Is Trade Bad for the Environment? Decomposing the Impact of Trade on Environmental Quality

Abstract: The impact of trade on environmental quality has received a considerable attention, both in policy debate and in theoretical literature. However, the empirical evidence on the topic remains lagged. This thesis adds to the empirics by unearthing the relationships and decomposing the effect into scale-technique effect and trade-induced composition effect using Arellano-Bond GMM estimation technique. Contrary to previous studies, the scale-technique effect is ascertained by controlling for the role of government. The study then compares the effect between OECD countries and SSA countries. An aggregated panel data on CO2 and N2O spanning from 1983-2008 are used as proxies for environmental quality. The results show that the role of a democratic government in ensuring a favourable scale-technique effect is dominated by the adverse composition effect on CO2 emissions. However, these effects are both bad for N2O emissions. These suggest that trade is generally detrimental to the environment. Comparing the results for OECD and SSA countries, the results also show that trade makes SSA countries relatively dirtier because of the global externality of CO2 emissions. It is therefore imperative that both developed and developing countries broaden their trade policies to encapsulate environmental concerns.