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Environmental Regulations and Trade in Europe: The Role of Differentiation

One of the aspects related to the pollution haven hypothesis is that by applying stringent regulations to protect the environment, countries tend to reduce their international competitiveness. Most studies that apply gravity-type equations do not find robust support to that view. Very recent studies using US data but with another set-up than gravity, do find however a significant effect of high stringency on net imports (see Ederington, Minier, 2003; Levinson and Taylor, 2003; and also Ederington et al., 2003). The first aim of this paper is to go back to the gravity literature and show that one can obtain robust negative effects of stringency, as long as gravity equations are well specified with respect to theory. Second, this article puts forward a new hypothesis based on the degree of differentiati on in goods to explain the low impact of stringency on trade found so far, and tests it on a new Western and Eastern European dataset. By using alternative methods to condition out the degree of differentiation of goods produced by industries and/or countries, the paper finds a robust impact of a ‘pure cost’ effect of stringency lying generally from –0.3 to -3.5.