Unmasking the Pollution Haven Effect

This paper uses both theory and empirical work to examine the effect of environmental regulations on trade flows. We develop a simple economic model to demonstrate how unobserved heterogeneity, endogeneity and aggregation issues bias measurements of the relationship between regulatory costs and trade. We apply an estimating equation derived from the model to data on U.S. regulations and net trade flows among the U.S., Canada, and Mexico, for 130 manufacturing industries from 1977 to 1986. Our results indicate that industries whose abatement costs increased most experienced the largest increases in net imports. For the 20 industries hardest hit by regulation, the change in net imports we ascribe to the increase in regulatory costs amounts to more than half of the total increase in trade volume over the period.