Discussion Paper No. 633

TRADE REFORMS, DEFORESTATION
AND INDUSTRIAL POLLUTION
IN DEVELOPING COUNTRIES:ONE SIZE DOES NOT FIT ALL

Ian Coxhead
andSisira Jayasuriya

March 2005

The Institute of Social and Economic Research
Osaka University
6-1 Mihogaoka, Ibaraki, Osaka 567-0047, Japan

Submitted to OEP, March 11 2005

Trade Reforms, Deforestation and Industrial Pollution in Developing
Countries: One Size Does Not Fit All*

Ian Coxhead
Department of Agricultural and Applied Economics
University of Wisconsin, Madison
413 Taylor Hall, 427 Lorch St
Madison, WI 53706, USA
coxhead@wisc.edu
Sisira Jayasuriya
Faculty of Economics and Commerce
University of Melbourne
Parkville, VIC, Australia
skj@unimelb.edu.au*

This is a revision of University of Wisconsin-Madison, Department of Agricultural and Applied Economics
Staff Paper Series No. 462 (Revised, January, 2004). The authors would like to thank Max Corden, Bayou
Demeke, Charles Horioka, Yoshiyasu Ono, Peter Warr, participants at the European Association ofEnvironmental and Resource Economists annual congress (Bilbao, Spain; June 2003), and seminar participantsat the Melbourne University, UC-Berkeley, UC-Davis, Osaka University, and the University of Wisconsin for
helpful comments on earlier drafts. Remaining errors are ours alone.

Submitted to OEP, March 11 2005

Trade Reforms, Deforestation and Industrial Pollution in Developing
Countries: One Size Does Not Fit All

Many developing countries possess comparative advantage both in natural resources and inlabor-intensive industries, and experience both industrial pollution and natural resource
degradation. We present a model that incorporates these stylized facts together with key
spatial features and property rights failures typical of developing economies. We explore
consequences of anticipated domestic and global trade policy and world price changes.
Similar exogenous or policy shocks are seen to have contrasting effects, depending on initial
economic structure, trade orientation and policy regime. Further, when there is more than
one sectoral source of environmental damage, a policy or price change may have unexpectedenvironmental and welfare results. Nevertheless, in many empirically important cases,
reducing protection for capital intensive manufactures is likely to improve both income andenvironmental quality, a point that we illustrate by reference to some Asian case studies.
These results stand in contrast to those obtained in much of the current analytical literature.

Key Words: Trade, environment, pollution, deforestation, developing countries.
JEL: F18, O24, Q28

1

1 Introduction
Developing countries increasingly face problems of air and water pollution arising fromindustrial emissions, in addition to degradation of natural resources such as forest, land andwater. Though they may occur in different sectors, different types of environmental degradation
are not independent: in addition to bio-physical relationships, they are also linked by sectoralinterdependencies operating through factor and commodity markets. This means that strategies
for alleviating environmental degradation must take account of these linkages.
This need is of particular importance in analyses of the relationship between trade and theenvironment. By the 1990s, the benefits of liberalized trade for economic development had won
widespread acceptance, motivating trade policy reforms in most developing countries. Morerecently, however, concerns about environmental consequences of freer trade have reignited thetrade liberalization debate. The value of a better understanding of trade-environment links in thespecific context of developing economies is now very high. Sectoral interdependencies demandthat this relationship be approached from a general equilibrium perspective.
Although general equilibrium theoretical approaches to trade-environment questions arewell established, the current literature in this area has serious limitations where developing
economies are concerned. On environmental issues, many analyses are highly aggregative,
combining widely different types of environmental damage into a single variable. Though thisapproach can help elucidate basic principles, it is much less useful as a guide to normative
analysis and policy formulation. Other analyses choose to deal only with a single concern, suchas air pollution or deforestation.

Even in their excellent review of key literature andconsolidation of main analytical results, Copeland and Taylor (2003) deliberately restrict thescope of their analysis to industrial pollution, omitting analysis of natural resource use and2depletion.1 While the focus on industrial pollutants may arguably be adequate for someindustrialized economies, it is inadequate for developing countries, where natural resource
degradation shares top billing or even outranks industrial pollution as a leading environmental
problem (Asian Development Bank 1997; Jha and Whalley 1999). Nowhere is this more true
than in tropical Asia, where natural resource stocks are under severe threat, with deforestation
rates the highest of any world region (Table 1).
For the past three decades, the fundamental rationale for trade policy liberalization indeveloping countries has been the recognition of multiple sources of comparative advantage,emphasizing their potential for export success not only in natural resource products, but also inlabor-intensive manufactures (Little et al 1970; Bhagwati 1978; Papageorgiou et al 1991; Collier
and Gunning 1994). Though this literature is silent on the environmental consequences of trade,any policy-relevant analysis of trade-environment questions cannot afford to ignore its central
insight on comparative advantage, highlighting the critical importance of labor intensive exports
for economic growth.
The seminal formalization of the links between manufacturing sector trade reforms andnatural resource degradation in a developing country setting is Deacon (1995). He analyzes theimpact of tariff reform on deforestation in a Ricardian model with two traded goods (a protected,
import competing manufactured good and an exportable agricultural good) and one
intersectorally mobile factor, labor. Labor is also used to convert open-access forest into
agricultural land. Trade liberalization shrinks the manufacturing sector, which releases labor.
This reduces the cost of forest conversion for agriculture, thereby unambiguously increasing
deforestation. This illustrates the proposition that an institutional failure, a particular type of
distortion of which open access to a natural resource is one example, will lead to socially3

excessive pollution (or resource degradation) when trade frictions are reduced, if the country hascomparative advantage in the polluting sector (Brander and Taylor 1997). At the same time,
however, this result pits environmental concerns against the conventional gains from tradeliberalization; if preservation of the natural environment has positive value, then the Deacon
result indicates a welfare tradeoff.
This tradeoff, however, is contingent on a model structure that precludes by assumption
the more realistic case in which a developing country also has comparative advantage in somelabor-intensive manufacturing industry. In addition, the model assumes that there is no welfarereducing industrial pollution. In fact, empirical evidence indicates that capital-intensive heavy
industry—the sector typically protected—is much more pollution-intensive than are laborintensive industries (Table 2 illustrates this point). As we will show in this paper, the implicationof an unambiguously negative relationship between trade liberalization and environmental
quality that emerges from the Deacon model, as with the Brander and Taylor result on reducing
trade frictions, does not hold robustly in models that are consistent with the key stylized facts ofdeveloping countries.
In the following section we set out a model which retains the key institutional assumptionof weak property rights in natural resources, but in which there is scope for more diversified
production structures both in manufacturing and in natural resources sectors. We show thatwhile there may in principle be a tradeoff between industrial pollution and natural resource
degradation, in the most empirically relevant cases lowering manufacturing sector protection is
likely to reduce both industrial pollution and natural resource degradation. We also explore
likely implications for developing countries of some other important trade-related shocks andpolicy reforms, including those anticipated in the current Doha Round negotiations. Our results

4highlight the sensitivity of outcomes to differences in economic structure and the need forcaution when generalizing about the environmental effects of trade reforms and price shocks;
because relevant aspects of economic structure vary even among apparently similar developing
countries, one size does not fit all.
2 Model structure and assumptions
As indicated, our model attempts to capture key stylized features of small developing economies,
particularly those in tropical Asia, though many of its features are common to many otherdeveloping countries.2

In particular, we model a small open economy with comparativeadvantage in two types of good, an agricultural commodity and labor-intensive manufacturing.
The model comprises two sub-economies, manufacturing and agriculture.

We make thefollowing initial assumptions:
1. Manufacturing (M) is a mini-Heckscher-Ohlin economy with mobile labor and capital,
producing an import-competing, tariff-protected good H, and an exportable X. X has arelatively high labor-to-capital ratio (). Based on empirical evidence on the relative
pollution intensity of industries in developing countries, we specify that the low  sector
is pollution-intensive (‘dirty’), while the other sector is ‘clean’. Industrial emissions, J,
are produced in constant proportion to the output of H, i.e. J = βyH, β > 0. The externalcosts of pollution are not internalized by dirty sector firms.
2. Agriculture (A) is a mini-Ricardo-Viner-Jones economy, in which the sectors are distinct
sub-regions, ‘upland’ (U) and ‘lowland’ (F) with region-specific endowments of land, T
in upland and N in lowland. T and N differ due to variation in elevation, soil type, accessto irrigation and other agro-climatic factors. Labor is mobile between the two sectors.

5

Initially we assume that the lowland region produces import-competing ‘food’, whereas
the upland produces plantation crops for export, as is typical in many tropical countries.3
This regional division reflects the important stylized fact that in much of the tropics, riceand other staple foods are grown primarily in river deltas and other low-lying, often
irrigated areas, while ‘uplands’ or ‘dry lands’ are often planted to a mix of crops that may
include food alongside perennial crops such as tea, rubber, cacao and oil palm.
Conversion of ‘uplands’ to ‘lowlands’ is thus very costly, and differences in key agroclimatic factors result in continuing productivity differences that justify treating these as
essentially two different land types. The outer boundary of upland cultivation in thetropics is usually the forest frontier; the conversion of forest land to agriculture isessentially an upland phenomenon. 4
3. Forest is an open-access resource that yields T through deforestation. To focus on theenvironmental benefits of forest we assume it to produce only non-marketed outputs.5 T
is produced and maintained using labor LT according to T = LT/α, where α > 0 is the unit
labor requirement. Thus the labor available for upland agricultural production is LU – αT.
We also assume that labor (L) is freely mobile among all activities and sectors; there areconstant returns to scale, complete markets (except for environmental goods) and perfectcompetition in goods and factor markets.

Consumers derive utility from consumption ofmarketed goods and environmental goods (standing forest and clean air).

Environmental

phenomena affect the economy only through consumer utility rather than through intersectoral
effects on production costs, and we ignore trans-boundary pollution issues.6 Finally, to focus on
the environmental stories we assume that tariff and tax revenues are redistributed to consumers
in lump-sum fashion. We recognize that trade liberalization does have important dynamic growth

6effects, and thereby contributes to what Antweiler et al. (2001) have termed the ‘scale effect’ (abigger economy pollutes more, other things equal). However, our focus is on changes in the
structure of production and factor demand, or the ‘composition effect’ of trade-related changes
derived via comparative static analyses.7
The foregoing assumptions mean that we have an economy with three distortions: a tariffin the import-competing manufacturing sector, an absence of property rights in forests, and a
missing market for pollution produced by firms in manufacturing. In principle, first-best policies
would imply moving to free trade while imposing Pigovian taxes on polluting firms, andenacting appropriate reforms to ensure that forest-related consumption externalities are fullyinternalized. But analytical issues arise precisely because in practice, such first best policies arevery difficult to implement. Hence it is appropriate to explore the effects of specific policy
reforms in the continuing presence of one or more of these distortions.
Turning to the model, full employment of labor implies L = LU + LF + LM. Prices foreach good are denoted by pU and pF for upland and lowland agriculture respectively, and pH andpX (= 1 by assumption) respectively for the import-competing (dirty) and exportable (clean)manufactures. We assume these prices to be set in world markets and thus to be exogenous to
the economy.

The quantities of lowland land and manufacturing capital (K) are assumed

exogenously fixed, but there is an endogenous supply of upland land through deforestation.
Using this notation and assuming profit-maximizing producers, we define maximum revenue
functions for each sector or region:
Lowland (food):

Q(LF, N, pF)

Upland:R(LU – αT, T, pU)

7

Manufacturing:S(L – LF – LU, K, pH).

These functions reflect profit maximization subject to endowment constraints and are nondecreasing and homogeneous of degree 1 in prices and endowments. Their sum is equal to total
value added, I:
I = Q(LF, N, pF) + R(LU – αT, T, pU) + S(L – LF – LU, K, pH)(1)

We capture consumer preferences and behavior with a conditional minimum expenditure
function, in which the quantity of industrial emissions, J, and the area of standing forest cleared
for agriculture, T, are exogenous to the consumer. Letting p stand for the vector (pF, pU, pH, 1):
E = E(p, J, T, υ)(2)This embodies all the information on the preferences of a utility-maximizing representative
consumer with utility function υ(F, U, H, X; J, T), with υj > 0 for all j ∈ (F, U, H, X), υJ ≤ 0, υT ≤0. We follow existing trade models in assuming utility to be separable between marketed goods
and environmental goods.
Let subscripts on Q, R, S, and E indicate derivatives of these functions with respect to
subscripted variables, for example RT = ∂R/∂T. To reduce notational clutter we write derivatives
with respect to sectoral prices using sectoral symbols, for example, EM = ∂E/∂pH, EHF =∂2E/∂pH∂pF, and so on. By the properties of the revenue and expenditure functions and theenvelope theorem, RU is the supply of upland output, QN is the shadow value of lowland, EH isdomestic demand for import-competing manufactures, ET is the negative of willingness to pay
for standing forest, Eυ is the reciprocal of the marginal utility of income, and so on. Finally,recall that the initial domestic price of H is increased by a tariff; this is given by t H = p H ! p H ,where p H is the world price in domestic currency terms.

8Given return of tax revenues to consumers in lump-sum form, the aggregate budget
constraint of this economy is:
E = I + tH(EH – SH)(3)

There is full employment in equilibrium, so the usual marginal productivity condition for labor
requires that the following conditions hold:
QL(LF, N, pF) = RL(LU – αT, T, pU)(4)

RL(LU – αT, T, pU) = SL(L – LF – LU, K, pH)(5)

RT(LU – αT, T, pU) – αRL(LU – αT, T, pU) = 0(6)

Conditions (4) and (5) state that in equilibrium, the marginal product of labor is equal in value
terms across all sectors. Condition (6) ensures that within the upland sector, labor used in land
clearing and in production are of equal value at the margin. It is thus a property of the modelthat since labor is the only input to land clearing, any shock that raises labor productivity inupland production also generates pressures for deforestation.8 The solution to equations (3) to(6) yields equilibrium values of real income, LF, LU, and T, each as a function of (p, tH, L, N, K).
From these we can calculate changes in LM as well as sectoral and regional outputs, the wage,
and industrial emissions. So long as production of land from forest is a linear function of laboralone, however, we can obtain all the comparative static results of interest by solving (5) and (6)for LF and LU. The solution will then yield LM from the labor constraint, and T can be founddirectly from LU.

For price changes, comparative static results are obtained by totallydifferentiating (4) and (5), holding all factor endowments except land constant, to yield:

9

"QLL
$S
# LL

!RLL % " dLF % " !QLF dp F + RLU dpU %,=(RLL + SLL ) '& $# dLU '& $# SLH dp H ! RLU dpU '&(7)

in which |Δ|, the determinant of the coefficient matrix, is quickly established as

QLL ( RLL + SLL ) + RLL SLL > 0 . Comparative static results are obtained using Cramer’s rule.
3. Environmental and welfare effects of trade policy reforms
In this section we use the model first to see the effects of domestic trade policy reforms. WTO
compliance by developing countries typically requires reduced manufacturing sector protection,so we stylize this reform as a manufacturing tariff reduction (the agricultural tariff case will be
explored later in the paper). Subsequently, we examine potential changes in international prices
reflecting the relaxation of rich-country cereal export subsidies as envisaged under the Doha
Round, then a counterpart shock affecting world demand for tropical industrial crops, which aremainly grown in the areas we have described as ‘upland’.
Effects of domestic tariff reformIn this model, a price shock in one sector alters economy-wide resource allocations, and so
affects the production of each type of environmental damage, with economy-wide labor mobility,
and capital mobility within manufacturing, serving as adjustment mechanisms. Consider first atariff reform. A ceteris paribus tariff reduction in the capital-intensive manufacturing sector
raises the return to labor and causes out-migration of workers from agriculture. Solving from(7), using the definition of tH and setting dtH < 0 gives:

dLF =

1
RLL SLH dt H < 0
!

(8)

10

dLU =

1
QLL SLH dt H < 0!

(9)

By substitution into the full employment constraint (with dL = 0) we also find:dLM = !

1
SLH (QLL + RLL ) dt H > 0 ,"(10)Tariff reduction, by raising labor productivity in manufacturing relative to that (measured atinitial wages) in other sectors, results in labor migration to manufacturing from agriculture. This
leads to the following proposition concerning environmental damages:

Proposition 1 (Tariff reform): Reducing the tariff on the polluting manufacturing sector reduces
deforestation and reduces industrial pollution when the protected manufacturing sector isrelatively pollution-intensive, and increases overall welfare.

Because H is capital-intensive, reducing its relative price causes X to expand, driving up wages.
The drop in H output results in lower emissions, i.e. dJ < 0. Labor moves out of agricultural
sectors, and since dT/dLU = α > 0, deforestation declines. It is thus a feature of the model thateven with comparative advantage in plantation crops and open access to forested land forconversion into plantation crop land, the plantation sector contracts when the tariff on an importcompeting sector is reduced.
The real income effect of a small change in the tariff is found by totally differentiating(3), using (2) and (1) and setting changes in the exogenous prices and quantities equal to zero.
Defining net imports ZH = (EH – SH), and using (4) – (6) to eliminate some terms, we obtain:!d" + E J dJ + E T dT = t H Z HH dt H # t H S HL dLM

(11)

11

where γ = Eυ – tHEHυ > 0 and dLM = –(dLF + dLU). The first term on the left hand side provides
the usual measure of change in the real consumer income; the second and third terms capture theutility effects of changes in environmental variables. If we ignore these for a moment by setting
EJ = ET = 0, then (11) provides a measure of real income change due to the tariff change. The
first term on the right hand side conveys the familiar deadweight loss of protection due toreallocation of resources within the manufacturing sector. Since ZHH = (EHH – SHH) < 0, this term
is positive for dtH < 0. The second term captures an additional efficiency change due to thereallocation of labor between manufacturing and agriculture. For a tariff reduction this signed
term is also positive. In sum, real income must increase when trade is liberalized. Finally, weknow that both dT < 0 and dJ < 0 for a tariff reduction, so if EJ ≤ 0 and ET ≤ 0, a broad measureof consumer welfare, consisting of the sum of all three terms on the left hand side of (11), is
unambiguously increased by trade reform.9
Effects of global market shocks
The Doha round of world trade talks includes proposals for the major industrialized foodexporters to reduce subsidies paid to their own farmers. These measures, if implemented, would
raise world prices of most agricultural products—especially cereal grains. Wheat and feedgrain
prices are predicted to rise by about 25%; rice and corn by 8-12%, and oilseeds by 8%(Dimaranan et al. 2002). Global trade reforms could thus impose large terms of trade shocks on
food-trading developing economies.

This motivates our second experiment, in which we

examine the effects of a rise in global grain prices.
By the same method as in the tariff change analysis, the labor market effects of anincrease in the price of food, the lowland agricultural product (dpF > 0) are:

12

1
(QLF (RLL + SLL )) dp F > 0
"

(12)

dLU =

1
QLF SLL dp F < 0
!

(13)

dLM =

1
QLF RLL dp F < 0 .
!

(14)

dLF = !

The food price rise causes labor to migrate out of uplands and manufacturing. In ourmodel, lowland agriculture is a ‘clean’ industry producing import-competing goods. A firstreaction would be to predict a real income loss offset by gains from reduced environmental
damage. The story, however, is not so neat.

Proposition 2 (food price rise): A rise in the world price of import-competing food crops, withlabor mobile across all sectors and capital mobile within manufacturing, reduces real income
and deforestation but increases industrial pollution. Welfare gains are theoretically ambiguous.

The labor market response shown in (12) to (14) is clear. It can readily be deduced that the priceshock results in a contraction of upland production, so dT < 0. In manufacturing, however, lesslabor means lower output in the clean sector and thus, with a fixed capital stock, more in the
dirty sector, so dJ > 0. In this model the projected grain price increases from the Doha Roundwill have positive net environmental effects only if the benefits of lower upland production andreduced deforestation exceed the costs of increased pollution from expansion of ‘dirty’ capitalintensive manufactures.
The real income effect of the rise in pF is given by:

γdυ + EJdJ + ETdT = –ZF dpF + tH(EHFdpF – SHLdLM)

(15)

13

For tH taking small values, a rise in pF has a direct real income effect in which consumer losses
are proportional to food imports. This first-order effect is modified by two second-order effects
capturing, respectively, higher tariff revenues due to substitution in consumption between F andH, and in manufacturing, an increase in tariff-related losses due to the expansion of H andcontraction of X. The first of these offsets part of the first-order real income loss while thesecond causes additional losses. Real income net of environmental effects thus declines while
industrial pollution increases. Hence overall welfare, inclusive of environmental changes, canincrease only if the gains from reduced deforestation outweigh combined losses in real income
and higher industrial pollution. Empirically, a gain is possible only if EJdJ and the effects offood price rises are very small, while utility gains from reduced deforestation are very large.
The second global price shock experiment concerns exportable agricultural products,
which we assume (for now) to be grown in uplands only. Global demand for tropical plantationcommodities such as rubber, oil palm and timber is expanding rapidly, in large part because of
the continuing rapid growth of large developing economies such as China and India. What willbe the net environmental and welfare effects a global boom in upland crop prices?
For an increase in the upland commodity price (dpU > 0) we obtain labor market
responses as:

dLF =

1
RLU SLL dpU < 0
!

(16)

1
RLU (QLL + SLL ) dpU > 0
"

(17)

1
RLU QLL dp F < 0 .
!

(18)

dLU = !
dLM =These results provide an indication of the likely direction of output changes, and motivate
proposition 3.

14

Proposition 3 (Plantation crop price rise): An increase in the price of plantation crops grown in
uplands, with labor mobile across all sectors and capital mobile within manufacturing, increases
real income but also increases both forms of environmental damage. Welfare gains are more
likely the lower the value attached to environmental damages.

Raising the upland price produces a positive real income effect through the terms of trade, but
unambiguously increases deforestation as upland agriculture expands, through in-migration oflabor. But this is only the direct environmental impact. Less obviously, intersectoral migration
also contributes to an increase in industrial pollution.

At constant relative prices ofmanufactures, reducing the labor endowment of manufacturing as a whole causes X to contract,drawing capital and labor into H; thus, the dirty sector expands and the clean sector contracts.
To find welfare effects, take the total differential of (3) with respect to pU, holding thetariff, factor endowments and other product prices constant:γdυ + EJdJ + ETdT = –ZUdpU + tH(EHUdpU – SHLdLM)(19)

The symmetry with the food price case is clear. For an exportable, domestic excess demand ZU <0, so the first expression on the r.h.s is a positive direct terms of trade effect which raises real
income. Indirectly, the price change causes both expenditure and M sector resources to switch
toward H. As before, these second-order effects have opposed signs, so their net effect must be
small in relation to the first-order impact through ZU. The environmental losses are clear: dT is
positive (i.e. deforestation increases), reflecting the higher value of open-access upland, and thetransfer of M sector resources into H makes manufacturing more emissions-intensive, i.e. dJ > 0.

15

Welfare will rise only if environmental losses, weighted by their utility valuations, are smaller
than the real income gain.
This case if of particular interest to resource-abundant developing economies. Higher
global demand for industrial plantation crops such as oil palm and rubber produce income gains
for major exporters, such as Indonesia, but they come at a substantial environmental cost interms of the deforestation.10
No additional calculations are needed in order to see that the joint effects of global priceshocks affecting both categories of agricultural product will be ambiguous: real income may riseor fall, and pressures on forests may increase or decline. The only definite outcome is that as
agricultural prices rise, industrial pollution will also rise as withdrawal of labor frommanufacturing, with a fixed capital stock, causes the labor-intensive industry to contract and thecapital-intensive industry to expand. Deforestation will rise or fall, depending on the extent towhich manufacturing releases labor and on the relative magnitudes of the labor demand effects
from lowland and upland agricultural price changes.

In a nutshell, country-specificenvironmental consequences of global agricultural trade policies depend on initial economic
structure.
Structural effects: a geometric illustration
The intuition underlying the above analyses can be appreciated with a geometric model. In
Figure 1 the central panel (b) shows the economy-wide labor market. The width of the panel
denotes the economy’s total labor endowment; employment in agriculture is measured to theright from 0A, and that in manufacturing to the left from 0M. Labor demand curves for the M and
A sub-economies are constructed by horizontal addition of those for the respective sectors, as16

shown. In the initial equilibrium, the economy-wide wage (w) is given by the intersection of LA
and LM.
The right-hand panel (c) shows unit cost (i.e. zero profit) curves for each manufacturingsector in factor price space (Mussa 1979). Note that the wage is set economy-wide, rather thanpurely within the manufacturing sector. Product prices and the wage determine the set of
feasible manufacturing industries and the location of their unit cost curves. The (negative of the)aggregate capital-labor ratio in manufacturing is shown by the line ′; an increase in the ratio
increases the slope of this line, and a ratio higher than the slope of a line tangent to cH at theintersection of the unit cost curves (point G) implies specialization in capital-intensive
production.11 For given wage and prices, with both goods being produced, we can read off theequilibrium return to M sector capital, rM, on the horizontal axis.
In the left-hand panel (a) we show the analogous curves for the two agricultural sectors.
The horizontal axis shows unit returns to land in each agricultural region, rU and rF. These are
not required to be equal, though for convenience we have chosen units of land so as to equate
them in the initial equilibrium.
Weak property rights in uplands means that profit-maximizing producers use thisresource up to the point at which its average product is equal to average cost (Gordon 1954). We
can capture this by interpreting the curve LA in panel (b) as the horizontal sum of labor demands
in lowland and upland agriculture, noting that under open access to forests, upland labor demand
exceeds the quantity that would be observed if property rights were enforced. In the initial
equilibrium, open access means that there is overuse of labor in upland; were property rights
enforced, the total labor demand curve in agriculture would lie to the left of LA.

17

In manufacturing, because we assume that producers in the dirty industry are notpenalized for emissions, free disposal of air and water pollutants leaves producers on their(private) marginal product curves, while producing a negative social externality.
To illustrate the working of the model, let the labor-intensive manufacture, X, be thenuméraire good and set pX = 1. Consider the example of an increase in the price of uplandagriculture, pU. As shown in panel (b) of Figure 2, this displaces the demand for upland labor
vertically upwards by the amount of the price rise, and aggregate agricultural labor demand
curve is increased by the price change times the upland share of agricultural labor. With nochange in manufacturing prices, labor is withdrawn from manufacturing and moves into
agriculture; within agriculture, it is reallocated from lowland to upland production.
As a result of the price change, production in upland agriculture rises and that in lowland
falls. For the lowland, where the quantity of land is fixed, the output change is proportional to
the reduction in labor use at the new, higher wage. For the upland, we suppose that new land
may be brought into production; however, as long as the labor required for forest conversion is
directly proportional to that required for upland production, the change is still proportional to thecorresponding labor demand shift. Returns to land in each agricultural region are altered, as seenin panel (a); that in upland must rise, and that in lowland fall.
At the original wage and price levels, the withdrawal of labor from M has predictable
resource allocation effects. The aggregate labor-capital ratio in manufacturing falls (in terms of
Figure 1, the line ′ becomes steeper) and the labor-intensive sector contracts, while H expands.
This is not an equilibrium, however, as the increase in upland labor demand also exerts upward
pressure on the wage. With constant output prices, the productivity of labor in M must rise tomatch the wage increase. As a consequence of the wage increase the M sector’s aggregate labor18

demand falls and the LM curve in panel (b) moves to the right.

The final labor market

equilibrium, depending on the extent to which the M industries in aggregate release labor, will bean economy-wide labor allocation lying between L1 and L2, with a wage between w0 and w1. In
manufacturing, both the quantity and price effects of the economy-wide labor market adjustment
reduce the output of the labor-intensive sector; the output of the capital-intensive sector may riseor fall. The return on M sector capital must also fall.
The environmental effects of the agricultural price increase can be inferred from thediagram. In manufacturing, dirty output has expanded relative to clean, so the overall emissionsintensity of manufacturing has risen. Whether total emissions rise or fall depends on whether or
not the dirty sector has expanded in absolute terms. The price rise for upland raises the return tolabor used in clearing forest along with that of labor used in production. Looking across the
economy as a whole, the price rise is an environmental lose-lose outcome (more deforestation,
more emissions) if H expands, or a lose-win outcome if H contracts.
The geometric exposition again highlights the observation that when there is more than
one source of environmental damage, and when these are associated with activities in distinct
sectors of the economy, the net effects of a policy or price shock may differ from its direct
sectoral effect. It may confer an environmental benefit in the directly affected sector, but may
indirectly confer a benefit or a loss in another sector. This point is not captured in models where‘environmental damage’ refers to a single phenomenon such as forest loss or industrial pollution.
Effects of domestic agricultural trade reforms
Many developing countries are net food importers and protect domestic food sectors. WTO
agreements, among other influences, have led many, such as China, India, Indonesia and Sri19Lanka to relax agricultural protection over the past decade. What are the environmental
consequences of such reforms?
We can adopt the previous approach, with minor modifications, to analyze this case. For
greater policy relevance, in this exercise, we also relax Assumption 2, that food is produced onlyin the lowland, and suppose that both regions grow food crops that are substitutes (e.g., rice andcorn), and that production is sold in competition with imports in a tariff-protected domestic
market. This better fits the stylized facts of food-importing countries (see next section).
Redefining the domestic price vector so p = ( p F + t F , pU + t U , p H + t H ,1) , the aggregate
budget constraint is rewritten as E = I + t′Z, where t′Z is the inner product of the tariff vector
and the vector of excess demands for F, U and H. From (4) and (5), the labor market impacts oftariff reforms in agriculture follow by substitution of tariff changes for price changes. The
aggregate budget constraint, ignoring variables held constant at their initial values, is:E(t,J,T,!) = Q(LF ,t F ) + R(LU ,T,tU ) + S(LM ,t H ) + t'Z j

for j ∈(F,U,H).

(20)

Then the effects of changes in tF and/or tU are again found by total

differentiation. The results differ from terms-of-trade shocks by the absence of first-orderwelfare effects and presence of second-order terms capturing tariff distortions and the extent towhich output in each sector responds to a labor endowment change.

Proposition 4 (Agricultural trade liberalization):

In food-importing countries, lowering

protection on food crops reduces industrial pollution, and may also reduce deforestation.

Taking the total differential with respect to the agricultural tariffs gives:20

E ! (1" t'E j! )d! + E J dJ + E T dT = t'Z jj dt j + (t H SLL " t F QLF )dLF
+ (t H SLL " tU RLU )dLU

(21)

In this expression, the first term on the r.h.s. is the standard real income loss due to an increase ina tariff, and is negative (positive) for dtj > (<) 0. The other two terms within parentheses areboth non-positive, so the overall sign depends on changes in LF and LU. Solving for changes inlabor demand due to tariff reductions, analogously to the procedure shown in (7) to (10), givesdLF dt F < 0, dLU dt F > 0, dLM dt F > 0, and dLF dtU > 0 , dLU dtU < 0, dLM dtU > 0 . Hence theprediction of aggregate real income change (with EJ = ET = 0) is indeterminate. By the same
logic used earlier, the environmental consequences are dT dt F > 0, dJ dt F < 0 for a reduction intF, and dT dtU < 0, dJ dt F < 0 for a reduction in tU. Lowering the tariff on the lowland food cropincreases deforestation but reduces industrial pollution, while lowering that on the upland foodcrop reduces both. If the two occur together, industrial pollution will unambiguously diminish,
but the deforestation rate may rise or fall. The following table summarizes these results.

Tariff change
dtF < 0dtU < 0

Both

dLF

<0

>0

?

dLU

>0

<0

?

dLM

>0

>0

>0

dJ

<0

<0

<0

dT

>0

<0

?

21

Tariff reduction in upland agriculture yields conventional real income gains, and reduces bothforms of environmental damage—a win-win outcome. Lowland agricultural tariff reduction may
increase deforestation but is otherwise economically and environmentally desirable.12
Strengthening upland property rights
The open access nature of property rights in the forest sector leads to overexploitation of forests,
and establishing well-defined property rights is an important element of the institutional reform
agenda in developing countries.

Though space limitations preclude presenting the formal

analysis, the economic reasoning is clear. Recall from the discussion of Figure 1 that because
there is open access to forests for conversion to upland land, the privately optimal labor
allocation in upland agriculture equates average, rather than marginal costs and returns. Thus thecurve LA in panel (b) of the figure is equal to the horizontal sum of labor’s value marginal
product in lowland agriculture and its average product in upland. It follows that enforcing
property rights in forests, which reduces the rents earned from land-clearing, displaces the LA
curve to the left—in the limiting case, when property rights in forest are fully enforced, to thepoint at which it is simply the sum of the upland and lowland marginal (i.e. labor demand)
curves. In panel (c), increased labor availability to lowlands and lower economy-wide wage will
once more reduce the overall emissions-intensity of manufacturing production. Thus theestablishment of property rights in forestland will tend to reduce both deforestation and urban
pollution in this case, even though forestlands will continue to remain undervalued as long as
their full environmental benefits are not reflected in their land values.
4. Economic structure and environment: some stylized Asian economies
The core model outlined in section 2 is capable of a number of permutations, each reflecting a
different economic structure and set of policies. It can be easily adapted, for example, to model a

22

range of cases in developing Asia, where countries such as Indonesia, Malaysia, Philippines, Sri
Lanka, Thailand and Vietnam provide a laboratory of sorts for the comparative study of theinteraction of growth, trade, policy reforms, and environment. Despite many similarities, theydiffer in terms of some key aspects of economic structure (Table 3). Some, for example, areimportant food exporters (Thailand and Vietnam) while others are net importers and typicallyprotect their food sectors (Philippines, Indonesia). All, however, face common problems interms of rising industrial pollution, deforestation and other forms of natural resource degradation.
Until the 1990s most countries maintained high protection for import competing capitalintensive manufactures, with outcomes strongly consistent with the discussion above. Protection
raised profitability of capital intensive manufactures, discouraged labor-intensive exports, andmade the manufacturing sector as a whole more emissions-intensive. Because the tariff lowered
returns to labor in manufacturing, labor moved into agriculture, reduced the cost of land-clearing
for upland agriculture, and increased deforestation. This has been a common story throughout
tropical Asia. But contrasting outcomes emerge when the effects of agricultural trade policies are
examined.
In the Philippines, a net food importer, food is cultivated in both lowlands and uplands,
with rice in the lowlands and corn in the uplands. Its policy of food sector protection draws laborout of manufacturing, and as the model showed, the labor-intensive, export-oriented
manufacturing industry experiences the largest relative output decline. Both upland and lowland
agriculture expand. Lowland, however, is constrained by a fixed land endowment; in uplands,
the higher food price increases the return to forest clearing to create new lands. Thus theprotection for food producers increases deforestation and reduces the output of labor-intensive
manufactures. The emissions-intensity of manufactures rises, but overall industrial pollution

23

may rise or fall since the sector as a whole will contract.

The combination of industrial

protection and agricultural protection in this type of economy thus favors both emissionsintensive industrial development and deforestation at the upland agricultural margin. By thesame token, liberalization of both agricultural and manufacturing trade is likely to have positive
income and environmental effects.13
In contrast, Indonesia’s upland agriculture produces primarily industrial crops for export.
Protection for lowland agriculture (food), in this economy, causes the lowland region to expand,raising labor demand; this promotes down-slope migration and discourages deforestation at theupland frontier.

As before, the protection for food producers also draws labor out of the

manufacturing sector, reducing the relative size of the clean exportable goods sector andincreasing emissions-intensity. By comparison with the first example, in this case food sector
protectionism tends to diminish pressures on forests. Hence, in Indonesia’s case, the real income
gains that will accrue from liberalization of food imports has to be balanced against increased
deforestation. Thailand and Vietnam, whose lowland agriculture produce an export crop (rice)present yet another variant, with different income and environmental outcomes associated withtrade policy reforms and exogenous price movements. Global reductions in food prices, forexample, may well cause increased deforestation as labor moves out of lowland agriculture, in
addition to the negative income effects associated with terms of trade declines.
These brief sketches indicate ways in which apparently minor variations in economic
structure can be associated with significantly different income and environmental outcomes in
response to similar policy shocks or exogenous changes. If nothing else, they do indicate clearly
that even within a relatively similar subset of developing economies, there are no grounds forsupposing the existence of a common set of environmental and natural resource depletion trends

24in the course of economic growth. Further, generalizations about the income and environmental
outcomes of domestic or international policy reforms for developing countries may be quite
misleading.
5. Conclusions
Debate on the environmental effects of trade liberalization in developing countries remains
intense, but available models often miss significant structural features critical to policy relevant
analysis. Our analysis in this paper highlights, first, the need to recognize that it may be
misleading to focus on only some types of environmental damage when considering the overall
impact on environmental degradation.

Different types of environmental damage—in our

example, industrial emissions and deforestation—respond in different ways to economic shocks,
requiring calculation of the relative economic value of different types of environmental resources
and the net economic value of the overall environmental effects. Second, the actual
environmental outcomes of specific exogenous shocks or policies depend critically on the initialstructure of the economy. The same shock could well have opposed environmental effects in
two developing economies that appear very similar in many respects. This finding undermines
the generality of findings on the trade-environment relationship that rely on more abstract
characterizations of economic structure. Third, in yet another illustration of the theory of second
best, when environmental externalities coexist with policy-induced distortions, partial policy
liberalization may have negative effects on aggregate welfare or on environmental problems.
However, from a policy standpoint, it should be stressed that the widespread opposition to tradeliberalization among many environmentalists may be misplaced: because most developing
countries have intrinsic comparative advantage in labor intensive products, liberalization of

25

manufacturing imports is likely to improve both (conventionally measured) real incomes andenvironmental quality in many developing countries.
None of these findings are novel to trade theorists, but they have yet to emerge as clearly
understood facets of economy-environment relationships in developing economies.

These

analytical results can also play an important role in highlighting the limitations of reliance on
oversimplified or over-general models in the trade-environment literature.
The model we have presented can be extended to address other important issues, such as
the impact of international capital flows into developing economies. It can also more explicitly
incorporate various types of intersectoral production externalities and issues related to internalmarket segmentation in factor and goods markets.14 In addition, the model provides guidance forconstruction of more richly specified applied general equilibrium analyses of the environmental
outcomes of policy and global market shocks. It should be emphasized, however, that trade
policies cannot substitute for targeted environmental policies, partly (but not only) because scaleeffects of growth are likely to dwarf composition effects in the longer run. On the other hand,that it is equally important to recognize that domestic and global trade policy liberalization is notalways anti-environment. Indeed, in a number of developing countries, trade liberalization may
not only confer conventional income gains, but be pro-environment as well.

26

References
Antweiler, W., B. R. Copeland, and M. S. Taylor, 2001.

“Is free trade good for theenvironment?”, American Economic Review, 91(4), pp. 877-908
Asian Development Bank, 1997. Emerging Asia: Changes and Challenges. Manila: AsianDevelopment Bank.
Bandara, J.S. and I. Coxhead, 1999. “Can trade liberalization have environmental benefits indeveloping countries? A Sri Lankan case study.” J. Policy Modeling 21(3). May, pp.349374.
Bhagwati, J., 1978. Anatomy and Consequences of Exchange Control Regimes. Cambridge, Mass.:
Ballinger.
Collier, P., and J. W. Gunning, 1994. Trade Shocks: Consequences and Policy Responses in
Developing Countries. San Francisco, CA: ICS Press.
Copeland, B.R., and M. S. Taylor, 1999. “Trade, spatial separation and the environment”,
Journal of International Economics 47: 137-168.
Copeland, B.R., and M. S. Taylor, 2003. Trade and the Environment: Theory and Evidence(Princeton, NJ; Princeton University Press).
Coxhead, I. and S. Jayasuriya, 2003. The Open Economy and the Environment: Development,
Trade and Resources in Asia. Cheltenham, UK, and Northampton, MA, USA: Edward
Elgar.
Coxhead, I. and S. Jayasuriya, 2004. "Development strategy, poverty and deforestation in thePhilippines”, Environment and Development Economics, 9(5): 613-644

27

Deacon, R., 1995. "Assessing the relationship between government policy and deforestation",
Journal of Environmental Economics and Management 28(1), January: pp. 1-18.
Dimaranan, B.; T. Hertel, and W. Martin, 2002. “Potential gains from post-UR trade reform:
impacts on developing countries”. Paper presented at the International Agricultural Trade
Research Consortium meetings, Whistler, British Columbia, Canada: June 16-17.
Gordon, H. S., 1954. “The economic theory of a common-property resource: the fishery”,
Journal of Political Economy 62(2), April, pp. 124-142.
Jha, R., and J. Whalley, 1999. “The environmental regime in developing countries”. NBER
Working Papers No. 7305.
Krueger, A. O; M. Schiff, and A. Valdés, 1988. “Agricultural incentives in developing
countries: measuring the effect of sectoral and economy-wide policies”, World Bank
Economic Review 2(3).
Little, I.M.D., T. Scitovsky, and M. Scott, 1970. Industry and Trade in Some Developing
Countries: A Comparative Study. London, New York, Oxford U.P. for the OECD.
Lopez, R. and M. Niklitschek, 1991. “Dual economic growth in poor tropical areas”, Journal of
Development Economics, 36(2), pp 189-211
Matthews, E., 2001. “Understanding the FRA 2000”. Forest Briefing No.1, World Resources
Institute, March. Accessed at http://www.wri.org/pdf/fra2000.pdf, March 2002.
Mussa, M., 1979. “The two-sector model in terms of its dual: a geometric exposition”, Journalof International Economics 9, pp. 513-526.
Papageorgiou, D., M. Michaely, and A. M. Choksi., eds., 1991. Liberalizing Foreign Trade.
Oxford, UK, and Cambridge, MA: Blackwell.

28

Table 1: Estimated changes in natural forest and plantation cover1990 (‘000 ha)

2000 (‘000 ha)

Average annual changeof natural forest

Nat. forest

Plantation

Nat. forest

Plantation‘000 haPer cent

Africa697,8824,415

641,828

8,038-5,589-0.8

Oceania

36,201

149

34,869

263

-133

-0.4

S. America

903,199

7,279

863,739

10,455-3,946-0.4

Asia495,340

56,117431,422

115,873-6,392-1.3—Tropical

289,820

22,486

233,448

54,624-5,637-1.9—Temperate 205,520
33,631
197,974
61,249-755
Source: World Resources Institute calculations from FAO data (Matthews 2001).

-0.4

Region29

Table 2: Capital-intensity and pollution intensity in Thailand

ImportWeighted AveragecompetingExporting

Effective rate of protection (ERP)

139.39-12.01

Labor -intensity (labor cost as a

0.42

0.61

6.47

2.92

fraction of total cost)Acute Human Toxicity Index

Sources: Coxhead (2003 )30

Table 3: GDP growth rates and shares (%) of major sectors, selected Asian countries
Country

GDP growtha

Years

Agric.

Industry(Mfg)

Services

Indonesia

3.97

1960-80
1981-90
1991-00

42
22
18

23
37
43

10
16
24

35
40
40

Malaysia

4.12

1960-80
1981-90
1991-00

29
20
13

30
39
42

14
21
27

41
41
45

Philippines

1.04

1960-80
1981-90
1991-00

28
24
20

31
36
32

23
25
23

41
40
48

Thailand

4.34

1960-80
1981-90
1991-00

29
17
11

25
33
39

17
24
29

46
50
50

Vietnam

5.37b

1960-80
1981-90
1991-00

..
40
29

..
29
30

..
26
20

..
32
41

Sri Lanka

2.99

1960-8030
24
17
47
1981-9027
27
15
46
1991-00
23
26
16
50
a. Real per capita income (1995 US$), annual average 1970-2000. b. 1991-2000.
.. = not available. Source: World Bank: World Development Indicators 2001

rN, rTcF

cU

Panel (a)

rN0
rT0

w0

0 A!

w

LF
L0

LA

FIGURE 1

Panel (b)

LM
LM
"0M

w0

!

w

Panel (c)

rM0

G
cH

!’ rM

cX

31

rN, rT

rT1

rN1

Panel (a)L0

L 1 L20M

Panel (b)FIGURE 2: INCREASE IN UPLAND AGRICULTURAL PRICE0A

rM0
Panel (c)

cH

LH

cF

LM

w

cX

w0

LA

LA

1

cU

cU1

w!

LF

w

rM

32

33

Notes

1

“One large omission from our review is any explicit discussion of renewable or non-renewable use of resource use or sustainability... but an analysis of trade’s impact on
resource use will take us too far afield”. (Copeland and Taylor, 2003:5).
2

The model is a major revision of Coxhead and Jayasuriya (2003). Some features, notably

the modeling of forest clearing in upland, are drawn from Lopez and Niklitschek (1991).
3This assumption is easily changed to reverse comparative advantage in the two crops, andalso to permit a single commodity to be produced in both areas but with different levels ofland productivity.
4

The spatial separation of upland and lowland can be exploited to yield richer model

specifications that generate insights into impact of enhanced domestic market integration inpreviously segmented labor and goods markets.
5

Our key point is that any reduction of virgin forest leads to environmental losses. We do notseek to address the widely analyzed case of the impact of higher timber prices on forests,
where commercial forests are included as part of the total forest endowment.
6This can be easily relaxed; see Copeland and Taylor (1999). Coxhead and Jayasuriya(2003) also explore intersectoral production externalities in a similar model.
7

The positive externalities associated with trade liberalization are often highlighted in theliterature. In principle, however, trade liberalization in capital/skill intensive manufacturing
may also imply foregoing positive externalities associated with ‘learning by doing’ typeeffects.

34

8This assumption is made for convenience only. Coxhead and Jayasuriya (2003) model

upland production with more than one output and different factor proportions.
9

If there were non-traded final goods in the economy, there would be additional substitution

terms in (6) due to endogenous price changes (Coxhead and Jayasuriya 2003).
10

Nor are the costs of forest clearing limited to the national economy. In Indonesia,

widespread forest burning to establish oil palm and other plantations since the late 1990s has
generated significant pollution in the form of smoke, or ‘haze’ in neighboring countries aswell as through much of Indonesia itself.
11

Output in each of the M sectors can also be computed from the diagram, by drawing lines

tangential to each unit cost curve at the point of intersection and calculating sectoral
employment shares of capital and labor along each axis. See Mussa (1979).
12

In countries with diversified upland sectors—producing both food and export crops—tariff

reduction will have an unambiguously pro-forest effect, if plantation crops grown in uplands
are less land-intensive and do not produce other forms of environmental damage (seeCoxhead and Jayasuriya 2003).
13

See Coxhead and Jayasuriya (2004) for a discussion of the Philippines case.

14

Such extensions can draw on Copeland and Taylor (1999) who present a model in which

industrial emissions degrade the natural resource base, and Bandara and Coxhead (1999) who
analyze the effects of soil erosion on industrial production costs through impacts on hydropower production.