NBER WORKING PAPERS SERIES ENVIRONMENTAL IMPACTS OF A NORTH AMERICAN FREE TRADE AGREEMENT Gene M. Grossman Alan B. Krueger Working Paper No. 3914 NATIONAL BUREAU OF ECONOMIC RESEARCH 1050 Massachusetts Avenue Cambridge, MA 02138 November 1991 This paper was prepared for the conference on the U.S.- Mexico to Free Trade Agreement. sponsored by SECOFI. We are grateful the Industrial Relations Section and International Finance Section of Princeton University, and the National Science Foundation for partial financial support. We thank Loren Baker. Kainan Tang, and GuillerInO Frias for research assistance, and Drusilla Brown, Gardener Evans, and Greg Schoepfle for sharing their unpublished data. Joanne Gowa. Howard Gruenspecht. and discussion. This Jeff Mackie-Mason provided helpful comments and in International paper is part of NBER's research program the authors and not Studies. Any opinions expressed are those of Research. those of the National Bureau of Economic NEER Working Paper #3914 November 1991 ENVIRONMENTAL IMPACTS OF A NORTH AMERICAN FREE TRADE AGREEMENT ABSTRACT A reduction in trade barriers generally will affect the environment by expanding the scale of economic activity, by altering the composition of economic activity, and by bringing about a change in the techniques of production. We present empirical evidence to assess the relative magnitudes of these three effects as they apply to further trade liberalization in Mexico. In Section 1. we use comparable measures of three air pollutants in a cross-section of urban areas located in 42 countries to study the relationship between air quality and economic growth. We find for two pollutants (sulfur dioxide and smoke") that concentrations increase with per capita GDP at low levels of national income, but decrease with GD? growth at higher levels of income. Section 2 studies the determinants of the industry pattern of U.S. imports from Mexico and of value added by Mexico's maquiladora sector. We investigate whether the size of pollution abatement costs in the U.S. industry influences the pattern of international trade and investment. Finally, in Section 3, we use the results from a computable general equilibrium model to study the likely compositional effect of a NAFTA on pollution in Mexico. Gene H. Grossman Woodrow Wilson School Princeton University Princeton, NJ 08544 and NBER Alan B. Krueger Woodrow Wilson School Princeton University princeton, NJ 08544 and NEER Environmental advocacy groups In the United States have voiced their concerns about a potential North American Free Trade Agreement (NAFTA). Some went so far as to oppose the Congressional. granting of fast-track negotiating authority to the President to enable American negotiators to enter Into talks with their Mexican counterparts. The reservations of the lobbying groups mirror a growing perception on the part of environmentalists worldwide that an open world trading system may be inimical to the goal of preserving a clean, healthy, and sustainable global commons. The arguments linking trade liberalization with environmental degradation have not been fully articulated.' With regard to a NAFFA, the environmentalists have expressed a number of reasons for fearing that freer trade and direct investment flows between the United States and Mexico may aggravate pollution problems in Mexico and in the border region.2 At the least discerning level, some have argued simply that any expansion of markets and economic activity inevitably leads to more pollution and faster depletion of scarce natural resources. A more pointed argument recognizes that pollution already is a severe problem in Mexico and that the country's weak regulatory infrastructure is strained to the breaking point. Under these conditions, it is feared that any further industrialization that results from the liberalization of trade and investment will exacerbate an already grave situation. Other environmentalists draw their conclusions by extrapolating the experience of the maquiladora sector in Mexico. The maquiladoras are See Low and Safedi (1991), who cite several examples of writings that view open trade as detrimental to environmental protection. 2 See, for example, Gregory (1991), Kelly and Kemp (1991). National Wildlife Foundation (1990), Leonard and Christensen (1991), and Ortman (1991). 2 predominantly foreign-owned firms that produce largely for export to the United States under a Mexican policy that allows duty-free imports of foreign components for further processing and re-export. Originally, maquiladoras were required to locate within a 20-kilometer strip along the U.S. - Mexico border in order to qualify for special customs treatment. The sector grew - quite rapidly and with little governmental oversight, and now is widely regarded as being a major contributor to the perilous environmental and social conditions in the border region. Environmental groups point to this sector as a prime example of how unregulated expansion in response to trade oppor- tunities can create risks to worker safety and public health. They argue that investments in this sector have been encouraged by the lax enforcement of environment and labor protection laws in t4exico and fear that any further expansion in trade and investment flows between the United States and Mexico will be motivated by firms' desires to avoid the high costs of meeting U.S. regulations. A further concern of some environmental groups is that a NAFEA may undercut regulatory standards in the United States. Spokespersons have made the political-economic argument that, with freer trade, industry groups in the United States will demand less stringent pollution controls in order to preserve their international competitiveness, so that environmental standards will tend toward a lowest common denominator. The environmentalists worry, moreover, that existing environmental protection laws in the United States may be seen as nontariff barriers to trade in the context of a regional trade agreement. While the environmental groups have raised a host of valid questions they have so far been unable to provide convincing and well supported answers 3 to these questions. Many of their arguments fail to recognize all of the implications of trade liberalization for resource allocation and natural resource use in each of the trade partner countries. Moreover, die empirical claims that have been made rely mostly on anecdotal evidence and on extrapolation of the experience in one region or industry to the entirety of economic activity in Mexico. Indeed, relatively little is known at any level of generality about the relationship between a country's trade regime and its rate of environmental degradatton. or even about the relationship between a country's stage of economic development and its output of pollution. Theoretical investigation of these topics has been limited, and empirical studies are virtually non-existent. It is useful to distinguish three separate mechanisms by which a change in trade and foreign investment policy can affect the level of pollution and the rate of depletion of scarce environmental resources) First, there is a scale effect, capturing the simple intuition espoused by the environmental advocates. That is, if trade and investment liberalization causes an expansion of economic activity, and if the nature of that activity remains unchanged, then the total amount of pollution generated must increase. The environmental groups point, for example, to the deleterious environmental consequences of the combustion of fossil fuels and to the air pollution that is generated by the trucking industry. To the extent that economic growth gives rise to an increased demand for energy, which then is generated by means similar to the prevailing methods, there will be an increased output of harmful pollutants that attends an increase in economic output. Similarly, to A similar decomposition of the effects of economic growth on the output of pollution has been proposed by the Task Force on the Environment and the Internal Market (1990). 4 the extent that expanded trade gives rise to an increased demand for cross- border transportation services without there being any change in trucking practices, increased trade will contribute to a deterioration in air quality. Second, there is a composition effect that results from any change in trade policy. When trade is liberalized, countries specialize to a greater extent in the sectors in which they enjoy competitive advantage. If competitive advantage derives largely from differences in environmental regulation, then the composition effect of trade liberalization will be damaging to the environment. Each country then will tend to specialize more completely in the activities that its government does not regulate strictly. and will shift out of production in industries where the local costs of pollution abatement are relatively great. On the other hand, if the sources of international comparative advantage are the more traditional ones, namely cross-country differences in factor abundance and technology, then the implications of the composition effect for the state of the environment are ambiguous. Trade liberalization will lead each country to shift resources into the sectors that make intensive use of its abundant factors, The net effect of this on the level of pollution in each location will depend upon whether pollution-intensive activities expand or contract in the country that on average has the more stringent pollution controls. Finally, there is a technicue effect. That is, output need not be produced by exactly the same methods subsequent to a liberalization of trade and foreign investment as it has been prior to the change in regime. In particular, the output of pollution per unit of economic product need not remain the same. There are at least two reasons to believe that pollution per unit of output might fall, especially in a less developed country. First, S foreign producers nay transfer modern technologies to the local economy when restrictions on foreign investment are relaxed. More modern technologies typically are cleaner than older technologies due to the growing global awareness of the urgency of environmental concerns. importantly, Second, and perhaps more if trade liberalization generates an increase in income levels, then the body politic may demand a cleaner environment as an expression of their increased national wealth. Thus, more stringent pollution standards and stricter enfoccement of existing laws may be a natural political response to economic growth. In this paper we explore some of the empirical evidence that bears on the likely environmental impacts of a NAflA. In Section 1, we shed some light on the relative magnitudes of the scale and technique effects. We use a cross-country sample of comparable measures of pollution in various urban areas to explore the relationship between economic growth and air quality. After holding constant the identifiable geographic characteristics of different cities, a common global time trend in the levels of pollution, and the location and type of the pollution measurement device, we find that ambient levels of both sulphur dioxide and dark matter suspended in the air increase with per capita GD? at low levels of national income, but decrease with per capita GD? at higher levels of income. The turning point comes somewhere between $4,000 and $5,000, measured in 1985 U.S. dollars. For a third measure of air quality, namely the mass of suspended particles found in a given volune of air, the relationship between pollution and GD? is monotonically decreasing. Sections 2 and 3 address different aspects of the composition effect. In section 2 we ask whether and to what extent the sectoral patterns of U.S. 6 foreign investment in Mexico and of Mexican exports to the United States are affected by the laxity of environmental regulations in Mexico as compared to the stricter enforcement of controls in the United States. We relate the sectoral pattern of maquiladora activity, of U.S. imports from Mexico under the offshore assembly provisions of the US. tariff codes, and of total US. imports from Mexico to industry factor intensities, U.S. tariff rates, and the size of pollution abatement costs in the U.S. industry. We find that the traditional determinants of trade and investment patterns are significant here, but that the alleged competitive advantages created by lax pollution controls in Mexico play no substantial role in motivating trade and investment flows. Finally, in Section 3, we begin with the premise that resource allocations in the United States, Mexico, and Canada have been guided by competitive advantages generated by differences in factor endowments. We borrow from Brown, Deardorff and Stern (1991) their estimates of the change in resource allocation that might result from a NAFTA, and discuss the implications of these predicted changes in the structure of production for levels of pollution in each country. 1 Economic Growth and Urban Air Pollution As we noted implications in the introduction, economic growth has offsetting for the anthropogenic generation of air pollution. On the one hand, some pollutants are & natural byproduct of economic activities such as electricity generation and the operation of motor vehicles. As economic activity expands, emissions of these pollutants tend to grow. On the other hand, firms and households can control their pollution to some degree by their 7 choice of technology. Cleaner technologies produce less pollution per unit of output. As a society becomes richer its members may intensify their demands for a more healthy and sustainable environment, in which case the government may be called upon to impose more stringent environmental controls, Little is known about the empirical relationship between national income and concentrations of various poLlutants. Investigation of this issue has been hampered by the paucity of data on air pollution that is available on a comparable basis for a representative sample of countries. However, since 1976 the World Health Organization (WHO) has collaborated with the United Nations Environment Programme in operating the Global Environmental Monitoring System (GEMS). The goal of this project has been to monitor closely the concentrations of several pollutants in a cross-section of urban areas using standardized methods of measurement. This data set, which to our knowledge has not previously been analyzed by economists, provides us with an opportunity to examine how air quality varies with economic growth.4 In the next subsection we describe the GEMS project, the types of pollution that it monitors, and the data that it has generated. Section 1.2 gives the details of the statistical analysis that we have performed. Our findings are presented in Section 1.3 and the implications for Mexico are discussed in Section 1,4. The GEMS data have been statistically analyzed by some enviroTuhlental to use scientists (see World Health Organization (1984]), but they have neglected any economic variables in their exclusively bivariate analyses. 8 1.1 The GEMS Data3 The GEMS monitors air quality in urban areas throughout the world. Daily (or, in some cases, weekly or less frequent) measurements are taken of concentrations of sulphur dioxide (SO) and suspended particulate matter Data on particulates, which are gases and liquids suspended in the air, are collected by different methods (described further below) that alternatively measure the mass of materials in a given volume of air and the concentration of finer, darker matter, sometimes referred to as "smoke". Sulfur dioxide is a corrosive gas that has been linked to respiratory disease and other health problems.' It is emitted naturally by volcanoes, decaying organic matter, and sea spray. The major anthropogenic sources of SO are the burning of fossil fuels in electricity generation and domestic heating, and the smelting of non-ferrous ores (World Resource Institute, 1988). other sources in some countries include automobile exhaust and the chemicals industry (Kormondy, 1989). Sulfur dioxide emissions can be controlled by the installation of flue gas desulfurization equipment (scrubbers) on polluting facilities, and by switching electricity-generating and home-heating capacity to lower sulfur grades of coal or away from coal altogether. Particulates arise from dust, sea spray, forest fires, and volcanoes. Most of these naturally produced particles are relatively large. Finer The GEMS data for 1977.1984 are published by the World Health Organization in the series Mr quality in Selected Urban Areas. Unpublished data for 19851988 have been kindly provided to us by Gardener Evans of the U.S. EPA. 6 Lave and Seskin (1970) find for example, that variation in SO2 and population density together explain two-thirds of the variation bronchitis in a sample of U.S. cities- in death from 9 particles are emitted by industry and from domestic fuel combustion (World Resources Institute, 1988). Larger particles reduce visibility but have a relatively minor health impact, whereas the finer particles can cause eye and lung damage and can aggravate existing respiratory conditions (U.S. EPA, 1982). Particulate emissions from anthropogenic processes can be reduced via the installation of control equipment and by switching to fuels that, when burned, emit fewer particles. The GEMS sample of cities has been changing over time. Sulfur dioxide was monitored in 47 cities spread over 28 different countries in 1977, 52 cities in 32 countries in 1982, and 27 cities in 14 countries in 1988. Measurements of suspended particles were taken in 21 cities in 11 countries in 1977, 36 cities in 17 countries in 1982, and 26 cities in 13 countries in 1998, while data for darker matter (smoke) are available for 18 cities in 13 countries for 1977. 13 cities in nine countries for 1982, and seven cities in four countries for 1988. In all, there are 42 countries represented in our sample for 502, 19 countries in our sample for dark matter, and 29 countries in our sample for suspended particles. The participating cities are located in a variety of developing and developed countries and have been chosen to be fairly representative of the geographic conditions that exist in different regions of the world (Betmett et at., 1985). In most of the cities included in the project, air quality measurements are taken at two or three different sites, which are classified either as center city or suburban, and as commercial, industrial, or residential. Multiple sites in the same city are monitored in recognition of the fact that pollutant concentrations can vary dramatically with local conditions that depend in part upon land use. Observations at most sites are made on a daily basis and the data set includes 10 measures of the mean, median, 80th, 95th, and 98th percentile of daily observations in a given site for a given year. Sulfur dioxide concentrations have been determined by a number of well accepted methods (see WHO, 1984). The reliability of these methods has been checked in independent studies, and an intercomparison exercise was performed using one particular method as a reference point (Bennett et al., 1985). It was concluded that the measurements by alternative methods are roughly comparable, although particular meteorological conditions can affect the various methods differently. With these results in mind, we have chosen to pool our sample of observations of 502 variable to concentration, but to allow for a dummy reflect the method of measurement at each site. Suspended particles are measured by two main methods. High volume gravimetric sampling determines the mass of particulates in a given volume of air while the smoke-shade method assesses the reflectance of the stain left on a filter paper that ambient air has been drawn through. The former method measures the total weight of suspended particles while the latter is predominantly an indication of dark material in the air. Since the two methods yield incomparable measures that capture different aspects of particulate air pollution, we treat the data generated by gravimetric and smoke-shade methods separately in our analysis.7 Table I provides the mean, and median and standard deviation for the 50th 95th percentiles of daily observations in our sample of cities for each of A few sites used nephelometric methods to measure suspended particles; i.e., they measured the light loss due to scattering when a light beam is passed through a sample of particle-laden air. This method gauges the mass of suspended particles, much as does the high volume gravimetric method. Since the estimates are comparable in many cases, we pooled the observations from these two types of instruments, but included a dummy variable to allow for device-specific measurement differences. 11 the three types of pollution. Figure 1 displays the The median of corresponding histograms. daily observations on SO2 range from a minimum of zero to a maximum of 291 micrograms per cubic meter (pg n13) of air, whereas the 95th percentile of daily measures range from zero to 1022 pg m3.8 These numbers can be compared with the World Health Organization recommendation that annual average SO2 concentrations ought not to exceed 40-60 pg m and that 98th percentile concentrations ought not to exceed 100-150 pg m3. The median of daily observations for suspended particles varied from zero to 715 pg nC3 while that for the 95th percentile observation ranged from [5 to 1580 pg The WHO guidelines for suspended particles list 60-90 pg nC3 as the safe limit for the annual mean and 150-230 pg as the safe limit for the 98th percentile. Finally, the median of daily observations of dark matter (or smoke) in the sample of sites varied from zero to 312 pg m3, while the 95th percentile observation varied from two to 582 pg m3. The WHO recommends that dark matter not exceed 50-60 pg & in annual average and 100-150 pg nC3 in the 98th percentile of daily observations. 1.2 Estimation Concentrations of pollutants in the air depend upon the amounts that are emitted by natural and anthropogenic sources and on the ability of the atmosphere to absorb and disburse the gases or particles. Thus, our analysis of the relationship between growth and air quality must allow for an influence of city and site characteristics on the observed concentrations of the various pollutants in addition to the dependence on national product. a Actlly, SO concentrations are never literaLly zero, but the machines are unable to detect very low levels of the gas. 12 We have sought to explain the median and 95th percentile of daily observations for SO2 suspended particles (gravimecric and nephelomecric methods) and dark matter (smoke-shade method). As explanatory variables, we have included functions of per capita GOP in the country where the site is located, characteristics of the site and city, and a time trend. We used the Summers and 1-leston (1991) data for per capita CD?, which attempt to measure output in relation to a common set of international prices. Initially, we allowed the coefficient on per capita CD? to vary across income ranges by including a dummy variable in our regressions for each $2,000 interval of per capita GDP. These relatively unrestricted regressions suggested that a cubic function of per capita CD? would fit the data fairly wellS The cubic equations are the main focus of our subsequent analysis.9 In the equation for concentrations of SO2, we included dummy variables for the location within the city (central city or suburban) and for the land use of the area near the testing site (industrial, commercial, or residential). We also included a dummy variable for the method of measurement
Purchase answer to see full attachment