Imperfect Competition, Foreign Trade, and the Environment
In the previous chapters, models have been discussed that are based on the assumption of perfect competition in all goods and factor markets. This assumption simplifies the analysis considerably and in many cases it is also a satisfactory approximation to real markets. However, not all markets are approximately competitive and this limits the applicability of perfect-competition models. For example, traditional models fail to explain the large share of intraindustry trade, i.e. trade in similar commodities between similar countries. Moreover, some of the policy implications derived from these models depend decisively on the assumption of price-taking behaviour and zero profits. In the late 1970s and early 1980s, a 'new' trade theory was established and one started to use the tools of modern industrial economics to look at non-competitive market structures. In the meantime, this approach has been incorporated into the main body of modern international trade theory. For surveys of the approach and the results see e.g. Bensel and Elmslie ( 1992), Helpman and Krugman ( 1985, 1989), Kierzkowski ( 1987), Krugman ( 1988a), and Vousden ( 1990, chs. 5-7).
The main differences between the new and the traditional approaches to international trade theory are threefold. First, the new approach explicitly concerns itself with non-competitive market structures whereas the majority of traditional models assume perfect competition. Second, in the new trade literature, one usually looks at single markets whereas the traditional approach is devoted to general-equilibrium analysis. Finally, the traditional approach has resulted in a unified framework of a many-countries, many-goods, many- factors version of the old Heckscher-Ohlin and Ricardo models that can be modified easily to include non-traded goods, endogenous factor supplies, etc. In contrast, the new theory of international trade still looks rather patchy and-like industrial economics-seems to lack a unified model framework. None the less, there are a number of 'core' models that have been influential in the economic-policy debate. They will be used here to discuss the effects of environmental policies on foreign trade in the case of non-competitive market structures.
The main focus of this chapter is to ask how instruments of environmental policy can be used to achieve trade-related policy objectives. Again, the underlying thought is that in an era of trade liberalization (albeit sometimes more on