Introduction

Partial equilibrium analysis has long been applied to trade policy and environmental policy. While the interconnections among markets and between aggregate production and consumption are suppressed, the greater simplicity of the partial equilibrium approach allows for a more detailed focus on particular market and policy features. This chapter extends and amplifies the general equilibrium analysis in Chapter 8 with partial equilibrium tools. The emphasis is again on the effects of trade and trade policy on the environment and the effects of environmental policy on trade.

Section 2 starts with a standard welfare economic analysis of externalities in production and consumption set in a trade context, and examines the effects of corrective environmental policies. It demonstrates how uncorrected production externalities constitute a subsidy and a distortion to international trade. As a general proposition, it is easy to show that the first-best policy response to externalities in production and consumption is to correct the distortion at its source, which means either controlling production if pollution abatement is not feasible or taking measures to control pollution, which will indirectly reduce output. Using trade policy in general will create by-product distortions and may worsen welfare. Nevertheless, first-best policies may be unavailable or ignored by governments. Section 3 delves into the murky world of the second-best.