Effect of the regionalization of European Union environmental regulations

We show that multilateral environmental regulations may affect trade flows differently than unilaterally generated environmental regulations. We build a theoretical model showing that a multilaterally-imposed environmental regulation will disproportionately harm exports coming from poor countries. The intution behind this model is similar to the Alchian and Allen hypothesis about how a per-unit transport cost lowers the price of high-quality goods relative to low-quality goods, thereby benefitting them when traded across large distances. Similarly, a multilateral environmental regulation that increases the production cost of goods will disproportionately benefit high-quality goods made in rich countries at the expense of lower-quality goods made in poorer countries. We then test this hypothesis empirically. Using the gravity equation, we examine the effect on bilateral trade flows of increases in environmental regulation stringency ratings, taken from survey data, with a broad panel of countries, controlling for European Union (EU) membership and income levels. We particularly look at EU members because EU environmental regulations are decided at the Union level and are imposed on all members simultaneously. While most EU members are relatively high-income countries, the expansion into East Central Europe in the last decade brought some lower-income countries into the Union who were nonetheless expected to adopt EU environmental regulations. We find that increased environmental regulation stringency has significantly different effects on EU members’ exports and non-EU members’ exports as well as across income levels of countries. An increase in environmental regulation stringency leads to a dramatic decrease in exports from low income EU-members; conversely, a similar change in environmental regulation does not appear to statistically affect the exports of high income EU-member countries. The results are consistent with our model of the uneven competitiveness effect and the uneven burden of compliance.