While the interaction between trade and environmental policies has attracted a considerable political and academic interest, there is little quantitative analysis due to a lack of reliable data.

In incorporating environmental parameters into a computable general Equilibrium model of the Trade Environment Relationship in North America (ETERNA) the author demonstrates how an analysis can use the limited data available, relying largely on the information provided by the World Bank International Pollution Projection System (IPPS).

The ETERNA distinguishes four different impacts of trade liberalization on the environment. These are (1) the growth effect, (2) barter or allocation efficiency effect, (3) structural or specialization effect, and (4) regulatory effect. The latter results from a model-endogenous regulation-setting, and is of particular importance. It reflects the increased demand for environmental quality (and the regulatory translation of this demand) caused by the trade-induced income growth.

The paper shows that concerns that trade liberalization might lead to an environmental erosion are largely misplaced for two reasons. First, the correlation between trade liberalization and specialization in polluting industry is weak. The paper finds that, as a result of NAFTA, Mexico specializes relatively in polluting sectors, the United States in less polluting ones, with mixed results for Canada. However, this specialization is far from systematic and is dominated by the trade impact on the location of just one sector (oil and petrochemical industry). For this trade specialization, the importance of differences in environmental stringency among countries is small. Instead, the trade specialization is strongly dominated by differences in the relative capital-labor endowments of the countries. The findings mean in practice, that trade and environmental policies can be pursued relatively independent from each other.

Second, it is demonstrated that even in the country that ends up specializing in the relatively polluting sectors (in this case Mexico), trade liberalization results in an environmental improvement in the long run, if reasonable assumptions are employed for an income-induced demand for environmental quality. In many cases it would therefore be counterproductive to errect trade barriers, if one wanted to preserve the environment at home and abroad.