Harmonizing Environment and Trade Policies

II. Basic Issues for the Integration of Environmental and Trade Policies

1. Internalization of Environmental Costs

(1)Importance and Challenges of Internalization

The most fundamental cause of environmental problems lies in the fact that the environment is not appropriately taken into consideration in the process of decision-making in various economic activities. In order to solve environmental problems, therefore, it is important to appropriately reflect environmental costs upon the market prices of goods and services by making polluters or originators pay for the costs of pollution prevention, treatment of wastes, restoration of environmental values associated with the use of natural resources, etc. This enables free trade to make optimal allocation of resources through market mechanism, taking into consideration environmental values, and to make environmental protection and free trade compatible. In this sense, the internalization of environmental costs is an important key to making environmental and trade policies mutually supportive.(9)

However, because socio-economic conditions and environmental regulations can be different from country to country, there are various questions concerning the internalization of environmental costs. They include: what are the correct environmental costs to be internalized? (content of environmental costs); how to evaluate the values of clean water and air, greenery and wildlife? (methods of evaluation); what kind of regulations or economic instruments should be employed to internalize environmental costs? (instruments for internalization); and who should pay the environmental costs? (distribution of costs).

For example, tropical forests possess extremely high environmental values due to their rich biodiversity. It is often argued that if we are to internalize in the prices of tropical timber the costs to conserve those environmental values, the tropical timber prices will inevitably rise, leading to a reduction in the tropical timber trade as a result of a loss of competitiveness against non-tropical timber. When one considers that the environmental benefits of tropical forests, such as their function as the CO2 sinks and sources of biodiversity, belong to the world as a whole, important questions such as whether the costs of conservation should be borne only by local people or how to internalize those costs need to be answered. Another question concerns the evaluation of environmental costs. For example, in the case of endangered species, it is virtually impossible to calculate their environmental costs. In these cases, measures based on international consensus toward sustainable forest management, formulation of international environmental policies for the conservation of habitat and propagation of wildlife, etc., play an important role.

In the case of global warming, the important issue is to internalize environmental costs associated with the emission of greenhouse gases, such as CO2, appropriately in the prices of products and services. Those gases are emitted as a result of ordinary business activities and a broad range of socio-economic activities including daily living. In this case, it is generally thought that various kinds of economic measures, such as taxes and charges, which make use of the price mechanism, are effective in curbing greenhouse gas emissions. In the Basic Environment Law, it is stipulated that Japan shall appropriately conduct surveys and research on the effectiveness of implementing such measures and on their effects on the Japanese economy.10 In the case of these domestic measures for the protection of the global environment, building an appropriate coordination mechanism while paying due consideration to international cooperation would largely alleviate the concern that they might distort international trade.

(2) Polluter Pays Principle (PPP)

With respect to the question of who should bear the environmental costs to be internalized, there is the Polluter Pays Principle (PPP) (see Annex 4). However, if we are to try to apply the principle to international relations, we encounter problems in the case of transboundary and global environmental problems such as pollution of international rivers, acid rain, and destruction of the ozone layer. Because of them, simply applying the PPP does not ensure that the country in question takes effective measures, and this causes fears that consequential environmental damage will spread to other countries.

For typical global environmental problems, there already exist such undertakings as the Global Environment Facility (GEF), based on the idea of "common but differentiated responsibilities."11 There are also such attempts as "debt for nature swaps," whereby environmental conservation is linked to the reduction of debt in developing countries. Furthermore, within the OECD's formulation of PPP, possible exceptions to the use of PPP are allowed, which include government assistance for "pollution control to ease transition periods when especially stringent pollution control regimes are being implemented." This line of thinking would also be justified internationally and, in dealing with environmental problems of developing countries and countries with economies in transition, there will be cases where it is effective to make use of ODA, taking into account the severity of the problems as well as relative priorities of other social objectives in those countries.

2. Coordination in the Formulation of Environmental and Trade Policies

Including the issue of the internalization of environmental costs mentioned above, how to make environmental and trade policies mutually supportive is very often an issue of policy substance. In order to promote substantive integration of policies, however, procedural coordination is also important. For example, when national eco-labeling programs have an impact on trade, some coordination in the policy-making process may be necessary taking into account a trade point of view. Conversely, some adjustment mechanism is necessary from the viewpoint of preventing environmental damages for those trade policies that can affect the environment.

On this point, it is noteworthy that the OECD adopted "Procedural Guidelines on Integrating Trade and Environment Policies" in June 1993 (see Annex 5). In Japan, some of the recommendations contained in the guidelines are already well implemented such as the integration of "government policy-making" through the process of cabinet decisions, etc. For such recommendations as "transparency at the inter-governmental level," " consultation with non-governmental interested parties," and "availability of information," further efforts are needed to ensure steady implementation of the guidelines.

Looking at the international side, many international organizations such as the WTO, OECD, UNCSD, UNEP, UNCTAD, UNDP, and ITTO are strengthening their efforts on the issue of trade and environment. This necessitates better communication and coordination between them.

3. Dimension of Developing Countries

There are different stages of development among various developing countries. Some are grouped as least developed and others are closer to developed counties. Therefore, it is important to consider a differentiated approach that corresponds, to a certain degree, to the different stages of development that the countries have reached in both trade liberalization and environmental protection.

In many least-developed countries, there exists a vicious cycle of population growth, poverty, and environmental degradation. Even from the viewpoint of improving the environment, it is extremely important to sever this vicious linkage and to consider the role of trade in this context. At the macro-level, economic development will curb population growth through the raising of living standards, while creating resources that could be used for environmental conservation. Therefore, in those developing countries, it is of particular importance to achieve economic development even when we concentrate on solving environmental problems only. Trade should be promoted bearing this point in mind. We need to be careful, however, not to stretch the point too far, because even if there is a linkage between economic development and environmental improvement, its validity stands only in a long-term and macro-based sense. For this reason, efforts to minimize negative environmental effects, such as air and water pollution and nature destruction, are important as well. When developed countries engage in economic cooperation with those developing countries, they should pay enough consideration to its environmental effects.

In contrast, more advanced developing countries, which are confronted with various environmental problems ranging from industrial pollution, household-generated pollution to global environmental problems, are often suffering from a lack of institutional capacity, in terms of financial, technological, and human resources, to cope with environmental problems, even when they are equipped with environmental legislation and standards. Towards these countries, it is important to provide financial and technical assistance to enhance their capacity to achieve sustainable development.

4. Trade in Renewable Commodities and the Environment

Commodities can be categorized into non-renewable resources such as oil and coal, and renewable resources such as agricultural, forestry and fishery products. With regard to the latter, they are generally more closely related to the environment than most industrial products and their harvesting and production are greatly dependent on the maintenance of a healthy environment. On the other hand, the negative impacts of their inappropriate harvesting and production are also direct. Compared with industrial products, it is difficult to reflect environmental costs associated with commodities in their prices, for the calculation of environmental costs is complicated and commodity price change is big due to the difficulty in adjusting the supply in a short period. This is a common characteristic of commodities irrespective of whether their production takes place in developed or developing countries, although the problem tends to be especially pronounced in developing countries, which cannot rely on exports of industrial products and are highly dependent on commodity trade. Often these countries have little choice but to produce and export commodities with no regard to the environment because of their balance of payment problem.

For these reasons, in comparison with the case of industrial products, there is a need to consider the relationship between commodity trade and the environment from a slightly different angle.

(1) Trade in Agricultural Products and the Environment

The interaction between agriculture and the environment is both close and complex. On the one hand, agricultural land constitutes semi-natural environment and possesses environmental value including a provision of wildlife habitat as well as amenity value such as a good landscape. On the other hand, when agricultural practices are inappropriate, agriculture can be a source of environmental pollution in the sense that it can degrade soil and water through the application of excessive agricultural chemicals and fertilizers. Also, agriculture is one of the sources of greenhouse gases, e.g. methane and N2O, which contribute to global warming.

For agriculture that relies on natural environment, the preservation of a healthy environment is essential to prosper. The worsening of global environmental problems such as global warming, destruction of the ozone layer, and acid rain, threatens the foundation of agriculture, affecting considerably the supply of foods, which are essential to human existence. In addition, as the growth in the world's population is expected to lead to an imbalance in the supply and demand of food, it is extremely important to promote appropriate trade in agricultural products while maintaining the agriculture that has environmental conservation functions in an adequate manner.(12)

Even for agriculture, the viewpoint of optimal resource allocation through market mechanism is important. At the same time, in agriculture, it is problematic to leave everything to free competition and comparative advantage. As has been mentioned before, agricultural production depends largely on natural conditions. So even if environmental costs can be adequately internalized, production costs differ widely depending on countries and locations. Also once agriculture is abandoned, its re-establishment will be much more difficult than would be the case with manufacturing and service industries. Therefore, the decline of agriculture in rural areas that have conservation functions is not desirable from an environmental point of view.

As an example of negative environmental effects on the environment, it is reported that in some parts of Europe and North America, environmental degradation such as soil erosion, water and soil contamination, and reduction in biodiversity resulting from land cultivation highly concentrated on a single crop has been taking place.(13) It is thought that many of those environmental effects are likely to have resulted from a lack of due consideration being paid to externalities of this kind of agriculture, especially the effects of massive application of pesticides and chemical fertilizers, prompting the implementation of environmental policy measures in those countries in recent years.(14) At the same time, it is pointed out that the negative environmental effects of agriculture are partly due to policy failures such as inappropriate domestic price support systems and export subsidies associated with them. From this perspective, the steady implementation of Uruguay Round agreements, which call for the reduction of export subsidies, etc., can have positive environmental effects.(15)

It has been often argued that agriculture in developing countries is less likely to cause environmental degradation because it is more labor intensive and less dependent on pesticides and chemical fertilizers. However, if we look more closely at the situation in those countries, it is difficult to make a general statement as cases are reported where the expansion of agricultural production has been dependent on massive use of chemical fertilizers as well as inappropriate application of pesticides. In some developing countries, which are stricken with population growth and poverty, the expansion of agricultural land sometimes contributes to environmental degradation like deforestation and loss of biodiversity.

By contrast, there is an argument that the traditional type of paddy field agriculture in the Asian monsoon climatic zone has, because of its cultivation methods, environmental conservation functions including prevention of soil erosion, preservation and nurturing of ground water, and micro-climatic adjustment. On the other hand, environmental degradation such as water contamination resulting from excessive application of pesticides and fertilizers is also reported in paddy fields, necessitating the establishment of environmentally friendly agriculture. Although such efforts have already begun in Japan's agriculture, environmental consideration should be further promoted and efforts are needed to evaluate agriculture's environmental functions in a comprehensive and objective manner and to ensure agriculture's environmental conservation functions to the maximum extent possible.

With regard to agricultural products, special consideration different from that given to industrial products is granted in the agreement on agriculture as a result of Uruguay Round negotiations, with the need for environmental protection listed as non-trade concerns together with food security.

(2) Timber Trade and the Environment

Worldwide deforestation and forest degradation is an issue of international concern. It is generally said that the timber trade is not its major cause, and that timber trade restrictions cannot be a fundamental measure to cope with the problem. However, there are regions where the export of timber has been one of the major contributors to deforestation and forest degradation. There are also situations where the import of cheap foreign timber, which does not necessarily include environmental costs, makes it difficult to ensure sustainable forest management on the part of importing countries like Japan. There is a proposal, therefore, to conclude special bilateral or regional arrangements with a view to internalizing costs for sustainable forest management into timber prices. However, increasing the prices of some types of timber in the world timber market will advantage other timbers that do not reflect environmental costs in their prices. Moreover, if there does not exist a proper mechanism to channel additional earnings into forest management, it may lead to accelerated harvesting of trees. It is not necessarily easy, therefore, to solve forest problems through intervention in the timber trade. In order to remove the fundamental causes of deforestation, it is important to deal directly with forest conservation and sustainable management.

Nevertheless, if we consider the fact that timber trade and forest management are sometimes related, it is noteworthy that the International Tropical Timber Organization (ITTO) has adopted the approach to link forest management with timber trade with the goal of "achieving exports of tropical timber and timber products from sustainably managed sources by the year 2000." However, this principle should be applied to all types of timber, considering that the share of tropical timber trade accounts for only 10% or so in the world timber market and is competing with other types of timber, together with the fact that the management of non tropical forests is not necessarily sustainable.

Currently, various efforts are being undertaken not only for tropical forests but also for boreal and temperate forests, such as the formulation of criteria for sustainable management, based on the Statement of Forest Principles. Bearing in mind the possible need to conclude a Forest Convention in the future, Japan should play a positive role in building international confidence and consensus by contributing to the implementation of the Forest Principles and the relevant chapters of Agenda 21. In particular, because Japan is the biggest importer of tropical timber, it should further promote cooperation for sustainable tropical timber management, which it has been conducting towards developing countries in South East Asia and elsewhere.

5. Efforts by the Private Sector

In considering "environment and trade," undertakings by private sector actors such as enterprises, NGOs, and consumers are as important as those by the government. For example, eco-labeling programs for the dissemination of environmentally friendly products and the introduction of environment management systems(16) by private firms have much to do with the issue of the environment and trade through their impacts on trade.

If appropriate environmental information, related to products and companies' environmental profiles, is provided to consumers with a high environmental consciousness, consumer behavior will encourage more environmentally friendly trade. At the same time, it is important to ensure that private initiatives neither send wrong information to consumers nor unnecessarily obstruct trade flows. In this context, the work of the International Standardization Organization (ISO) for the standardization of eco-labeling, environmental management systems, etc. has an important meaning in creating fair and rational international systems. The government should enhance environmental awareness among its people and assist efforts by the private sector where appropriate, while exchanging views with the private sector.

The liberalization of trade and investment increases opportunities for firms of developed countries to engage in various activities in developing countries and countries with economies in transition. Quite often, however, the receiving countries lack the institutions and capacity to cope effectively with environmental problems. This makes it all the more important for private firms to make voluntary efforts to avoid environmental damage caused by their trade and investment activities. Therefore, it is necessary to further encourage private firms' voluntary activities as is exemplified by the Global Environment Charter of the Keidanren (Japan Federation of Economic Organizations) and to provide necessary information to medium-and small-size enterprises in order to raise their environmental awareness when they do business abroad.

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NOTE:

9	Currently, international efforts are being undertaken to develop a system of "resource accounting" to elevate the complex relationships between the environment and economy by taking account of environment-related externalities, which have not been appropriately accounted for, in the concept of economic growth.
10	The use of economic instruments has been recommended by such fora as OECD, G-7 Economic summit, and UNCED. Especially in European as well as North American countries, there are various examples of the use of economic instruments. In this connection, international joint activities are also being discussed including countermeasures against global warming, such as those controlling greenhouse gas emissions and those contributing to the expansion of sinks like forests.
11	Principle 7 of the Rio Declaration on Environment and Development is as follows: "states shall cooperate in a split of global partnership to conserve, protect, and restore the health and integrity of earth's ecosystem. In view of the different contributions to global environmental degradation, States have common but differentiated responsibilities. The developed countries acknowledge the responsibility that they bear in the international pursuit of sustainable development in view of the pressures their societies place on the global environment and of technologies and financial resources they command."
12	According to UNFPA, the world population, which recorded 5.66 billion in 1994, is estimated to reach 6 billion by the year 1998, 8.5 billion by the year 2025, and 10 billion by the year 2050.
13	"The Environmental Effects of Trade" published by OECD says as follows: For example in the agricultural sector, expansion of export markets may lead to greater specialization in the production of certain goods in certain locations with environmentally-damaging consequences. Farming operations that rely heavily on energy and chemicals and detrimental land-use practices may in some cases, be the most competitive types of farming operations after trade liberalization. Contraction of certain types of agriculture may result in the loss of some environmental and landscape amenities.
14	For instance, the United States introduced environmental arrangements in agriculture for the first time in the 1985 Agricultural Act. These measures can be seen as a kind of penalty designed to protect soil and marsh. The environmental measures were later expanded in 1990 under the new Agricultural Act. In the case of EU, measures to protect the environment have been strengthened since the EC introduced the Common Agricultural Policy in 1985, in which each member state may designate environmentally protected regions and subsidize farmers who conduct farming with environmentally favorable manners.
15	During the Uruguay Round trade talks, developing countries exporting agricultural products expressed concern that the lower export subsidy by the western nations will increase the prices of agricultural products.
16	"Environment management system" refers to a series of procedures in which each enterprise formulates, implements, and reviews guidelines, objectives, and plans on environmental protection voluntarily. Such follow-up is called "environmental audit."

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