Production fragmentation and the environment : modelling and testing the relationship between international trade in intermediate goods and pollution in East Asia

Abstract

This thesis addresses a broad research question "Is there a link between international production fragmentation and environment?" In order to investigate this research question, this thesis develops a theoretical model that allows one to establish a link between international production fragmentation induced-international trade in intermediate goods and pollution. Using country level panel data from East Asia, the link between international trade in intermediate goods and carbon emission is empirically investigated. The theoretical model used in this thesis is based on the pioneering work of Copeland and Taylor (2003). Specifically, a general equilibrium model is used, where an industrial good is produced by means of a large number of varieties of an intermediate good. The production of the intermediate good leads to environmental pollution. Government controls the level of pollution through pollution permits. The equilibrium level of pollution is determined by the interaction of demand and supply of permits. Liberalisation of trade in intermediate good leads to an increase in the number of varieties that are available to industrial good producers. The theoretical model suggests that an increase in trade in intermediate goods can result in higher level of pollution in developed countries. In other words, opening up of international trade in intermediate goods, through increased fragmentation of intermediate good production, causes more environmental damage in developed countries compared to developing countries. The theoretical model is also used to examine the link between government environmental policy and comparative advantage. When two countries are identical in every respect, except for differences in their environmental policy, the country with a relatively strict environmental policy is found to be a net importer of varieties of the intermediate good that cause pollution. In other words, countries that have relatively strict environmental policy import pollution intensive products. Based on the theoretical results and the existing literature, three empirical research questions are developed. These questions are answered by testing a series of hypotheses using country level panel data over the period of 1998 to 2010. The data covers all major East Asian countries and their trading partners. The first empirical research question "Does growth in trade in intermediate goods lead to environmental degradation?" is answered by empirical estimation of an augmented environmental Kuznets curve (EKC) model. The empirical results suggest that imports do not affect the level of pollution in East Asia. However, the exports of intermediate goods are found to reduce pollution, which is good for the environment. The second empirical research question "What is the impact of pollution on international production fragmentation and trade in intermediate goods?" is answered by making use of an extend trade gravity model, where pollution has been introduced as one of the determinants of trade in intermediate goods. Pooled ordinary least squares (OLS) and panel fixed and random effects approaches are used. This analysis is based on different assumptions regarding the multilateral trade resistance (MTR) of the sample countries. The empirical results suggest that in general pollution has a positive impact on trade in intermediate goods. However, the strength of this relationship varies across different measures of trade in intermediate goods and model specifications. The last empirical research "Is the relationship between trade in intermediate goods and environment affected by the level of economic development?" is answered by the comparison study of different country groups. The empirical analysis suggests that the level of economic development does play an important role. This thesis makes a significant contribution to both theoretical and empirical literature that deals with the link between international trade and pollution. The theoretical results show that international production fragmentation induced-trade in intermediate goods can also affect the equilibrium level of pollution. The main empirical contribution of this thesis is that it explicitly focuses on the link between trade in intermediate goods and environment in East Asia. East Asia accounts for a very large proportion of world trade in intermediate goods. At the same time East Asia also includes some of the most polluted regions of the world. It is shown that environment-trade nexus is also affected by the level of economic development, which allows a better understanding of the implications of economic development.

Date of Award	2015
Original language	English