International Trade and the Environment

Firms based in large home markets like the United States and the European Union (EU) should pay great attention to domestic environmental regulations. In contrast, firms from smaller countries like Canada (which is one-tenth the size of the United States), most Asian countries and all Latin American countries should focus primarily upon the environmental regulations of their major customers (usually the "triad" economies of the United States, the EU, and Japan). The current paper develops a new conceptual framework which addresses this asymmetry by examining the interactions between the government and the firm. In the following section of the paper, I examine the relationship between environmental regulations and firms’ responsiveness to them providing a managerial perspective on compliance with international environmental policies. Paper particularly emphasizes the environmental side agreement of the North American Free Trade Agreement (NAFTA) linking Canada, Mexico, and the United States. NAFTA is a major breakthrough since it is the first international trade agreement (other than internal EU regulations) to explicitly incorporate environmental issues and to establish a bureaucracy to administer trade and environment interaction, primarily through the NAFTA Commission on Environmental Cooperation (CEC). NAFTA and the CEC can be seen as benchmarks for analysis of other international environmental organizations and agreements.
Further, the discussion of a corporate strategy framework follows with which managers can determine the appropriate choice of strategy in response to both international and national environmental pressures. They can comply with new environmental regulations, but also develop green capabilities which may allow them to outperform competitors on environmental strategy grounds alone. Green strategies may focus on responding strongly to national regulations, international regulations or both simultaneously. In Section 4 we discuss the argument that firms can seek to avoid domestic environmental regulations by moving offshore. the Mexico pollution-haven case.
At the level of the firm targeted by international environmental policies, the corporate response in terms of compliance depends upon its expected economic benefits. These economic benefits can be high or low, as shown on the vertical axis of Figure 1. A second issue (on the horizontal axis) is whether these benefits are driven primarily by expected improvements in industrial performance (e.g., market share, profitability, growth, etc.) or by sanctions associated with non-compliance. In the latter case, it is mainly the strength of the administrative enforcement apparatus which determines compliance. For a discussion on the benefits of compliance, see Barrett (1992), Henriques and Sadorsky (1996), Nehrt (1998), Walley and Whitehead (1994).