Trade Liberalization, Standards and Protection

Abstract As conventional trade barriers fall, nations may increasingly resort to product standards to protect domestic industries. While ostensibly protecting their citizens from the environmental and health side-effects of a particular product, countries could enact standards that are facially-neutral, but impose greater compliance costs on foreign producers. This paper examines the impact of trade liberalization on standard setting by using a two-country Cournot duopoly model in which the Domestic government imposes a standard to mitigate a consumption externality. The standard increases production costs for both Domestic and Foreign firms, especially for the latter. The paper finds that one cannot make an unequivocal connection between falling tariffs and subsidies and rising standards. If the initial tariffs or subsidies are prohibitive, reducing subsidies and tariffs to allow minimal import penetration will generally create incentives for the Domestic government to impose higher standards. If the ex ante tariffs are not prohibitive, however, it is only optimal for the government to raise standards following tariff cuts if (i) tariff revenues are an important component of the welfare calculus and the ex ante tariff rate is high, or (ii) the standard's effect on the per unit externality is large. Likewise, if the initial subsidies are small enough to allow imports the government should only raise standards following subsidy reductions if the per unit externality is substantial, or the standard's impact on the per unit externality is large.