Raising the Cost of Doing Business in Lower Income Countries: Trade Agreements with Stringent Multilateral Environmental Regulations

Abstract

We explore how multilateral environmental regulations may adversely affect trade flows between countries with different incomes. Using the gravity equation, we examine the effect on bilateral trade flows of increases in environmental regulation stringency ratings, taken from survey data covering a panel of 137 countries. We test for significant differences in the effects of the stringency of environmental regulations on exports across countries’ income levels and EU membership. We show that an increase in environmental regulation stringency leads to a dramatic decrease in exports from poorer EU members; conversely, a similar change in environmental regulation does not appear to significantly affect the exports of richer EU members. The results are consistent with our theoretical model of the costs of multilateral environmental regulations, which are disproportionately borne by poorer countries due to both the uneven competitiveness effect and the uneven burden of compliance.

Keywords: International trade, gravity equation, regional regulations, environmental regulations, European Union regulations, environment and trade

JEL Classification: F18, L51, Q56