of tariff escalation by reduction of the tariff on processed goods increases allocative efficiency
and reduces the IS externality, a win-win situation. This finding has obvious implications for
many exporters of raw and processed commodities. For example, several countries that are
members of the Association of Southeast Asian Nations (ASEAN) are major exporters of
forestry products both raw and processed. A reduction in the tariff escalation faced by forestry
exports from ASEAN countries would produce a global win-win outcome: both economic
efficiency and environmental sustainability would be enhanced in all countries involved. This
implication is particularly relevant in the context of sustainable trade. Reductions in tariff
escalation as designed in our analysis insure an expansion of value-added activities and exports
by developing countries while mitigating environmental externalities directly associated with
trade.
It is well known that a first-best policy menu calls for free trade and an additional
targeted policy instrument to address the IS externality. In absence of such an instrument or if
such an instrument is not set optimally, we show that the tariff structure can be changed to insure
that allocative efficiency improves while keeping the IS risk in check or even reducing it. If the
IS risk is contained to the raw input market, any reduction of the tariff on the final good leads to
a desirable outcome. We also show that both tariffs can be decrease in an orderly fashion such
that the risk of IS is not increased while deadweight loss in both markets can be reduced. Finally
we also show that if the processed final good carries some moderate IS risk, that is smaller than
the raw input import does, policy menus that reduce escalation and IS risk also exist but need to
be designed to insure that the IS risk is kept in check. In the latter, win-win situations are
characterized by a price-elastic supply of the processed good, a price-inelastic demand for the
processed good, a predominant domestic supply of the processed good, and a high initial tariff
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