AGRICULTURAL TRADE LIBERALIZATION AND STRATEGIC ENVIRONMENTAL POLICY: A FORMAL ANALYSIS

This paper develops an extended general equilibrium model of international trade in order to analyze the welfare effects of agricultural trade liberalization if a large country influences its terms of trade by means of environmental policy. We derive globally optimal first-best and second-best environmental and trade policy combinations as a benchmark for assessing the trade-distorting character of strategically motivated environmental policies and demonstrate that if second-best rather than first-best policies are chosen as a benchmark the conclusions may differ not only in magnitude but also in direction. We further demonstrate that if a Pigouvian instrument is transformed into a strategic environmental policy, following trade liberalization, the global welfare effect is unambiguously positive. We thereby prove that the distorting effect of an optimal tariff is generally greater than that of a strategically motivated environmental policy