Environmental & Resource Economics (2006) 33: 1–37 DOI 10.1007/s10640-005-0070-9
Springer 2006
Eco-labels, Trade and Protectionism MADS GREAKER Statistics Norway, Centre for Development, P.O. Box 8131, 0033 Oslo, Norway (e-mail:
[email protected]) Accepted 8 June 2005 Abstract. Eco-labels are suspected to serve protectionist purposes. We analyze the choice between an environmental standard and a voluntary eco-label scheme in a partial trade model with one domestic firm and one foreign firm. The environmental standard will only apply to the domestic firm, while both firms can adopt the eco-label. Pollution is production related, and domestic consumers demand products that are produced in an ‘‘environmentally friendly’’ way. Our results show that it may be optimal for the domestic government to introduce an eco-label and get both firms to adopt the label, instead of setting an environmental standard. However, to what extent this policy serves protectionist purposes is ambiguous. In particular, if the willingness to pay for green products is sufficient to cover the pollution abatement costs of the foreign firm, foreign firm profit will increase while domestic firm profit will decrease compared to the outcome with a domestic environmental standard. On the other hand, if the willingness to pay for green products is insufficient, the foreign firm would be better off with a domestic environmental standard. Key words: eco-labels, product differentiation, trade policy JEL classifications: H2, H7, Q2, Q28
1. Introduction All industrialized countries except Australia have an eco-label scheme in place, while no country in Africa and only Brazil in Latin-America has one (Environmental Protection Agency 1998). Eco-labels have received considerable attention in the WTO (WTO 1999), and are criticized for imposing the environmental concerns of importing countries on the production methods of their trading partners. However, the trade and welfare effects of voluntary eco-label schemes, including prescriptions for production methods, have scarcely been analyzed before in formal models. Most eco-label schemes are put in place on an initiative from a governmental body, e.g. the EU eco-label, the US EPA Energy Star and the Nordic Swan. It is also evident that eco-label schemes frequently include prescriptions regarding process and production methods. One example is the EU ecolabel criteria for copying paper, which only include prescriptions related to the production of the paper, i.e. demand for sustainable forest management,
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chlorine free bleaching and maximum limits for polluting discharges per tonne paper produced (EU Eco-label Regulation). If pollution is local and production related, any domestic environmental target could be reached by subjecting local firms to environmental standards. So why do countries include production related criteria in voluntary eco-label schemes instead of regulating their firms directly? Some suspect that ecolabels are used instead of environmental standards in order to serve protectionist purposes. Hence, we ask whether eco-labels have a negative impact on exporting countries and reduce global welfare compared to national environmental standards. Our point of departure is a trade model introduced by Reitzes (1992) to analyze quality choice and trade policy in a horizontally differentiated Bertrand duopoly. Like Reitzes (1992), we look at a domestic market with a domestic and a foreign firm which both are making a profit ex ante due to the horizontal differentiation. However, while Reitzes (1992) looks at product quality in general, we look at the environmental quality of production. Further, unlike Reitzes (1992), we assume that consumers in the domestic market differ in their valuation of quality as in the models of vertical differentiation (see for instance Shaked and Sutton 1982). Our results show that it may be optimal for the domestic government to introduce an eco-label, and get both firms to adopt the label, instead of setting an environmental standard. Since both the domestic and the foreign producer make a profit ex ante, there is scope for shifting the profit among the firms by choosing the right environmental policy instrument. However, the effect of the introduction of eco-labels on firm profits are ambiguous. In particular, if the willingness to pay for green products is sufficient to cover the foreign pollution abatement costs, we find that the foreign firm may gain on an eco-label scheme vis-a`-vis a domestic environmental standard while the domestic firm may lose. On the other hand, if the willingness to pay for green products is insufficient, the foreign firm would be better off with a domestic environmental standard. There exists a well developed strand of literature analyzing consumer demand for environmental quality in models of vertical differentiation, see Arora and Gangopadhyay (1995), Cremer and Thisse (1999), Motta and Thisse (1993), Morgara-Gonzalez and Padro´n-Fumero (2002), Bansal and Gangopadhyay (2003) and Amacher et al. (2004). This literature does not include any ex ante product differentiation, and treats only ex post vertical differentiation in environmental quality. In this paper we present a duopoly model of green demand with differentiation in two dimensions. The model is based on the work by Neven and Thisse (1990), and incorporates both ex ante horizontal differentiation in product taste, and ex post vertical differentiation in environmental quality. This opens up for other kinds of equilibria in duopoly markets with demand for environmental quality. Typically, the literature based on vertical differentiation alone concludes that firms will
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supply different levels of environmental quality in equilibrium. However, with differentiation in two dimensions, the equilibrium may be that firms supply the same level of environmental quality.1 Not all contributions on demand for environmental quality and eco-labels utilize oligopoly models. Sedjo and Swallow (2002) and Rege (1998) analyze eco-labels in a perfect competition setting. With respect to potential market outcomes, Sedjo and Swallow (2002) obtain many of the same results as this paper. Further, with respect to international competitiveness and the effect of environmental regulation, Rege (1998) shows that an eco-label/an environmental standard may increase the market share of the domestic industry in international markets.2 This corresponds to the result given in Proposition 1, second part, in this paper. However, neither Sedjo and Swallow (2002) nor Rege (1998) include any analysis of rent-shifting by governments. Our analysis is simplified in a number of ways; for example, the number of firms is only two, we assume unit demand and full coverage of the market, there are no sunk costs involved in pollution abatement or in production, etc. Nonetheless, our preliminary results suggest that exporting countries may benefit from eco-labels in certain situations. The rest of the paper is organized as follows. Section 2 presents the model. Section 3 looks at the optimal environmental standard, while Section 4 looks at the optimal eco-label criterion. In Section 5, we analyze the choice between an eco-label and an environmental standard. Section 6 discusses a variant of the model, while Section 7 concludes. 2. The Model The model consists of a three-stage game between a domestic government, a domestic firm and a foreign firm exporting to the domestic market. The production process implies local pollution. At stage 1, the domestic government chooses whether to regulate pollution with a national environmental standard or include the product category in an eco-label scheme. Simultaneously, it decides either the strength of the environmental standard, rs , or the strength of the eco-label criterion, rc . At stage 2, the domestic and the foreign firm choose whether to adopt the eco-label if it is offered. Finally, in stage 3, the two firms compete in prices on the domestic country market. While there is perfect information among the domestic government and the firms, domestic consumers cannot observe the environmental performance of the firms. 2.1. FIRMS
The firms’ cost functions are given as c0qi+ai, i=d, f, where ai is the level of pollution abatement measured directly in $, qi is output, c0 is marginal cost, and the subscript i = d, f denotes domestic/foreign.
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Emissions ei are production related, proportional to output, and not transboundary. In order to simplify the analysis as much as possible, we use the following emission function: ei ¼ qi ai ai ;
i ¼ d; f;
ð1Þ 3
where ai is a parameter denoting the efficiency of abatement. The domestic government targets emissions per unit of output; qeii . The level of regulation is either given as a proportional environmental standard ð1 rs Þ, or as a proportional eco-label criterion ð1 rc Þ, with rs ; rc 2 ½0; 1. Thus, if an environmental standard is chosen, it implies qedd ð1 rs Þ, or by inserting from the emission function; ad ad rs qd . Correspondingly, if an ecolabel is introduced, and the firm(s) choose to adopt the eco-label, we have ei qi ð1 rc Þ or ai ai rs qi . Normalize c0 to 0, ad to 1 and let af 2 23 ; 1 (henceforth; we write a instead of af). Given that firms never over-comply with the level of regulation, we have for the unit costs cd of the domestic firm and cf of the foreign firm:4 8 rs if environmental standard : C t½1 x2 d ðe Þ d ðe Þ if no regulation d d f f ð5Þ (The parameter G is exogenously given). The parameter t expresses the strength of personal taste in the horizontal dimension, often coined the transportation cost parameter. The distance x, alternatively [1)x], measures how far the consumer is from her ideal product in the same dimension, i.e. along the bottom line of the unit square. The t parameter can be normalized to 1 without loss of generality. rj Þ; j ¼ s; c, is the consumer’s personal benefit of contribThe term, kx mð uting to the environment, also called the warm glow effect.5 In particular, we assume that m is continuously differentiable, and m(0)=0, m¢ ‡ 0, m¢¢ ð1 aÞrc þ a rs , global welfare is higher when both firms adopt the eco-label than it would be when only the domestic firm is regulated by an environmental standard. Global welfare is defined as the sum of domestic welfare and foreign profit. The corollary then follows directly from the fact that the eco-label r
mð r Þ
maximizes domestic welfare when as 2 s 4 rs , and that foreign country profit would be lower with an environmental standard than with an eco-label amð r Þ rc þ a rs . The eco-label makes it possible for the as long as 2 s > ð1 aÞ foreign firm to commit to a cleaner production process from which both the foreign firm and the domestic consumers benefit. On the other hand, if the foreign firm also supplies its domestic market from the same production unit, the foreign country may incur a loss in consumer surplus which we have not taken into account. mð r Þ r rs , is only sufThe condition in Proposition 3, namely that as 2 s 4 ficient for the result in Proposition 3, and not necessary. It may be optimal to mð r Þ r introduce an eco-label and get both firms to adopt the label even if 2 s < as . Further, foreign output and profit could go both ways compared to the environmental standard case. We provide an example of this situation below. 3 ¼ 2; a ¼ 2 ; dd ðed Þ ¼ qd ðed Þ2 and df ðef Þ ¼ qf ;C Let mðrÞ ¼ 32 50rþ2 3 ðef Þ2 where qd and qf are parameters. Let qf=0, hence, the foreign environment does not influence domestic welfare at all. We can then simulate the model for different values on qd, and solve for the optimal environmental standard rs , and for the optimal eco-label scheme criterion rc given that both firms adopt the eco-label. The higher the qd, the more stringent policy is required to curb environmental damage, and hence, the less likely it is that the average warm glow is sufficient to cover the increased unit cost (Table III): The second row of Table III is an illustration of Propositions 3 and 4. When qd=1, the optimal environmental standard yields an average warm mð r Þ r glow effect 2 s that is higher than the unit cost increase as (the last column). Hence, by applying an eco-label criterion that is identical to the environmental standard, the domestic government can get both firms to adopt the eco-label. However, this is not the optimal eco-label scheme criterion, and the domestic rs . Foreign output and profit are then higher with the governments sets rc as in Propositions 3 and 4 is not fulfilled. Hence, the domestic government cannot get both firms to adopt the eco-label by applying an eco-label criterion that is identical to the environmental standard. However, it is still optimal for the domestic government to introduce the eco-label, and the domestic governments sets rc ¼ 0:42, which induces both firms to adopt the mð rc Þ rc eco-label since 2 a ¼ 0:06. Partly, because we no longer have that mð rs Þ rs > , 2 a foreign output and profit are lower with the optimal eco-label scheme criterion than with the optimal environmental standard. have that the Finally, when qd=5, as in the fourth row of Table III, we still mð r Þ r average warm glow 2s is lower than the unit cost increase as . In this case it is optimal for the domestic government to introduce the environmental standard since the optimal eco-label scheme criterion would be too lax given the high level of environmental damage. In other words, since the domestic government mð r Þ mð r Þ r r is bounded by the adoption constraint 2c ac , it sets rc such that 2c ¼ ac . However, this yields lower welfare than in the environmental standard case as can be seen from Table III, the fourth row, the fifth and seventh column. 6. Vertical Domination Our model can also be applied to situations in which products are poorly differentiated from the beginning; one example could be copying paper. As already mentioned, Neven and Thisse (1990) refer to this situation as vertical domination. In our model vertical domination occurs when m(r)>2. In Appendix A.2, B5–B8, C2, D2 and E2 we have solved the model for the case rs 2 h0; 1. When the government sets an environmental in which mð rs Þ 3; 8 standard, the profits of the domestic and foreign firm are given: pd ¼ and: pf ¼
½2mð rs Þ rs 2 ; 9mð rs Þ
ð18Þ
½mð rs Þ þ rs 2 : 9mð rs Þ
ð19Þ
While for horizontal domination we could not have an equilibrium in which only the foreign firm adopted the eco-label, this is not the case with vertical
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domination. In particular, we may have two Nash equilibria in pure strategies in the second stage of the game; one in which the domestic firm adopts the eco-label and the foreign firm does not, and one in which the foreign firm adopts the eco-label and the domestic firm does not (see Appendix). We may also have combinations of mð rc Þ and rc in which the unique equilibrium is that both firms adopt the eco-label. The government may prefer such an equilibrium due to the boost in aggregated warm glow and reduced transport costs. As shown in the example above for horizontal domination, the extent to which such an equilibrium is desirable depends on the environmental damage functions. In general, it is more difficult to compare welfare levels in the vertical differentiation case, however, simulations show that we get much the same results. Either the government prefers to let both firms have the eco-label, and consequently sets a low criterion, or the government sets an environmental standard which only commits the domestic firm. In the latter case the standard is set strong, as illustrated in Table IV below. Let mðrÞ ¼ 4 2 1 5 50rþ1 ; C ¼ 2; a ¼ 6 ; dd ðed Þ ¼ qd ðed Þ and df(ef)=0 where qd is a parameter as above. We can then simulate the model (Table IV): From Table IV, second row, we note the following: When qd=1, it is optimal to introduce the eco-label and get both firms to adopt it, which will happen when rc ¼ 0:12. Foreign output and profit are then higher with the optimal eco-label scheme criterion than with the optimal environmental rs ¼ 0:15Þ ¼ 0:47 which is slightly lower than standard, i.e. pf ð rc ¼ 0:12Þ ¼ 0:49. pf ð Second, when qd=5 as in the third row of Table IV, the domestic government would still like both firms to adopt the eco-label, however, due to the adoption constraints the government cannot set the criterion higher than rc ¼ 0:18. Consequently, the level of environmental damage is far higher with the eco-label scheme than with the optimal environmental standard. The boost in warm glow and the lower transport costs make the eco-label viable even with qd=5. Note also, that for this case foreign profit is lower with the optimal ecolabel scheme criterion than with the optimal environmental standard. Finally, in the fourth row of Table IV, when qd=10, it is optimal for the domestic government to introduce the environmental standard. Given that both firms should adopt the eco-label, the optimal eco-label scheme criterion would be too lax and the level of environmental damage too high. In the new equilibrium both firms increase their profit compared to the ex ante situation due to the increased product differentiation (profits equal 12 ex ante). In the latter case, the government would be indifferent between setting an environmental standard and introducing an eco-label if the government could somehow reserve the eco-label for the domestic firm. However, for the eco-label criterion rc ¼ 0:87, there are two Nash-equilibria in the second stage of the game. Hence, the resulting outcome could be that the foreign
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Table IV. Simulation results vertical domination qd
rs
1 5 10
0.15 0.75 0.87
ws ð rs Þ 2.55 2.19 2.14
pf ð rs Þ 0.47 0.62 0.66
rc 0.12 0.18 0.18
wc ð rc Þ 3.03 2.31 1.43
pf ð rc Þ 0.49 0.48 0.48
The sub-game perfect equilibrium policy is emphasized.
firm adopted the eco-label and that the domestic firm did not. This would result in lower welfare for the domestic government than with the optimal environmental standard, among other things, due to the high domestic environmental damage when only the foreign firm adopts the eco-label. Since reserving the eco-label for the domestic firm is not possible, an environmental standard is the preferred policy. 7. Discussion Clearly, our results depend on the assumption that the domestic government cannot make the environmental standard binding for the foreign firm. As far as we can judge environmental standards imposed on exporters in order to regulate local, production related environmental problems in other countries are a delicate issue with respect to the GATT rules. On the one hand, we have the US–Mexico tuna case in which the GATT panel ruled against the use of an environmental standard on the fishing methods of the exporter as a basis for a trade ban. The US referred to article XX in the GATT which is an exception clause. However, in their report the panel explicitly states that article XX can neither be invoked to protect animal, human or plant life, nor exhaustible natural resources outside of the jurisdiction of the country taking the measure (see, GATT/WTO dispute settlement practice relating to GATT article XX, 2002). On the other hand, in the US shrimp case between the US and India, Pakistan, Malaysia and Thailand the topic of extrajurisdictional measures is not mentioned although this case has many similarities to the US–Mexico tuna case. However, the GATT panel ruled against the US, and argued among others, that the US should have initiated multilateral negotiations before imposing a trade ban based on the methods of shrimp harvesting in exporting countries (WTO 2002).9 Other similar cases are the EU ban on imports of beef being produced by using growth hormones, and of beef produced by using antibiotics, and likewise on the EU moratorium on genetically modified crops. Clearly, the beef-hormone case and the genetically modified crop case deviates from the case in the paper. The EU has backed their bans by referring to the need to protect human health inside the union. According to EU scientists both hormone-treated beef
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and genetically modified crops could pose a health risk when consumed. However, when the US brought the beef-hormone case for a GATT panel, the EU lost because of insufficient scientific evidence for the claim that the hormone treated beef posed a threat to human health (Herald 1999). One way to defend the assumption that the domestic government cannot make the environmental standard binding for the foreign firm, is to interpret the restriction in the domestic government’s choice set as political cost restriction. That is, we assume that the political costs of making the standard binding for the foreign firm are too high with respect to the environmental regulation case at hand. Clearly, by introducing a voluntary eco-label scheme instead, the domestic government avoids a potential trade conflict, and the set-up of a GATT panel. Another central assumption in this paper is that consumers are willing to pay more for ‘‘greener products’’. There exists some empirical evidence directly suggesting that this could well be the case. Almost all tuna fish sold in the US now have a ‘‘dolphin safe’’ label. In order to obtain the label the number of dolphins killed accidentally during a tuna fish catch has to be below a certain limit set by the US government. In an empirical study Teisl et al. (2002) find that the label has led to a significant increase in total tuna fish sales. There is also a study from Denmark on shop purchases data by Bjørner et al. (2003). They find that the Nordic Swan label significantly increases the marginal willingness to pay for two types of products, namely detergent and toilet paper. They find no significant effect on paper towels, but according to the authors, this could be due to the green consumer rather choosing a reusable alternative to paper towels. The study of Brockman, Hemmelskamp and Hohmeyer on certified tropical timber should also be mentioned (Brockmann et al. 1996). In their report they present a case study of low pollution emulsion lacquer paints which indicates that low pollution paint significantly increased its marketshare after the introduction of the Blue Angel (the German eco-label). Further, they report from a general study of the Blue Angel that on average consumers are willing to pay 2.6% more for labelled products. We have assumed throughout the paper that only the domestic government can inform domestic consumers about the environmental performance of products. Hence, firms do not have an incentive to do abatement when left to themselves. In this we closely follow the analysis of Rege (1998). However, there may be other explanations for the relatively widespread use of ecolabels. Howarth et al. (2000) discusses the information aspect of eco-labels. As long as the eco-label is known to the consumers, it serves as a simple sign of environmental superiority. In the EU and in the Nordic countries, the same eco-label is used across many different product categories. Hence, the use of eco-labels is likely to have scale advantages in information processing,
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compared to a situation where each firm privately advertises the environmental performance of its products. Further, we have assumed away fixed costs. Clearly, there could be fixed cost connected to adopting an eco-label e.g. administrative costs. In this case, the firms would only adopt the eco-label if profit increased with an amount equal to or higher than the fixed costs. As far as we can see, this would not influence the basic message of the paper, but only the exact conditions for which the different cases occur. The model in the paper assumes full coverage of the market, and thus total supply does not change with the policy instrument. There are reasons to believe that the price increase for simple environmental improvements will be modest, see for example Jaffe et al. (1995) which suggests that abatement costs are in the range of 1% of product prices. The assumption about full coverage of the market may then not be too far from reality since we are looking at small price changes. On the other hand, without the full coverage assumption, it is not given how total supply would develop. If consumers with a high valuation of the environment have stayed out of the market, we could have that total supply increased with the introduction of eco-labels. The analysis of Teisl et al. (2002) indicates that this could have happened with the demand for canned tuna. Further, in the theoretical article of Morgara-Gonzalez and Padro´n-Fumero (2002), the increase in total supply may lead to increased pollution even though the pollution intensity of the product decreases. In the model set-up of this paper, the government should however be able to take such effects into consideration, and set the environmental standard/eco-label criterion sufficiently stringent. 8. Conclusion Free-trade agreements, like the GATT, do not, as far as we know, rule out unilateral introduction of domestic environmental standards for production and process methods even if they may have ‘‘protectionist-like’’ effects. The ‘‘protectionist-like’’ effects could result from consumers valuing cleaner production, and hence, switching from the imported product to the domestically produced product at once the standard becomes known. In such a case, it may be beneficial for foreign exporters to adopt an eco-label making it possible for them to credibly commit to a less emission intensive production process. It is in this context the claim that eco-labels are not necessarily protectionist must be understood. A prerequisite for this case to come about is of course that the willingness to pay for cleaner production is of some size compared to the pollution abatement costs of the firms. On the other hand, if the environmental damage is large, and further, the pollution abatement cost is significant, the willingness to pay for cleaner production could be inadequate, and either only the low abatement cost firm
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or no firm would adopt an eco-label with sufficiently stringent criteria. It may still be optimal to introduce an eco-label with ‘‘too weak’’ criteria since an eco-label not only reduces emissions, but also provides the consumer with good conscience – so called warm glow. In this case, an eco-label could well be protectionist in the context above. The reason is that if an environmental standard were introduced instead, it would place far harder pollution abatement demands on the domestic firm than the ‘‘too weak’’ eco-label criteria. This would in turn have given the foreign firm a cost advantage big enough to lead to an improved marketshare and a higher profit compared with the situation in which both firms comply with the ‘‘too weak’’ eco-label criteria. Acknowledgements I am very grateful for the excellent advice and comments I have received from my former thesis supervisor Nils-Henrik von der Fehr. Further, I would like to thank two anonymous referees for very helpful comments and good suggestions on an earlier draft. I would also like to thank the Research Council of Norway for financial support. Notes 1. This paper also differs from the aforementioned literature in that we assume asymmetric information between consumers and firms. In the contributions mentioned above, consumers know the environmental performance of firms, and hence, there is no analysis of eco-labelling. 2. See also Rauscher (1997) on demand for ‘‘green products’’ and international competitiveness. 3. The emission function (1) has constant returns to abatement. However, if we relax the constant returns assumption, all the results in the paper would still hold provided that the unit cost function can be written ci ¼ gi ð rh Þ, with h=c,s and g0i > 0; g00i 0, and where (1)rh) is the emission per unit of output relationship. For instance, the emission function pffiffiffiffiffiffiffiffi ei ¼ qi qi ai , exhibits decreasing returns to abatement, and yields the following unit cost function: ci ¼ ðrh Þ2 . 4. It is shown in Appendix B.1 that over-compliance does not occur in equilibrium. 5. According to Andreoni (1990) voluntary contributions to a public good like the environment can be explained by what he coins impure altruism. In the impure altruism case the consumer gets utility from both giving (referred to as warm glow by Andreoni (1990)) and from the public good in question. This corresponds to the way we have modelled demand for green products above. 6. One example could be food with different taste for which the environmental externality was animal welfare. 7. The complete derivation of the demand functions, the Nash-price equilibrium, the equilibrium outputs and profits, the transport cost and the warm glow effect are shown in Appendices A.1, A.3, B.1, B.4, D.1, E.1. 8. In a similar setting as in this paper Fischer and Serra (2000) define a minimum standard to be protectionist when it exceeds what a planner would impose if all producers were local. For instance, this would be the case if the loss in foreign profit over-compensates the domestic welfare gain from the minimum standard. Thus, we cannot rule out that both the
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optimal environmental standard and the optimal eco-label criterion are protectionist in the sense that the optimal policies with two domestic firms would differ from the optimal policies that we have derived. 9. See also John H. Jackson (1997), The World Trading System (Jackson 1997, p. 235), which supports the view that trade bans based on the pollution intensity of production and process methods in the exporting country are not eligible under the GATT rules. 10. In particular, if mðrÞ 32, " r2[ 0,1], the condition will always be fulfilled.
References Amacher, G.S., E. Koskela and M. Ollikainen (2004), ‘Environmental Quality Competition and Eco-Labeling’, Journal of Environmental and Economics and Management 47, 284–306. Andreoni, James (1990), ‘Impure Altruism and Donations to the Public Good: A theory of warm glow giving’, The Economic Journal 100, 464–477. Arora, Seema and Shubhashis Gangopadhyay (1995), ‘Toward a Theoretical Model of Voluntary Overcompliance’, Journal of Economic Behavior and Organization 28, 289–309. Bansal, S. and S. Gangopadhyay (2003), ‘Tax/Subsidy Policies in the Presence of Environmentally Aware Consumers’, Journal of Environmental Economics and Management 45, 333–355. Bjørner, B. T., L. Ga˚rn Hansen and C. S. Russel (2003), ‘Environmental Labelling and Consumers’ Choice – An Empirical Analysis of the Effect of the Nordic Swan’, Journal of Environmental Economics and Management 47, 411–434. Brockmann, K. L., J. Hemmelskamp and O. Hohmeyer (1996), Certified Tropical Timber and Consumer Behaviour, Germany: Centre for European Economic Research, Physica Verlag Heidelberg. Cremer, Helmuth and Jacques-Francois Thisse (1999), ‘On the Taxation of Polluting Products in a Differentiated Industry’, European Economic Review 43, 575–594. Environmental Protection Agency (1998), Environmental Labeling – Issues, Policies, and Practices Worldwide, Washington, DC: U.S. EPA. EU Eco-label Regulation, europa.eu.int/comm/environment/ecolabel. Fischer, R. and P. Serra (2000), ‘Standards and Protection’, Journal of International Economics 52, 377–400. Herald Tribune (1999), ‘Trade War Looms Over Hormone Beef Ban as EU Reiterates Health Fears’, http://www.iht.com/IHT/BJ/99/bj051399. Howarth Richard, B., Brent M. Haddad and Bruce Patton (2000), ‘The economics of energy efficiency: insights from voluntary participation programs’, Energy Policy 28, 477–486. Jackson, J. H. (1997), The World Trading System, The MIT press. Jaffe, A. B., S. R. Peterson, P. R. Portney and R. N. Stavins (1995), ‘Environmental Regulation and the Competitiveness of U.S. Manufacturing: What Does the Evidence Tell Us?’, Journal of Economic Literature XXXIII,132–163. Moraga-Gonza´lez, J.L. and N. Padro´n-Fumero (2002), ‘Environmental Policy in a Green Market’, Environmental and Resource Economics 22, 419–447. Motta, Massimo and Jacques-Francois Thisse (1993), Minimum Quality Standard as an Environmental Policy: Home Country and International Effects, Fondazione Eni Enrico Mattei: Nota di Lavoro 20.93. Neven Damien and Jacques-Francois Thisse (1990), On Quality and Variety Competition. Economic Decision-Making: Games, Econometrics and Optimisation, Elsevier Science Publishers B.V.
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Nordic Environmental Label, http://www.ecolabel.no. Rauscher Michael (1997), International Trade, Factor Movements, and the Environment. Oxford University Press. Rege, Mari (1998), ‘Strategic Policy and Environmental Quality: Helping the Domestic Industry to Provide Credible Information’, Environmental and Resource Economics 15, 279–296. Reitzes, J. D. (1992), ‘Quality Choice, Trade Policy and Firm Incentives’, International Economic Review 33(4), 817–835. Sedjo, Roger A. and Stephen K. Swallow (2002), ‘Voluntary Eco-Labeling and the Price Premium’, Land Economics 78, 272–284. Shaked, A. and J. Sutton (1982), ‘Relaxing Price Competition Through Product Differentiation’, Review of Economic Studies XLIX, 3–13. Teisl Mario, F., Brian Roe and Robert L. Hicks (2002), ‘Can Eco-Labels Tune a Market? Evidence from Dolphin-Safe Labeling’, Journal of Environmental Economics and Management 43, 339–360. Tirole Jean (1997), The Theory of Industrial Organization. The MIT Press. WTO (1999), ‘Trade and the Environment’, http://www.wto.org. WTO (2002), ‘GATT/WTO dispute settlement practice relating to GATT Article XX, paragraphs (b), (d) and (g),’ http://www.wto.org.
Appendix A: Demand in the Two Dimensional Differentiation Case We start off by looking at the case in which only the domestic firm is regulated by an environmental standard. This case also corresponds to the case in which only the domestic firm adopts the eco-label, given the same stringency of regulation i.e. rs ¼ rc .
A.1. HORIZONTAL DOMINATION
The straight line kx ¼
2 pd pf 1 xþ ; rs > 0; mð rs Þ mðrs Þ
ðA:1Þ
divides the unit square into the market shares of Firm d and Firm f. The demand function consists of three line segments. The first line segment covers the case in which pd is so high that the line (A.1), which divides the unit square, does not cross the x-axis, i.e. it only cuts off the upper left corner of the unit square. Demand is then given by the following integral: mð rs Þpd þpf þ1 2
2 pd pf 1 yþ dy mð rs Þ mð rs Þ 0 mð rs Þ pd þ pf þ 1 1 ; 2 mð rs Þ pd þ pf þ 1 0; for pd pf 1 0 and 2
qd ðpd ; pf Þ ¼1
Z
ECO-LABELS, TRADE AND PROTECTIONISM
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mð r Þp þp þ1
i.e. all consumers to the right of s 2d f on the line, buy from Firm f irrespective of their k, mð r Þp þp þ1 while consumers between 0 and s 2d f may buy from either firm depending on their k. The second segment is the case shown in Figure 1. The line (A.1) then cuts off the unit mð rs Þpd þpf þ1 square from the x-axis, but because < 1, all consumers to the right of 2 mðrs Þpd þpf þ1 on the line, still buy from Firm f irrespective of their k. For this intermediate 2 case, demand is given by the following integral: mð rs Þpd þpf þ1 2t
Z
qd ðpd ; pf Þ ¼1
2 pd pf 1 yþ dy mðrs Þ mð rs Þ
pf pd þ1 2
mð rs Þ pd þ pf þ 1 ; 1 2 mð rs Þ pd þ pf þ 1 for pd pf 1 4mð rs Þ > < mðrs Þ2ðp p d f 1Þ for mð rs Þ þ pf 1 > for p 1 p mð r Þ þ p 1 : f d s f 4mð rs Þ It is easy to check that the three expressions yield a continuously differentiable demand function. The demand for the product of Firm f is then 1)qd ( pd,pf).
A.2. VERTICAL DOMINATION
In order to derive the demand functions in the vertical domination case we also have to set up three integrals. However, it is only the intermediate case that differs from the horizontal domination case. For the intermediate case the line (A.1) now divides the unit square from the k-axis to the vertical line x=1. This intermediate integral in the vertical domination case can be written: qvd ðpd ; pf Þ
¼1
Z1
2 pd pf 1 yþ dy; mð rs Þ mð rs Þ
0
for pf þ 1 pd mðrs Þ þ pf 1:
24
MADS GREAKER
The integral can be solved. We can then write the demand function for the product of Firm d as above: 8 ðmð rs Þpd þpf þ1Þ2 > > for mð rs Þ þ pf 1 pd pf þ mð rs Þ þ 1 > 4mð rs Þ < mð rs Þpd þpf v qd ðpd ; pf Þ ¼ : ðA:3Þ for pf þ 1 > 4mðrs Þðpf pd 1Þ2 : for pf 1 pd pf þ 1 4mð rs Þ It is easy to check that the three expressions give a continuously differentiable demand function. The demand for the product of Firm f is then 1 qvd ðpd ; pf Þ. A.3. BOTH FIRMS ADOPT THE ECO-LABEL/NO REGULATION
When either both firms adopt the eco-label or none of the firms are regulated, there is no vertical differentiation, and demand can be written: qd ðpd ; pf Þ ¼
1 pd þ pf ; 2
ðA:4Þ
which is the Hotelling demand function for the product of the domestic firm. In the Hotelling model with two symmetric firms both firms charge a constant mark-up on their marginal cost, earn profit, pd ¼ pf ¼ 12, and produce qd ¼ qf ¼ 12 as long as the market is covered.
Appendix B: Deriving the Nash-Price Equilibrium B.1. HORIZONTAL DOMINATION, ENVIRONMENTAL STANDARD
As shown above, the demand function facing Firm d is composed of three segments of which we have chosen to focus on the intermediate, linear segment where the following condition must be met: mð rs Þ þ pf 1
