1. Alejo Etchart Ortiz
September 2009
THE ROLE OF ECONOMY FOR THE ENVIRONMENT
Torrens (1815) and Ricardo (1817) theorized that each country and the global
economy can gain through the specialization of each country in the production
of the goods for which they have a comparative advantage (Teson and Klick
2007). In economics, comparative advantage refers the ability of a person or
country to produce a good most efficiently in comparison with all the other
goods that could be produced. It contrasts with absolute advantage, which
refers the ability of a person or country to produce that good at a lower absolute
cost than other persons or countries. Some authors (Chenery 1961; Krugman
1987; Laursen 1998; Daly 1999) discuss the applicability of this Ricardo’s
principle of ‘comparative advantage’ to today’s economy, due either to the
strong power gained by specific market players who distort the optimal
resources allocation, or to the market failures (Bermejo 2008) –which will be
commented in the next chapter.
Economy is the science of resource allocation (Ayres 2008). It exists because
resources are scarce and tries to solve the problem of its most efficient
allocation, by giving them a cost and a price (ibid.). Zarsky (2002) states that
the environment has not been given a cost, and it has therefore not been
considered for measuring the comparative advantage, so that the costs of
environmental degradation are not reflected in marketplaces but borne socially,
either today or in the future. When a part of a system fails, the whole system
fails (RAI n.d.); if an element of a system fails to handle a stress, the other
system elements share this stress (Sanjaykumar 2008). The environment is
mostly out of the equation at the time of considering the optimal resources
allocation (Zarsky 2002). Therefore, the economic system is inefficient in the
global resources allocation (Ayres 2008; Vegara 2009). Hardin’s (1968) ‘tragedy
of the commons’ theorizes that, in the absence of restrictions, users of an open-
access resource, such as the environment, will use it more than if they had to
pay for it. Consequently, without a market price, the only possible path for the

2. environment will remain being a continuous degradation (Hardin 1968;
Baumgärtner 2006).
This study gathers academic research about the importance of giving value to
the emissions (section 0), which is later done in the case studies; and about two
consequences that the subsequent reallocation of resources could carry within:
the shift to more local economies (0) and the closure of material cycles (0). Both
are proposed by many authors as necessary steps towards sustainable
development. The objective of the case study is to give values to the extra
emissions that occur due to the import of some valve components from China
instead of being produced locally and to add them to the product cost, in order
to learn if, once they are born in mind, the imports remain more competitive.
International trade and the environment
This chapter discusses how the fact of not having in mind the emissions
embodied in international trade may be distorting the optimal allocation of
resources. It is directly related with the objective of this study, as referred in the
introduction. Then, this chapter introduces two potential consequences of a
complete environmental cost allocation: a local economies system and of a
closure of material cycles, and discusses their benefits.
Market failure
The concept of ‘externality’ lies within the field of Environmental Economics,
particularly focused on the costs and benefits of environmental policies to deal
with air pollution, toxic substances, solid waste and global warming (Stavins
2007). Basic to it is the concept of ‘market failure’, which occurs when the
market does not allocate scarce resources to generate the greatest social
welfare, due to the difference between what a person does, given the market
process, and what the society wants him or her to do (Hanley et al. 2007).
Externalities are one of the market failures that happen when a person makes a
choice whose implications upon others are not accounted for in the market
price, leading to a global inefficiency in resources allocation (Arrow 1969). The

3. agents who produce the negative effects caused by an externality do not pay for
the costs that they generate (Vegara 2009a). If prices reflected the
environmental costs, therefore making the polluting activities more expensive,
they would become clear incentives for increased resource and energy
efficiency (OECD 2008).
Environmental costs for business have started to be imposed in global markets,
but the low environmental achievements suggest that industry production costs
and hence market prices do not incorporate the real cost of environment
destruction (Zarsky 2002). The Kyoto Protocol (KP) aimed to allocate a cost to
the environment, but it is only a small first step with symbolic significance and a
derisory GHG abatement effort (Ayres 2008). Evidence shows the small impact
of carbon abatement policies globally undertaken up to now (Peters and
Hertwick 2007; Wara 2007; Bermejo 2008). On the other side, the KP did not
consider the emissions in consumption, but the ones in production. Thus some
countries, specially the ones producing large volumes of metal and
manufactured goods, as China (Ward 2005; Peters and Hertwick 2007),
generate emissions to make goods that are used somewhere else in the world,
which involves that those who receive the goods benefit from the emissions
generated by others (Ashton and Wang 2003). Academics, government
agencies and businesses have criticised the KP because it does not actively
encourage economies to increase the production of goods where their
production processes have low carbon intensity (Ahmad 2003).
The World Trade Organization (WTO) pursues the reduction of commercial
barriers (WTO 2003), leading the world economy to the current globalization
(Zarsky 2002). Environmental standards for production and resource
management are less subject than product standards to policy transformation
effects, as the fact that the environment has been practically left aside in global
policies proves (ibid.). Some countries have often tried to impose limitations to
imports claiming environmentally damaging production and processing methods
(PPMs) in the origin countries, but the WTO prohibits states from unilaterally
imposing process and PPMs standards on imports (ibid.). Wiers (2001) argues
that PPMs are not prohibited by the WTO as such, but that they often hinder
protectionist objectives inconsistent with the principles of WTO. The debate on

4. the imposition of taxes to extra polluting PPMs in the forthcoming COP15
continues (TWN 2009)
In spite of its huge importance, there has been little research on how trade may
impact climate policy (Zarsky 2002; Peters and Hertwick 2007). Zarsky (2002)
thinks that the primary impact of globalization is to keep environmental policy
initiatives ‘stuck in the mud’, due to the unwillingness of governments to adopt
unilateral measures for an environmentally responsible performance from
domestic producers that could impose extra-costs, and to the tendency to take
steps following the primary competitors, who do not use to be the most
environmental-friendly performers (ibid.). Measures undertaken by a specific
country to internalize environmental costs could run them out of competition in
export markets and make it non-attractive for investors (ibid.). Without
regulation, environmental production standards trend towards developing
countries benchmark, generating a ‘race to the bottom’ in terms of
environmental production standards (Revesz 1992), resulting in industries
closing down in countries with mandatory environmental regulation and moving
to countries with low regulation as China (Peters and Hertwick 2007). The
search for higher returns and lower costs will drive international investment
towards the low standard countries, while capital outflow and/or the threat of
relocation will create pressures to lower standards in high standard countries
(Zarsky 2002). Copeland and Scott (2003) find strong evidence that industries
location and trade flows have been heavily affected by a ‘pollution haven’ effect
under which polluting industries have relocated in countries with low stringency
environmental policy, resulting either on an increase in global pollution or on a
chilling effect on environmental policy. Countries are reluctant to tighten
regulations that could make them lose international competitiveness (ibid.).
Since 1970, global production of high polluting industries has increased
dramatically (271% in cement, 223% in aluminium, 84% in steel, 200% in
ammonia, 180% in paper), and most of this increase has located in developing
countries with lower environmental stringencies (Worrell et al. 2009). The
evidence of this pollution haven effect will appear in section 5.1.3, while
discussing emissions embodied in Chinese exports; and in sections 5.2.1 and
5.3.1, while commenting the reallocations in ‘iron and steel’ and aluminium

5. industries. Therefore, the differences in pollution policy are other factors that
determine the comparative advantage together with factor endowments (ibid.).
International trade is nowadays being discussed as a way to enforce climate
policy (Aldy et al. 2001). Some authors (Ismer and Neuhoff 2004; De Cendra
2006; Peters and Hertwick 2007) propose trade-based mechanisms such as
border-tax adjustments to correct the ‘pollution haven’ effect. Cosbey (2009)
thinks that it the impact of international trade on the environment will occur
through the reduction of tone-miles transported, following an increase of
maritime transportation fuels costs.
Sneddon et al. (2006) think that the economic globalization, and subsequently
the ecological one, makes necessary the reduction of national sovereignties in
favour of a trans-national authority. In most countries, the use of scarce natural
resources remains under-priced and even subsidised, and the ‘polluter pays
principle’ is rarely implemented fully (ibid.). Through a national sovereignty
cession, the underpricing of pollution might more feasibly be corrected (López
2002; Dalby 2003; Bates and Knopman 2000; Batabyal 1998).
Local economies
Curtis (2007) reverses the approach of how globalization affects the
environment, to analyse the impacts of changes in natural capital on the
economy. He concludes that the climate change and the peak oil will strongly
undermine the economic logic of globalization. The current pattern and distance
of goods transportation will be much less profitable than now, because costs will
rise significantly. Food will become much more local and seasonal, and also
more expensive. Consumers’ disposable income for manufactured goods will be
reduced, and therefore global trade will lower.
Preston and Leng (2004) think that the non-fossil fuel-dependent development
can only be reached emphasizing small, localized and decentralized systems
radically opposite to the earth-destroying, globalized systems that nowadays
exist. Industrial agriculture, manufacturing and retail trade will change
significantly. They think that Wal-Mart style national retail chains whose profit
margins depend on goods made 12,000 miles away will not function in a world
of $100-plus barrels of oil, and therefore the world must prepare for facing this

6. future. In accordance with Preston and Leng (ibid.) opinion, Curtis (2007) thinks
that the economy should start the process to internalize the costs of
environment depletion as soon as possible, in order for the change to be less
radical. The Chatham House (Stevens 2008) reports that the oil price could rise
over 200 US$/barrel in the next couple of years, due to a serious supply crunch
-the Brent crude oil is currently (24/08/09) quoting at 74.61 US$/barrel (BBC
2009a). The International Energy Agency’s Executive Director N. Tanaka thinks
that when the economy recovers from the current crisis there may not be oil
enough to go round (BBC 2009b). This could be reflected in a very strong oil
price rise.
The Life Cycle Assessment (LCA) is nowadays proposed as the best
environmental management tool by many authors (Sinding 2000; Korhonen
2002, 2007; HoL 2008). It considers the emission incurred by a product in its
whole life cycle, from ‘cradle to grave’, from materials extraction to final disposal
when it becomes waste. Transport is therefore a part of the product in LCA
approach. In the global market economy, the life cycles of products extend over
regional, national and continental borders, making extremely difficult to consider
all the environmental aspects involved (Korhonen 2007) and consuming huge
amounts of energy (Korhonen 2002). If all economic systems in the world would
rely on imports of material and energy exceeding their local ecological carrying
capacities, the total ecological footprints (Wackernagel and Rees 1997) would
exceed any global sustainability limits (Korhonen 2007). In a local production
and consumption ecosystem, life cycle could more easily be monitored, and
energy-, resource- and waste-intensive activities would be reduced (ibid.).
For many authors (Korhonen 2007, Ring 1997, Wackernagel and Rees 1997),
economic activity should strive towards local operation with local product life
cycles, and adapt to local carrying capacity. Ring (1997) affirms that
ecosystems have developed more and more efficient ways of using locally
available resources, and that spatial limits favour increases of the system’s
internal efficiency with respect to the local environment. He thinks that the
crossing of spatial boundaries helps neglect efficiency in local resources use.
Mirata (2004) also proposes regional levels as a limit to the economy, and
affirms that a big efficiency in resources use can be achieved regionally. On the

7. other side, the necessary cooperation between parties to achieve the
sustainability also seems more feasible in a local rather than in a global setting,
due to the common culture between the actors involved in a shorter ‘mental
distance’ and the more closely shared common objectives that occur regionally
than within big distances (Ehrenfeld and Gertler 1997). Hopkins (2008) thinks
that, when peak oil is dropped into the economic mix, localization is no longer a
choice, but the inevitable direction in which the world must move. He thinks that
the unsustainability of massive transport of goods is the main reason for this
necessity.
Nevertheless, Korhonen (2007) conditions the reliance on local economies to
the availability of resources, saying that, e.g., it is more beneficial if forest rich
countries export this renewable resource to those that would otherwise have to
rely on non-renewables. Therefore, he suggests a case-by-case study rather
than locality as a prescriptive principle for environmental management. Also
Hopkins (2008) considers that the matter is not a complete localization, but a
move to build resilience in communities.
In the case studies presented in this document, local alternatives are available
in all cases. They have been the main sources until recent years and remain
being used occasionally.
A reinforcement of local economies is proposed by many authors (McCartney et
al. 2008; Buterbaugh 2008; Curtis 2007; Norberg-Hodge 2000; Ekins 1986;
Sale 1980) as an imperative for sustainability (see Bermejo 2008).
Closure of material cycles
Boulding (1978) affirms that for the human race to survive, cyclic economies in
which all materials are obtained from big deposits and returned to them must be
achieved, among other requisites. Korhonen (2002) states that the Economy is
just a subsystem of the focal major system that is our common planet, and
therefore the natural capital (e.g. resources and services that the natural stocks
provide humans with) is now the limiting factor of economic development. This
idea was originated by Hartwick (1977) and Solow (1986), who adds man-made
capital to natural capital as a limiting factor.

8. In the field of Industrial Ecology (ISIE n.d.), many authors have observed (see
Korhonen 2001a, b) that the wastes generated by an industry may be beneficial
for the environment when other industries in close physical proximity can use
those wastes as a raw material or as fuel substituting for imported, non-
renewable and emission intensive fossil fuels or for natural resources. Bermejo
(2008) agrees that the current globalization causes worldwide production
structures in which, at the end of its useful life, products can hardly be reused
as inputs for new goods that are produced very far away.
The closure of material cycles is, for many authors, a key factor in the industrial
ecosystem ‘win-win-win’ vision, together with the use of local renewable
resources (Korhonen 2007), as illustrated in Figure 1. When a regional system
involves many actors and a large diversity of resources, there is a better chance
to secure the availability of resources and fuels, including those derived from
wastes.
Figure 1- The four industrial ecosystem principles in the ‘win-win-win’ vision (Korhonen
2007)

9. Despite the evidence that high-grade rates of recycling are feasible and
imperatively necessary, progress towards material cycle closure is very slow,
and industrial society maintains a dominantly ‘extract, expend, expel’ rather
than a ‘reduce, reuse, recycle’ modus operandi (Peck 2003).