Is Environmental Tax Harmonization Desirable
in Global Value Chains?
Haitao Cheng1

Hayato Kato2

Ayako Obashi3

1 Hitotsubashi University
2 Osaka University
3 Aoyama Gakuin University

JSIE Chubu @ Nanzan University

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GVCs and the environment• The current globalization is characterized by the spatial
unbundling of production processes (i.e., 2nd unbundlng).
→ Environmental damage is also unbundled.
cf. Over 30% of global CO2 emissions is from those generated when producing
traded goods in 2004 (Davis et al. 2011).

• The unbundling allows firms to locate their production processes
in countries with lax regulation.
→ Concern on the ”pollution haven” effect.

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Environmental policy harmonization• One measure against the harmful impact of unbundling is toharmonize environmental regulations among countries.
cf. Actively discussed in the EU.

◦ The harmonization may mitigate the divergence ofenvironmental quality.
◦ It may be difficult, however, to address local environmental
impacts given the heterogeneity of countries.
→ Focusing on environmental taxation,
we evaluate the effectiveness of harmonization in a modelof value chains before and after the 2nd unbundling.
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Preview• Setup• Based on a trade model with input-output linkages, known as
the ”spider” version of Baldwin and Venables (2013),
we characterize the socially optimal environmental taxes oninputs.
• Results• Before the 2nd unbundling where parts and assembly mustco-locate,• As costs of unbundling parts and components,
harmonization is desirable.
cf. Keen and Kotsogiannis (2014); Ogawa and Yanase (2019)• After the 2nd unbundling where parts and assembly canlocate separately,
harmonization is not desirable.
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Literature• Environmental policies and mobile firms◦ Markusen, Morey and Olewiler (1993, 1995);◦ Zeng and Zhao (2009);◦ Ishikawa and Okubo (2011, 2016, 2017).

• Environmental policies and vertical trade◦ Wan and Wen (2017);◦ Wan, Nakada and Takarada (2018).

• Trade policy analysis in global value chains◦ Obashi (2017, 2018).
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Agenda• Setup• Input sourcing patterns• The world before the 2nd unbunling: high unbundling costs• Assembly location• Optimal environmental tax• The world after the 2nd unbundling: low unbundling costs• Assembly location• Optimal environmental tax

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Setup7/1

Spider model à la Baldwin and Venables (2013)• Two countries: N and S have an equal population.
• Non-numéraire goods: a final good and many intermediate
goods (parts).
◦ A final good producer (assembler) locates either in N or S andsources parts from both countries.
◦ Parts production uses labor and takes place in both countries.
• Numéraire good: by an appropriate choice of units, the wage rate in
two countries equals one.

8/1• Unbundling costs◦ When the location of parts differs from that of assembly,sourcing one unit of a part involves θ units of unbundlingcosts.
◦ The final good is costlessly traded.

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• Environment◦ Parts production generates local pollution.
◦ One unit of inputs = one unit of pollution.
→ Government i ∈ {N, S} imposes environmental tax ti per unit ofpollution.

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• If the assembler is in N:

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• If the assembler is in S:

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Technology of parts production• Parts are indexed by z ∈ [b, b].
• Two countries are good at producing different parts.
◦ In N, the unit cost of any parts : 1.
◦ In S, the unit cost of part z: b(z) = z ∈ [b, b].
→ N has advantage in z ∈ [1, b].
→ S has advantage in z ∈ [b, 1].

13 / 1• We assume S has an average cost advantage over N, i.e.,(b + b)/2 < 1.
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Input sourcing patterns

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Parts location• The assembler sources parts from the least cost supplier.
• Supposing the assembler is in N, a part z is produced in N if
1 + tN < b(z) + θ + tS ,| {z } |{z}Cost in N

Cost in S→ b(z) > bN ≡ min[max{b, 1 − θ + ∆t}, b],
where ∆t ≡ tN − tS .
• Supposing the assembler is in S, a part z is produced in S if
1 + θ + tN > b(z) + tS ,| {z } | {z }Cost in N

Cost in S→ b(z) < bS ≡ max[min{b, 1 + θ + ∆t}, b].
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Parts location under high unbundling costs

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Parts location under high unbundling costs

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Parts location under low unbundling costs

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Parts location under low unbundling costs

21 / 1• A higher tax in a country reduces parts production there.
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Socially optimal environmental taxes
in the pre-globalized world

23 / 1Assembler’s location choice• Suppose θ > θ is so high that parts and assembly mustco-locate.
• The social planner maximizes the global welfare by choosing
environmental taxes (tN , tS ).
• The planner pays attention to the assembler’s location choice.

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• Let Ci be the unit production cost of the final good when theassembler is in i ∈ {N, S}.
Z bN
CN =b|

Z b(1 + tN )d be(be + θ + tS )d be +bN{z}{z} |Parts from S

Parts from N= (b − b)(1 + tN ).
Z bSZ beeCS = τ +(b + tS )d b +(1 + θ + tN )d bebbS{z}{z} ||Parts from N
Parts from Sb+b= τ + (b − b)+ tS .
225 / 1• Assembly takes place in N if
∆C ≡ CN − CS = −τ + (b − b) (β + ∆t) ≤ 0,→ τ ≥ τ ∗ ≡ (b − b) (β + ∆t) ,where β ≡ 1 − (b + b)/2 captures S’s average-cost advantage.
• The assembler is more likely to locate in N if
trade costs are higher (higher τ );N’s tax gets lower (lower ∆t);
N’s parts are more costly (higher β).

26 / 1• Due to the assembler’s location choice, the global welfare isdiscontinuous!
• If τ ≥ τ ∗ , the assembler locates in N. The indirect utilities of Nand S are
VN |A=N = (u − CN ) + tN (b − b) − (γ/2)(b − b)2 + X ,VS |A=N = X .
◦ u: utility from consuming the final good.
◦ β: sensitivity to environmental damage.
◦ X : endowment of the numéraire.

• The global welfare is defined as W |A=N = VN |A=N + VS |A=N .
• If τ < τ ∗ , the assembler locates in S. The global welfare issimilarly defined as W |A=S = VN |A=S + VS |A=S .
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Socially optimal outcomes• Environmental tax harmonization maximizes the global welfare!

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Socially optimal environmental taxes
in the globalized world

29 / 1Assembler’s location choice• Suppose θ < θ is so low that parts and assembly can locate indifferent countries.
• The unit production cost isb + bN(bN − b) + (1 + tN )(b − bN ),CN = θ + tS +|{z}2|{z}Parts from N
Parts from Sb + bS
CS = τ + tS +(bS − b) + (1 + θ + tN )(b − bS ),
|{z}
2{z}
|
Parts from N
Parts from S

where bN = 1 − θ + ∆t and bS = 1 + θ + ∆t.
30 / 1• The assembler locates in N ifCN ≤ CS ,→ τ ≥ τ ∗∗ ≡ 2θ (β + ∆t) .
• Unlike the previous case, unbundling costs θ show up!
• Higher θ makes stronger the assembler’s incentive to co-location
with S’s suppliers.
→ higher τ ∗∗ → less likely to locate in N.

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• If τ ≥ τ ∗∗ , the assembler locates in N. The indirect utilities of
N and S are
VN |A=N = (u − CN ) + tN (b − bN ) − (γ/2)(b − bN )2 + X ,VS |A=N = tS (bN − b) − (γ/2)(bN − b)2 + X .
• Parts are produced in S as well.
• The global welfare W |A=N is defined as the sum of the two.
• If τ < τ ∗∗ , the assembler locates in S. The global welfare
W |A=S is similarly defined.

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Socially optimal outcomes• Environmental tax harmonization (almost) never maximizes theglobal welfare!
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Summary• Before the 2nd unbundling where parts and assembly mustco-locate,harmonization maximizes the global welfare.
• After the 2nd unbundling where parts and assembly can locate
separately,harmonization (almost) never maximizes the global welfare.
• Message• As the unbundling proceeds,environmental policies are more likely to change firms’
location decisions.
→ Policies should be carefully designed.
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