Are free trade agreements good for the environment? A panel data analysis

• Author: Mehdi Nemati,Wuyang Hu,Michael Reed
• Date: 01 February 2019
• Published date: 01 February 2019
• DOI: http://doi.org/10.1111/rode.12554

REGULAR ARTICLE

Are free trade agreements good for the

environment? A panel data analysis

Mehdi Nemati

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Wuyang Hu

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Michael Reed

3

1

School of Public Policy, University of

California, CA, USA

2

Department of Agricultural,

Environmental, and Development

Economics, The Ohio State University,

OH, USA

3

Department of Agricultural Economics,

University of Kentucky, Kentucky, USA

Correspondence

Mehdi Nemati, School of Public Policy,

University of California, Riverside, CA

92507, USA

Email: mehdi.nemati@ucr.edu

Abstract

This study empirically examines the relationship between

free trade agreements (FTAs) and greenhouse gas (GHG)

emissions. For this purpose, we use three different FTAs:

the Southern Common Market, the North American Free

Trade Agreement, and the Australia–United States Free

Trade Agreement. These FTAs are between developing,

both developing and developed, and only developed

countries, respectively. Panel unit root, panel cointegra-

tion, and fully modified ordinary least squares estimations

are employed to examine the long‐run relationship

between GHG emissions and trade liberalization. The

results indicate that the environmental effects of FTAs

depend on the different agreement types. When FTAs are

between only developed or developing countries, overall

there is no environmental damage, and these types of

FTAs can be beneficial for the environmental quality in

the long run. However, when developing and developed

countries are in a trade agreement, overall environmental

quality decreases due to increased GHG emissions.

KEYWORDS

developed countries,developing countries,free trade agreements,

greenhouse gas emissions,panel cointegration

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INTRODUCTION

Free trade agreements (FTAs) have become increasingly prevalent since the early 1990s. A WTO

report (2014) shows that 585 notifications of regional trade agreements (counting goods, services,

and accessions separately) had been received by the General Agreement opn Tariffs and Trade/

World Trade Organization. Multilateral trade has intensive and extensive implications for all trade

DOI: 10.1111/rode.12554

Rev Dev Econ. 2019;23:435–453. wileyonlinelibrary.com/journal/rode © 2018 John Wiley & Sons Ltd

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partners involved. FTAs can be important in reducing trade barriers and creating a more stable

trade environment, thus intensifying the impact of multilateral trade. FTAs also can affect environ-

ment quality, among other things, through three main channels. These channels are change in pro-

duct composition (composition effect), change in production techniques (technical effect), and

economic activity expansion (scale effect) (Grossman & Krueger, 1995).

There are two sides to the argument concerning the effects of FTAs on environmental qual-

ity. Free trade proponents argue that FTAs have a positive impact on the environmen t because

after liberalization countries will have access to environmentally friendly technologies, produce

goods in which they have a competitive advantage and have higher income due to trade

liberalization. In contrast, environmentalists argue that trade liberalization is detrimental for the

environment because it will encourage more polluting industries to locate in countries with lax

environmental regulations. They also believe that scale effects cause more pollution

(Antweiler, Copeland, & Taylor, 2001; Frankel, 2009; Frankel & Rose, 2005; Grossman &

Krueger, 1995).

Both free trade proponents and environmentalists may have a legitimate argument from eithe r a

theoretical or empirical standpoint (as shown in later sections). For this reason, many researchers

have begun to empirically examine the effects of FTAs on environmental quality. Research find-

ings are largely inconclusive. On the one hand, some researchers find trade agreements improve

environmental quality (Antweiler et al., 2001; Birdsall & Wheeler, 1993; Lucas, Wheeler, & Het-

tige, 1992; Wheeler & Martin, 1992). On the other hand, some studies find that trade agreements

reduce environmental quality (Frankel & Rose, 2005; Reinert & Roland‐Holst, 2001; Rock, 1996;

Yu, Kim, & Cho, 2011). Other studies find no statistically significant relationship between envi-

ronmental quality and FTAs (Gale & Mendez, 1998). Finally, some studies find conflicting evi-

dence on the relationship between trade agreements and environmental quality (Beghin, Roland‐

Holst, & Van der Mensbrugghe, 1995; Dean, 1992; Gale, 1995; Gale & Mendez, 1998; Jayade-

vappa, 1996; Koo, 1974; Leonard, 2006; Logsdon & Husted, 2000; Low & Safadi, 1992; Stern,

2007; Tobey, 1990; Walter, 1976).

A commonality among all the previous studies is that they do not differentiate between the

countries involved in the trade agreement. It is logical that countries at differing levels of develop-

ment, therefore using differing production technologies and having differing tradeoffs between eco-

nomic growth and environmental degradation, would react to trade liberalization in different ways.

In reality, the effect of the trade agreement on environment quality may be dependent on the coun-

tries involved in the agreement, which is the focus of this study. Specifically, we note that trade

agreements can be established among developing countries, among developed countries, or

between developed and developing countries.

From a theoretical standpoint, several hypotheses argue that when developing and developed

counties are involved in an FTA, then environmental quality could be improved or worsened

depending on the country type. For example, according to the “pollution haven hypothesis”(John-

son & Beaulieu, 1996), developing countries will have more pollution after an FTA because of

their lax environmental regulations. Polluting industries will relocate from countries with strict

environmental regulations to developing countries (Johnson & Beaulieu, 1996). Developing coun-

tries will also become producers of more pollution‐intensive products (Korves, Martínez‐Zarzoso,

& Voicu, 2011).

Other hypotheses in this area are the “factor endowment”(FEH), “Porter”or “regulatory chill”

and “race to the bottom.”The FEH hypothesis argues that trade flows are determined by the

amount and type of resources owned by trade partners. Usually, developing countries produce

more labor‐intensive products that are clean and developed countries produce capital‐intensive

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