International Business & Economics Research Journal Volume 1, Number 1 133 Environmental Policy And Firm Relocation: The Case Of U.S.-Mexico Patrik T. Hultberg (E-mail: hultberg@uwyo.edu), University of Wyoming Abstract The paper studies the effect of stringent environmental policy on domestic firms' location decisions, especially in the context of a bilateral trade agreement. The main variables included are market size, trade barriers, and fixed costs of establishing abroad. The results show that parameter assumption in the inverse demand function matter. In addition, changes in model variables yield both intuitive and some less intuitive results. For example, predictions on firm movement following economic integration are not as clear as might be expected. The results are discussed in the context of U.S.-Mexico economic integration. Introduction olicy makers, industrialists, and environmentalists all express concern about the impact of more stringent environmental policies on the competitiveness of the domestic industry and, in particular, about the possibility that a domestic producer may relocate plants to countries with less stringent environmental regulations. These concerns are precipitated by changes in both U.S. levels of environmental control and trade and investment patterns. For example, between 1973 and 1982 manufacturing industries in the U.S. nearly doubled their expenditures for pollution control from $3 billion to just under $6 billion (Leonard, 1984) and from 1973 to 1994 U.S. pollution abatement operating costs increased more than eight times (U.S. Bureau of the Census). At the same time the U.S. has moved from a position of approximate trade balances to operating with trade deficits. Many businessmen and policymakers attribute this deficit to the rising production costs resulting from strict environmental standards, while empirically the results are less clear. 1 A summary of the empirical literature concludes that the evidence regarding environmental policies' effect on firm movement is mixed. Empirical studies indicate that dirty industries are more prevalent in developing countries which may be due to specialization in pollution-intensive industries (Lucas et al., 1992, Low and Yeats, 1992). Also, the share of dirty-industry exports in industrialized countries has been reduced while the share of such exports has increased for some developing countries (Low and Yeats, 1992). Such evidence does not, in itself, necessarily support the conclusion that environmental cost differences lead to relocation, only that such an explanation is consistent with the empirical trends. However, as discussed by Beghin et al. (1994), most studies do not find strong evidence that environmental regulations per se lead to low competitiveness and firm relocation. The main reason for this result may be that the magnitude of environmental costs in total costs is presently small for most industries. For example, Low (1992) claims that the weighted average ratio of environmental costs (pollution abatement and control costs) to output in the U.S. was 0.54%, with the highest ratio being 3% for the cement industry in 1988. However, the author also points out that this may not cover the full cost to U.S. industry of pollution control. __________ Readers with comments or questions are encouraged to contact the authors via email. Despite the weak evidence on the role of environmental costs on plant location, several theoretical models have been built to explore this linkage. The theoretical research on plant location differs from standard industrial 1 Of course much concern has been expressed about differential labor costs as well. P