can also play a role as companies clearly listen to what consumers say with their purchasing decisions.

Other Labor Agreements Consumer Responsibility How much do consumers value the idea that clothing purchased is made under good working conditions? National Bureau of Economic Research (NBER) surveyed consumers on this question (see Table 11.2). Sample A asked if they cared “about the condition of the workers who make the clothing they buy.” 84% said “yes.” They were also asked “how much more they would be willing to pay for items made under good working conditions.” Premium was $2.80 for a $10 item and $15 for a $100 item.

Other Labor Agreements Consumer Responsibility Sample B was asked about the premium they would be willing to pay for workers in “good” conditions, and the discount needed to buy the T-shirt made under “bad” conditions. 84% would choose an identically priced alternative. 64% would not purchase the shirt at all. 35% would still consider buying the shirt (an average discount of $4.30). The premium willing to pay for a shirt produced under “good” conditions was $1.83.

Other Labor Agreements Consumer Responsibility One observation is that consumers have a downward-sloping demand curve for labor standards. Will pay a small amount to assume good standards. A second observation is that individuals need a higher discount to buy the shirt made under “bad” conditions than the premium they would pay for the one made under “good” conditions. Consumers are more worried about potential losses than potential gains. Similar results have been found in other surveys. We can conclude a significant number of consumers are willing to change shopping patterns in response to poor labor conditions of foreign workers.

Table 11.2 Survey Responses Table 11.2 Survey Responses This table summarizes the responses from a survey conducted by the National Bureau of Economic Research that asked individuals their attitudes toward an item made under good working conditions and under poor working conditions. Source: Kimberly Ann Elliott and Richard B. Freeman, 2003, Can Labor Standards Improve under Globalization? Washington, D.C: Peterson Institute for International Economics, Chapter 2, Table 2.1.

Other Labor Agreements Corporate Responsibility Pressure from consumers and unions has forced many corporations to report on the working conditions of their overseas plants and those of sub-contractors. Nike publicized the names of their sub-contractors overseas. We see that other corporations are following suit.

Nike Reveals Overseas Supply Chain
Nike chose to disclose the names and locations of about 700 factories that produce their shoe and apparel goods. This was on the tail of significant controversy over labor practices in their foreign factories. As a move toward more corporate responsibility and their corresponding report, Nike was the first major apparel company to voluntarily disclose this information.

Companies have been reluctant to give plant locations for independent assessments, due to the fear of revealing trade secrets. Nike stated that even thought the risk still existed, it was worth it to force facing some “endemic issues.” Nike acknowledges that conditions in some of its factories was less than desirable, such as sweatshop conditions and overtime hours.

In Nike’s report, they audited 569 factories during 2004 and 2005 with some of the following results: Physical or verbal abuses in about ¼ of South Asian factories. 25-50% of factories restrict access to water and/or bathroom facilities during the workday. More than half of South Asian and 25% of other factories have 60 or more hour workdays. In about 1 out of 10 factories, penalties existed for refusing to work overtime.

With all the demands from consumers and activist groups, companies are realizing the importance of their responsibility in their production processes. Many companies are hoping that revealing more of their production conditions will results in gains. According to a survey by London-based AccountAbility, 72 of the world’s 100 highest grossing companies produced annual corporate responsibility reports in 2004.

Other Labor Agreements Country Responsibility Should national governments monitor and enforce labor regulations in foreign countries? Many U.S. trade laws allow the President to withhold trading privileges from countries that do not give basic rights to their workers. In only about half the cases in which this has been done, has it been considered effective at improving rights. One problem with withholding rights, is that denying preferences to all industries in a country is a very broad action. A second problem is that these laws involve the comparison to U.S. labor standards. That is not a good or fair comparison.

Other Labor Agreements Country Responsibility Many think countries should choose their own domestic policies and countries should not impose their own beliefs on others. Another approach is to use a non-governmental organization (NGO) to take action in limiting sweatshop activities. Studies show NGOs are more effective at raising wages than U.S. policies have been, and at much lower costs to the foreign country.

Other Labor Agreements Country Responsibility U.S. doubled a minimum wage in Indonesia at a cost of 10% increase in unemployment. An NGO increase in minimum wage from anti-sweatshop activism led to more closed plants, but with losses more than offset by employment gains at remaining firms. Governments can force increased wages on foreign workers, but it is a very blunt tool. NGOs are better at targeting particular plants, and not the country as a whole.

Other Labor Agreements Living Wage Is it fair to expect foreign firms to pay a “living wage”? A wage above the norm. It is difficult because you then have to ask, how high should they be to be acceptable to activists? Economists typically do not believe that wages should be any higher than the market will allow, as this may lead to unemployment. In developing countries, workers laid off from these jobs are likely to end up in activities far worse. This often leads many economists to reject calls for “living wages.”

Other Labor Agreements Living Wage Other types of labor standards are important and should continue to be pursued. Workers in all countries are entitled to a safe and clean workplace, honest pay, and the right to unionize. Enforcement of labor standards can make sure that workers benefit from trade without being exploited in the workplace.

International Agreements on the Environment
Most of the protesters at the 1999 Seattle meeting of the WTO were concerned about how WTO rulings would affect the environment. Although the WTO does not deal directly with environmental issues, other international agreements called multilateral environmental agreements deal specifically with the environment. However, the WTO still indirectly affects the environment. We will begin by clarifying the role of the GATT and the WTO in environmental issues.

Environmental Issues in the GATT and WTO GATT has Article XX known as the “green provision.” This allows countries to adopt their own laws in relation to environmental issues, provided the laws are applied uniformly to domestic and foreign producers. Laws cannot discriminate against imports. If these provisions allow countries to apply their own environmental regulations, why were people protesting so heavily? Table 11.3 details some of the specific GATT and WTO cases.

Table 11.3 Environmental Cases at the GATT and WTO Case Issue Outcome Tuna-Dolphin In 1991 Mexico appealed to the GATT against a U.S. ban on Mexican tuna imports. The United States put a ban on imports of tuna from Mexico that were not with nets that were safe for dolphins (as required in the United States under the Marine Mammal Protection Act). In 1992 the GATT ruled in favor of Mexico that the U.S. import ban violated GATT rules. But the strong consumer response led to labeling of imported tuna as “dolphin friendly.” Table 11.3 Environmental Cases at the GATT and WTO This table shows the outcome of environmental cases ruled upon by the GATT and WTO.

Environmental Issues in the GATT and WTO Tuna-Dolphin Case In 1991, Mexico brought a GATT case against the U.S. The U.S. had banned tuna imports from Mexico because Mexican fishermen did not use dolphin-safe nets as were required by U.S. fishermen. The U.S. reasoned the rule should be the same for both Mexican and U.S. fishermen. GATT concluded that the U.S. could not ban tuna imports for this reason because the U.S. had applied the import restriction to the production process method and not the product itself. The idea that the production process could not be a basis for trade restriction was a principle of the GATT that was upheld here.

Environmental Issues in the GATT and WTO Tuna-Dolphin Case The GATT panel also wanted countries to know that GATT rules were not set up so that trade could be used for one country to impose its own rules on another country—even to protect the environment. Although environmentalists were upset, the response by consumers did lead to the dolphins being protected, as the U.S. and Mexico worked out a system of labeling tuna as “dolphin safe.” Major companies then only sold this “dolphin friendly” tuna, so despite the initial ruling, the dolphins were protected.

Table 11.3 Environmental Cases at the GATT and WTO Case Issue Outcome Shrimp-Turtle In 1996 India, Malaysia, Pakistan, and Thailand appealed to the WTO against a U.S. ban on shrimp imports. The United States put a ban on imports of shrimp from India, Malaysia, Pakistan, and Thailand that were not caught with nets that were safe for sea turtles (as required in the United States under the Endangered Species Act). In 1998, the WTO ruled in favor of India, Malaysia, Pakistan, and Thailand that the U.S. ban on shrimp imports violated WTO rules. But the United States could still require these countries to use turtle-safe nets, provided that adequate notice and consultation were pursued. Table 11.3 Environmental Cases at the GATT and WTO This table shows the outcome of environmental cases ruled upon by the GATT and WTO.

Environmental Issues in the GATT and WTO Shrimp-Turtle Case In 1996, a second closely related case came up where India, Malaysia, Pakistan, and Thailand appealed to the WTO against a U.S. ban on shrimp imports. Shrimp were not being caught using nets safe for sea turtles, required in the U.S. under the Endangered Species Act. The outcome was different from the dolphin case. The WTO still ruled against the U.S., but it did not rule against the principle that one country could restrict imports based on the production process of another country.

Environmental Issues in the GATT and WTO Shrimp-Turtle Case The problem with the U.S. ban was that it was applied without sufficient notice to, and consultation with, the foreign producers. Therefore, the foreign producers did not have enough time to employ turtle-safe devices. The WTO ruled on technical grounds, not on the principle of protecting endangered species in foreign waters. This ruling ended up more favorable to environmentalists since the WTO explicitly recognized the importance of “the conservation of exhaustible natural resources.” Agreements were made with foreign producers and turtle-safe nets were implemented.

Environmental Issues in the GATT and WTO Gasoline from Venezuela and Brazil A third GATT/WTO case was brought against the U.S. by Venezuela and Brazil in 1994. The U.S. restricted imports of gasoline from these countries since they did not meet the requirements of the U.S. Clean Air Act. The WTO ruled that the U.S. violated the principle that national and foreign producers should be treated equally. U.S. producers had been given a 3-year grace period to meet the Clean Air Act standards, but that grace period was not extended to foreign producers. Although often seen as a loss by environmentalists, economists see the ban as “disguised protection” against the foreign gasoline imports—the WTO was correct.

Environmental Issues in the GATT and WTO Asbestos from Canada In 1998, France blocked the imports of asbestos from Canada based on known health hazards. Canada appealed to the WTO, but lost the case in a 2001 ruling. The WTO ruled that Article XX(b) allowed for some exceptions to the equal treatment rule. Canada was prohibited from exporting products containing asbestos even though French firms were themselves using asbestos-based products. This ruling was considered a victory for environmentalists.

Environmental Issues in the GATT and WTO Biotech food in Europe A final ongoing case concerns whether genetically modified food can be imported into Europe. In 2003, the U.S. appealed to the WTO that the EU was keeping out genetically modified food and crops. The EU claimed that there was no “moratorium” on these imports even though none had been approved since 1998. Europe said that it needed more time to study the effects of genetically modified products and was keeping them out for precautionary reasons until more information was collected.

Environmental Issues in the GATT and WTO Biotech food in Europe In 2006, the WTO ruled that Europe’s actions violated the principle that restrictions must be based on “scientific risk assessments.” They cannot keep out imports due to precautionary reasons only, but had to have evidence to back up the import restriction. Europe decided to use consumer labeling to let buyers decide whether to purchase genetically modified foods or not.

Environmental Issues in the GATT and WTO Summary of GATT/ WTO Cases The outcomes of these cases have lead some observers to conclude that although some of the cases have been “lost” at the WTO, environmentalists have gained ground in making sure that environmental concerns are respected. This does not mean we can now drop environmental issues. The lobbying activity of environmental groups has been important in shifting public opinion and WTO rulings in support of the environment.

Does Trade Help or Harm the Environment? After looking at some specific cases, can we now answer a more general question about whether trade helps or harms the environment? We have clearly seen examples on both sides. So what are some possible outcomes? We can look at some other examples.

Does Trade Help or Harm the Environment? U.S. Sugar Quota As discussed, the U.S. maintains an import quota on sugar, leading to higher prices for U.S. buyers. One demand for imported sugar cane comes from firms producing ethanol. The import price for sugar cane is very high so farmers purchase American corn, which is federally subsidized. Therefore, more corn than sugar is used to produce ethanol due to the corn subsidies and the sugar quota.

Does Trade Help or Harm the Environment? U.S. Sugar Quota Why do we care if more corn than sugar is used for ethanol production? Producing ethanol from corn is much less efficient than producing it from sugar cane. Additionally, corn depletes the soil and requires significant fertilizers to grow. If we could purchase sugar cane at the world prices, it would be much more efficient to use it to produce ethanol than to use corn. The U.S. quota, therefore, has an indirect and negative impact on the environment.

The Power of Big Corn There has been a significant increase in demand for ethanol, a gasoline substitute. The demand has increased the price of corn and will likely lead to increases in prices of corn-based food and drink products as well. Environmentalists warn of a corn shortage. This could all be alleviated if the U.S. government removed trade restrictions and allowed more sugar-based ethanol production, which requires much less energy than corn.

The Power of Big Corn The country now relies on corn to produce its ethanol. Corn is not the optimal input for ethanol. The ratio of energy gained versus the energy needed to plant, fertilize, and harvest the crop of corn is very poor. Corn is very hard on the soil on which it is grown. Although sugar cane can be used with significantly less energy, the government price fixing, tariffs, and import restrictions lead to a very high domestic price for sugar cane.

The Power of Big Corn Since domestic producers can get a much higher price for their sugar outside the ethanol market, they are not likely to move to ethanol production. There are also significant tariffs and import limits on foreign sugar cane, keeping the U.S. from using that sugar for ethanol. Finally, Congress has placed a tariff on foreign sugar-based ethanol to make sure little of that is imported as well.

The Power of Big Corn The results of all the price controls, tariffs, import restrictions are that U.S. ethanol: Costs more than it has to, and Uses more energy to produce than is necessary. Studies are showing that the increased demand for corn is very likely to drive up food prices as well.

Does Trade Help or Harm the Environment? U.S. Automobile VER The sugar quota is not the only case where U.S. trade restrictions have lead to environmental harm. The VER on Japanese cars in 1991 limited the number of cars Japan could export to the U.S., but did not limit the value of the cars exported. This gave Japan an incentive to export larger and/or more luxurious models to gain greater profits. These luxurious models had larger engines and decreased fuel economy. Figure 11.4 shows the impact of the VER on gas mileage.

Figure 11.4 Figure 11.4 U.S. Imports of Japanese Autos This figure uses data on Japanese imported cars from 1979 to 1982, before and after the “voluntary” export restraint with Japan began. The horizontal axis shows the change in the quantity sold (in percent) between these years, and the vertical axis shows the gas mileage of each model. The models with the lowest mileage—such as the Maxima, Cressida, and Mazda 626—had the greatest increase in sales between these years.

Does Trade Help or Harm the Environment? U.S. Automobile VER The data show that the luxury models with the lowest gas mileage had the greatest increase in sales between the years of the VER. Prices on these did not rise as much as they did on the economy models, so sales went up. As consumers shifted toward the nicer, lower gas mileage cars, carbon dioxide emissions increased. A free trade policy would have kept Japan importing the smaller more fuel efficient cars during the 1980s. This would have been better for the environment.

The Tragedy of the Commons Trade in fish Because of overharvesting, many species of fish are no longer commercially viable. According to one study, 29% of fish and seafood species have collapsed. The catch declined more than 90% between 1950 and 2003. This occurs when you have many individuals competing for the same fish stock, but there is no real ownership and/or enforcement of the stock. This is the tragedy of the commons—the fish are treated as common property that anyone can harvest. International trade can make the problem worse as global demand is directed toward resources of a particular country or region, so even more overharvesting takes place.

The Tragedy of the Commons The solution to the tragedy of the commons The cause of the tragedy is not the international trade, but the fact that the resource is treated as common property. Assigning property rights to the resource, which allows the owner to limit the use of the resource, is one way to alleviate the tragedy. But with a truly global resource, this is not enough. International agreements are typically needed to prevent over-harvesting of the resource. One country acting on its own does not have enough control of the harvest. International agreements are arranged through the Convention on International Trade in Endangered Species (CITES).

Ban on Caspian Sea Caviar Exports
The export of caviar was halted by the Convention on International Trade in Endangered Species. This caviar is one of the most coveted and lucrative wildlife products. It was stated this was a temporary measure to compel nations that exported the caviar from wild sturgeon to prove they were not pushing the population to extinction. The suspension also barred nations from importing sturgeon products. Western retailers could sell what they had but could not get any additional supply.

A few months later the global suspension on exports of caviar and sturgeon products had been extended indefinitely from almost all of the Caspian sea, the world’s main caviar-producing region. CITES stated that Iran would be allowed to export a limited amount of one species, but other Caspian nations would not be granted annual export quotas. Export quotas from Black Sea harvests were set very low.

This ban occurred after years of reduced sturgeon catches. There is worry that the remaining population is under significant pressure from black market rings and poachers, many sponsored by or protected by governments. CITES officials stated the ban was necessary to protect the fish and to ensure sustainable trade into the future.

The Tragedy of the Commons Trade in Buffalo There is a historic case from the U.S. with the slaughter of the Great Plains buffalo, in a ten year period from 1870–1880, to the point of near extinction. There have been many arguments put forth for why this occurred, but new research offers another reason that seems to dominate. An invention in London in 1871 allowed buffalo hides to be tanned for industrial use. This created a huge demand for buffalo hides in Europe increasing the price significantly in the U.S. Most of the hides from the U.S. were exported to Europe.

The Tragedy of the Commons Trade in Buffalo Figure 11.5 shows estimates of the imports of untanned hides to the UK and France from the U.S. It looks at the extra demand in the UK and France after the invention was made. Imports into these countries grew rapidly after 1871, peaking in 1875. In that year, the UK and France combined imported more than 1 million hides, and from 1871–1878, imported about 5 million. This can plausibly explain the slaughter of the Great Plains buffalo.

Figure 11.5 Figure 11.5 Buffalo Hide Imports This figure shows estimates of the imports to the United Kingdom and France of buffalo hides from the United States. The amount of imports into these countries (in excess of imports to Canada) was small or negative before 1871 but then grew rapidly and peaked in In that year, the United Kingdom and France combined imported more than 1 million hides and over the entire period from 1871 to 1878 imported some 3.5 million hides. Much of this trade volume can be attributed to an invention in London in 1871 that allowed buffalo hides to be tanned for industrial use. Source: M. Scott Taylor, 2007, “Buffalo Hunt: International Trade and the Virtual Extinction of the North American Bison,” NBER Working Paper No , March.

International Agreements on Pollution Pollution is a by-product of many manufacturing activities. The tragedy of the commons applies to pollution too, as countries can consider the air or water as a common resource when emitting pollutants. Pollution can be an international issue. Global pollutants are substances that cross boundaries and affect many different countries. Examples: CFCs—chlorofluorocarbons which deplete the ozone layer—and CO2—carbon dioxide which contributes to global warming.

International Agreements on Pollution Global Pollutants A prisoner’s dilemma similar to figure 11.2 for tariffs can apply here as well. Since the pollution crosses countries, each country does not face the full cost of its own pollution. There is little incentive for one country to limit their pollution emissions. Therefore, in the absence of regulation, there will be a larger than efficient level of pollution. International agreements are needed.

International Agreements on Pollution Payoff Matrix Figure 11.6 shows the payoff matrix for two countries deciding on whether to regulate emissions or not. Again, Home’s payoffs are in the lower-left corner and Foreign’s payoffs are in the upper-right corner. We start at regulation and measure the change in welfare when there are no regulations. When both countries regulate, consumers are better off, but producers are worse off. If one country decides not to regulate, its producers gain, but consumers in both countries will lose. If neither country regulates, there is a large loss for consumers and a small gain for producers.

Figure 11.6 Figure 11.6 Payoffs in an Environmental Game This payoff matrix shows the gains and losses for Home and Foreign countries, depending on whether they adopt environmental regulations. If governments weight producer surplus more than consumer surplus, then the structure of payoffs is similar to the prisoner’s dilemma because the Nash equilibrium is to have both countries not adopt regulations. That outcome can occur with “global” pollutants.

International Agreements on Pollution Nash Equilibrium We start in the upper-left quadrant, with both countries regulating. If either country deviates from this position, it will experience a gain for producers and a loss for consumers. If pollution is local, the country might realize that the costs outweigh the benefits. With global pollutants, however, the calculation changes. If the pollution crosses borders, then the gains from regulation may appear less than the costs to the producers. Neither country will want to regulate.

International Agreements on Pollution Nash Equilibrium Given that one country does not regulate, the other country will have a greater incentive not to regulate. If Home does not regulate in figure 11.6, then Foreign’s best decision will likely be to not regulate either. The payoffs in the matrix can lead us to a situation where neither country regulates its pollution. This is very similar to the prisoner’s dilemma we discussed before. Both countries end up with a bad outcome even though they are making the best decision individually. Multilateral agreements are needed to ensure that countries end up in the upper left quadrant with both regulating.

Figure 11.6 Figure 11.6 Payoffs in an Environmental Game This payoff matrix shows the gains and losses for Home and Foreign countries, depending on whether they adopt environmental regulations. If governments weight producer surplus more than consumer surplus, then the structure of payoffs is similar to the prisoner’s dilemma because the Nash equilibrium is to have both countries not adopt regulations. That outcome can occur with “global” pollutants.

International Agreements on Pollution Multilateral Agreements One example of an international agreement is the Montreal Protocol on Substances that deplete the Ozone Layer. This has successfully eliminated the use of CFCs. The more difficult case the world has been dealing with is the discussion of global warming regulated by the Kyoto Protocol.

The Kyoto Protocol In December 1997, representatives from many nations met in Kyoto, Japan, to discuss non-binding targets for reducing greenhouse gas emissions. Carbon Dioxide (CO2) is emitted from fossil fuel combustion and becomes trapped in the atmosphere leading to increases in the earth’s temperature. Even small increases in the earth’s temperature can have drastic effects as weather patterns and ocean levels change, affecting many economic activities.

The Kyoto Protocol Building on the United Nation’s 1992 treaty on climate change, the Kyoto Protocol established specific targets for reduction in greenhouse gas emissions: Industrial countries should cut emissions collectively to 5.2% less than 1990 levels. Targets for individual countries range from 8% for the EU, 7% for the U.S., and to 0% for Russia. Additional allowable increases exist for Australia and Iceland. Targets were also established, for example, so that Russia could sell its credits if it ended up below its 1990 level.

The U.S. gives four reasons for this:
The Kyoto Protocol Over 160 countries have ratified this agreement, however, the U.S. has yet to and is the only industrial country not to. The U.S. gives four reasons for this: Although evidence for global warning is strong, we do not know the effect of policy actions. As the largest emitter, meeting Kyoto targets would greatly affect the U.S. economy. Kyoto failed to include the developing countries, mainly China and India. There are other ways to pursue reductions in greenhouse gas emissions.

The first point made by the U.S. has become less plausible over time.
The Kyoto Protocol The first point made by the U.S. has become less plausible over time. We have seen more evidence for global warming and its possible consequences. The second point is also true. The U.S. is the largest emitter of greenhouse gases and the reductions proposed in Kyoto will adversely affect the economy. Unlike many countries, the U.S. already had significant restrictions on plant emissions in 1990, making their baseline much lower to begin with.

The Kyoto Protocol The third point is probably the main point why the U.S. has not joined. As we saw with the prisoner’s dilemma game, if one country does not regulate, it decreases the incentives for the other country. Any further discussions will have to include China and India and other large developing countries. The fourth reason is also correct.There are other ways of reducing emissions. Many states and companies have taken it upon themselves to do things to reduce emissions, which can play a positive role.

Fixing Kyoto—A Global Superfund
This excerpt from an article by Jagdish Bhagwati speaks of a possible extension of Kyoto that would incorporate the developing countries of India and China with a unique twist. First, why were India and China left off the list? They were able to argue successfully that they were not responsible for most of the past emissions, so they should be exempt for now from changing their emissions.

Because of their successful presentation, Kyoto was left unsealable. The U.S., the largest producer of greenhouse gases, would not join. Professor Bhagwati proposes looking to the Superfund treatment as a solution. Superfund dealt with the cleanup of toxic waste when no responsible party could be found. Superfund created a trust fund to provide for “cleanup” in these cases.

Rich nations who have been the main contributors of greenhouse gases in the past, should agree to pay damage in a trust similar to the Superfund trust. Funds would be used to research alternatives to fossil fuels and provide developing countries with pollution-reducing devices. Additionally, many of the pollution-reducing technologies are produced by the rich countries, so business support for the regulation might also be expected.

In addition to the fund, greenhouse gas emissions should be taxed for each country. These taxes could partially be placed in the fund, and part could be spent domestically for similar purposes.

Conclusions Earlier chapters of the text have referred to international agreements on trade such as GATT, WTO, and NAFTA. This chapter looked at the rationale for these agreements in more detail, discussing other areas, labor standards, and the environment, that these agreements encompass. Initially we asked, why are international agreements needed at all? There are strong temptations for countries to use tariffs to their own benefit, or to avoid regulating the environment. The outcome is typically worse for everyone—high tariffs and/or high pollution.

Conclusions Why international agreements?
The prisoner’s dilemma type of game allowed us to show how the Nash equilibrium leads to both parties making decisions that seem right if taken on their own, but have bad outcomes when both countries act the same way. International agreements are needed to avoid these bad outcomes.

Conclusions The second issue addressed was the potentially negative outcome from regional trade agreements. Halfway steps toward complete free trade can end up being bad. Regional agreements can cause the amount of trade diversion to be greater than the amount of trade creation with negative social costs. Additionally, it is possible that low cost producers can be excluded from the agreement, which makes member countries worse off as well.

Conclusions Halfway steps can also lead to the over-harvesting of resources. If there are not well defined property rights, free trade leads to losses for the environment. We open one market without having a properly functioning market for the other good. This is not only bad for the exporting country, but for the world itself. Finally, we argued that actions by consumers, unions, and firms to improve labor standards and the environment are important.

Key Points There are two primary types of free trade agreements: multilateral and regional. Under perfect competition, we can analyze the benefits of multilateral agreements by considering the Nash equilibrium of a two-country game in which the countries are deciding whether to apply a tariff or not. The welfare gains and losses due to regional trade agreements are more complex than for multilateral trade agreements.

Key Points Trade creation occurs when a country within a regional agreement imports a product from another member country that it formerly produced for itself. Trade diversion occurs when a member country imports a product from another member country that it formerly imported from a country outside of the new trade region. Labor standards refer to all issues that directly affect workers, including occupational health and safely, child labor, minimum wages, and the right to unionize.

Key Points The WTO does not deal directly with the environment, but environmental issues come up as the WTO is asked to rule on specific cases. International agreements on the environment are needed for the same reasons that agreements on tariffs are needed: to avoid a “prisoner’s dilemma” type of outcome, which is bad for all countries.

INTERNATIONAL AGREEMENTS: TRADE, LABOR, AND THE ENVIRONMENT

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INTERNATIONAL AGREEMENTS: TRADE, LABOR, AND THE ENVIRONMENT

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