Agricultural Trade and Environment: On Parallel Tracks or a Collision Course?

Trade activities however have direct impact on natural resources and the environment, although there is no conclusive evidence that trade by itself necessarily harms the environment. Rather, trade often magnifies the environmental effects of economic activities. For instance, agricultural practices can cause negative externality. Farmers do not bear all the costs associated with agricultural production, such as soil erosion, surface and groundwater pollution, and chemical misuse and contamination.

Environmental regulations, on the other hand, can distort market access for certain agricultural produces. Thus just as the implementation of agricultural and trade policy creates a complicated set of environmental distortions, environmental regulations in turns generates an equally complicated set of trade distortion.

Environmental policies influence the composition of agricultural production and trade. Resources may be encouraged to move out of agriculture should environmental controls in agriculture become more restrictive than in other industries. These output composition effects also influence the relative mix of agricultural output and trade. The composition effect may also influence the relationship between primary production and processing of agricultural products. A country may then import more primary products for processing or may import the processed products and shift resources out of agribusiness.

Environmental requirements may also have potential effects on market access. These requirements include regulations (which are mandatory) and standards (which are voluntary and can be implemented by the private sector or NGOs); labelling requirements (either mandatory or voluntary, such as eco-labelling); packaging regulations; and certain sanitary and phytosanitary (SPS) measures. Many of these require proof of compliance – for example, through conformity assessment, including certification. If the developing countries are unable to comply with the environmental requirements, they are less likely to be able to take advantage of any environmental, health or social benefits at the domestic level.

Although environmental regulations often raise production costs and reduce competitiveness in the short term, long term effects are less certain as agricultural producers adjust and innovate. The regulations altered input values and imposed costs on producers, inducing a change in input use and the subsequent choice of alternative technologies. Thus, changes in relative factor prices stimulate innovative activities. Research institutions will innovate to remedy the constraint imposed by the policy-induced factor scarcity. Hence environmental regulation can act as a signaling mechanism that stimulates research into environment-conserving technologies.

So, is the world trade and environment on parallel tracks or a collision course? Freer trade generally increases the rate of economic growth, which can harm the environment if polluting activity increases with growth, but can improve the environment if resources are reallocated to less polluting activity, or if growth leads to the adoption of environmentally friendly technology. Economic growth is also recognized as a crucial factor in increasing the demand for environmental quality. Available evidence on the environmental impact of trade policy reform and integration in output and factors markets does not support the pessimistic conjecture of a wholesale specialization in dirty activities.

What has been the developing countries' experience with various policies and institutions? Market-based instruments have proven effective in tackling environmental problems. A reduction of subsidies on pollution-intensive activities or raising taxes on polluting activities decreases pollution and increases tax revenues. Furthermore, the cost of environmental protection is moderate and does not compromise competitiveness. For example, the Malaysian palm oil industry has been facing substantial environmental regulations. The industry faced a loss of profit, but has adapted well to the new regulations and taxes. Compliance is high and exports have not decreased, despite the limited opportunities to pass on to consumers the cost increase of crude and refined palm oil in world markets. Research conducted by MPOB and UPM has helped to develop commercial by-products, which reduced the cost of compliance by generating revenues from the by-products instead of dumping them and paying penalties.

Given that free trade and environmental protection should be undertaken jointly, which environmental policies are feasible and desirable? Environmental protection as part of the economic development process can be characterized by a continuum of institutional quality that guides and sustains economic activity. There is a supply and demand side to the quality of institutions protecting the environment, and both are influenced by the trade orientation of an economy. On the demand side, economic growth implies higher income and increasing demand for environmental protection and standards. On the supply side, governments in developing economies have scarce amounts of resources and human capital to allocate to the provision of competing institutional functions, including environmental protection. These governments are accumulating policy and institutional experience. Institutional knowledge can be transferred across industries and borders. Hence, the free movement of institutional knowledge reinforces the sustainability of economic development. Environmental side-agreements to trade agreements could facilitate such knowledge transfer.

Thus whether agricultural trade contributes to environmental degradation depends to a great extent on two factors: the strength of national environmental regulations, and the degree to which international trade regimes reinforce or undermine them. Well-designed and enforced environmental policies are more likely to ensure that trade liberalization will bring economic growth and gains in environmental quality. Economic growth and higher incomes engendered by free trade may also lead to a greater social preference for the resources available to achieve environmental improvement, as depicted by the environmental Kuznets curve.