Free Trade And The Environment: A Possible Friendship?

International Economic Essay

Free trade and the environment: a possible friendship?

An analysis of the impact of free trade in the environment

1. Introduction

In this essay I’ll try to analyze the relationship between free trade and the environment. Through economic formulas, I will explain the impact of free trade in the world we live, giving theoretical explanation to the question: is free trade good for the environment?

Before going deeper in the case, let’s have a look of the theory of international trade.

• Why do we trade?

Nations (or firms in different nations) trade with each other because they benefit from it.

We can divide the different trade theories in three categories:

• Classical Trade Theory: Ricardian Model

• Modern Trade Theory: Heckscher-Ohlin Model

• New Approaches to Trade Theory

Richardian Model

The Ricardian model affirms that the only difference between countries is in their production technologies.

The basis for trade in the Ricardian model is differences in technology between countries. It can be absolute advantage or comparative advantage,

To define absolute advantage it is useful to define labor productivity first. To define comparative advantage it is useful to first define opportunity cost.

LABOR PRODUCTIVITY is defined as the quantity of output that can be produced with a unit of labor. Since aLC represents hours of labor needed to produce one pound of cheese, its reciprocal, 1/aLC , represents the labor productivity of cheese production, Let’s say in the US. Similarly 1/aLW represents the labor productivity of wine production in the US.

A country has an ABSOLUTE ADVANTAGE in the production of a good relative to another country if it can produce the good at lower cost or with higher productivity. Absolute advantage compares industry productivities across countries. In this model we would say the U.S. has an absolute advantage in cheese production relative to, let’s say, France if

aLC < a*LC

or if

1/ aLC > 1/ a*LC

The first expression means that the US uses fewer labor resources (hours of work) to produce a pound of cheese than does France. In other words the resource cost of production is lower in the US. The second expression means that labor productivity in cheese in the US is greater than in France. Thus the US generates more pounds of cheese per hour of work.

OPPORTUNITY COST is defined generally as the value of the next best opportunity. In our case of national production, the nation has opportunities to produce wine and cheese. If the nation wishes to produce more cheese, then because labor resources are scarce and fully employed, it is necessary to move labor out of wine production in order to increase cheese production. The loss in wine production necessary to produce more cheese represents the opportunity cost to the economy. The slope of the PPF, -( aLC / aLW ), corresponds to the opportunity cost of production in the economy.

To see this more clearly consider points A and B on the adjoining PPF diagram. Let the horizontal distance between A and B be one pound of cheese. Label the vertical distance X. The distance X then represents the quantity of wine that must be given up to produce one additional pound of cheese when moving from point A to B. In other words X is the opportunity cost of producing cheese.

A country or a firm has a COMPARATIVE ADVANTAGE in the production of a good if it can produce that good at a lower opportunity cost relative to another country. Thus the US has a comparative advantage in cheese production relative to France if:

aLC/aLW < aLC*/aLW*

This means that the US must give up less wine to produce another pound of cheese than France must give up to produce another pound.

Absolute advantage.

Cheese Wine

US aLC = 1 hour/kg aLW = 2 hour/l

France aLC* = 6 hour/kg aLW* = 3 hour/l

US has Absolute Advantage in both goods.

Comparative Advantage.

Cheese Wine

US aLC / aLW = Ð'Ð... aLW / aLC = 2

France aLC* / aLW* = 2 aLW* /aLC* = Ð'Ð...

US has comparative advantage in Cheese

France has comparative advantage in Wine

Heckscher-Ohlin theory

The Heckscher-Ohlin theory argues that international differences in factors of production such as in labor, labor skills, physical capital or land create productive differences that explain why trade occurs.

• Countries have relative abundance of factors of production.

• Production processes use factors of production with relative intensity.

To explain the theory let’s consider two countries, US and France* like in the previous example, and two goods, steel and clothing. We assume a barter economy. Assume two factors of production, labor and capital.

The original H-O model assumed that the only difference between countries is the relative abundances of labor and capital. The original Heckscher-Ohlin model contained two countries, and had two commodities that could be produced. Since there are two (homogeneous) factors of production this model is sometimes called the "2Ð"--2Ð"--2 model".

Now we consider