Will trade liberalization harm the environment? The case of Indonesia to 2020

Abstract

Most-favoured-nation (MFN) trade liberalizations will always improve global economic welfare provided globally optimal environmental and other policies are in place. But since the latter proviso is not met in practice, empirical studies of the environmental and resource depletion effects of such reforms are needed to determine whether trade reform is still worthwhile. This paper provides a methodology for doing that. It is illustrated with a case study of Indonesia, a large newly industrializing country that is rich in natural resources and committed to taking part in major multilateral and regional trade liberalizations over the next two decades. A modified version of the global CGE model known as GTAP is used to project the world economy to 2010 and 2020 without and with those reforms. An environmental module is attached to the Indonesian part of that global CGE model so as to measure the effects of changes in economic activity on air and water pollution. The proportional contributions to environmental indicators of changes in the level and composition of output, and changes in production techniques, are identified. A base case projection without trade reform is compared with alternative scenarios involving full global implementation of Uruguay Round commitments by 2010, and the additional move to MFN free trade by APEC countries by 2020. The study suggests that, at least with respect to air and water, trade policy reforms slated for the next two decades would in many cases improve the environment and reduce the depletion of natural resources and in the worst cases would add only slightly to environmental degradation - even without toughening the enforcement of existing environmental regulations or adding new ones, and even if the reforms stimulate a faster rate of economic growth.