Interaction between trade and environment policies with special interest politics: A Case when commodity markets are imperfect

In the ambit of politics of special interest groups, this paper addresses the linkages between trade and environmental policies in imperfect commodity markets. A duopoly market is characterised by two-way trade in differentiated products that are polluting in nature. Firms in each country act as Cournot competitors in the international market and have direct stakes in both trade and environmental policies set by the incumbent government. Results suggest that in comparison to the baseline scenario where the incumbent is purely benevolent, the political equilibrium is characterised by higher import tariffs and lower pollution taxes. The voting support from political action groups (here firms) induces the incumbent to choose policies that favour them in general. However, the degree of product differentiation tends to bring down the divergence in policy outcomes under the two scenarios. Interdependencies between trade and environmental policies are also affected by the existence of producer lobbies. Unlike in case of the social optimum, the incumbent faces a trade-off between considerations for campaign funds from lobbies and the welfare motive for the population in general. Our study shows that environmental polices act as strategic substitutes, and trade policies may or may not be strategic substitutes. We find that complementarities in trade policies (a tariff war) arise only when incumbent governments are less corrupt. This outcome is attributed to the interdependencies between trade and environmental policies. For a less corrupt policy maker, the loss in campaign funds is outweighed by the net gains from environmental regulations, viz. improved environmental quality, gain/loss in consumer and producer surplus, pollution tax revenue, and tariff revenue. Therefore, the likelihood of trade wars would be lower if politicians are more corrupt.