Does trade liberalization harm the environment

Events such as the NAFTA and the completion of the Uruguay Round have raised concern over the impact of trade liberalization on the environment. It is believed that less stringent environmental standards in developing countries will give them a comparative advantage in pollution-intensive goods. Using single equation models, existing empirical studies have found either no relationship between environment and trade flows, or a positive relationship between trade liberalization and the environment. This paper develops a simultaneous-equations model to estimate this relationship, directly incorporating the effects of openness on growth of income, and of income growth on environmental damage. A two-good trade model with endogenous factor supply is estimated using pooled provincial data on Chinese water pollution from 1987-1995. Estimation of this model reveals that trade liberalization directly aggravates environmental damage via its influence on the terms of trade, but indirectly mitigates it via its effect on income growth. Simulations suggest that trade reform during the period may have had a net beneficial impact on emissions growth.