Zhao, Jinhua; Karp, Larry; Sacheti, Sandeep

Journal of Environmental Economics and Management Vol. 45 no. 2 (March 2003): 246-264.

We compare the short-run and long-run effects of environmental reform and
harmonization under autarky and free trade. When trade is driven by
environmental distortions rather than real relative advantages,
harmonization of environmental policies, even if achieved by lowering
standards in one country, can improve short-run aggregate welfare. With the
possibility of multiple steady states, long-run considerations favor a
``race to the top'' rather than a ``race to the bottom'' even when upward
and downward harmonizations are equivalent in the short run. For a country
trapped in a low (or bad) steady state, environmental reform may not move it
to a high (or good) steady state under autarky. However, under trade,
harmonization of policies may enable this country to reach the high steady
state. Conversely, reforms that increase the relative differences in
distortions may, under trade, cause economies to move to a low steady state.