Editors' Summary: In environmental economics, the concept of negative externalities refers to the costs of adverse environmental effects that result from resource extracting and industrial activities and that are borne by the public, rather than the responsible entity. While this concept is widely accepted, serious debate exists as to whether environmental regulation for internalizing environmental externalities is market correcting or market distorting. This debate is rooted in disagreement and uncertainty as to what constitutes an environmental externality and in the difficulty of assigning a specific monetary value to environmental externalities. Many environmentalists seek to correct the market failure associated with negative externalities by forcing the entity producing the product in question to internalize the costs of environmental protection. Free market advocates, however, often counter this strategy by citing the comparative advantage theory, which holds that government regulation that reallocates costs and benefits can reduce economic efficiency. Under a comparative advantage analysis, policies that impose environmental costs on producers often can be viewed as the causes of, not the solutions to, market distortions.

This Dialogue attempts to place the conflict between the principles of negative externalities and comparative advantage in a less theoretical context. To that end, the author examines the relationship between national incentives to protect natural resources and international trade rules that seek to restrict the use of natural resource subsidies. The author further evaluates the extent to which the international trade rules account for the problem of negative externalities, and the extent to which the rules recognize the potentially effective role that national incentive programs can play in correcting market failures. From this evaluation, the author concludes that the legitimacy of "green" subsidies under international trade rules is uncertain. The current trade rules define green subsidies too narrowly and may discourage the use of national incentive programs to improve protection of natural resources and the environment. Therefore, the author proposes changes to ensure that national incentives to protect natural resources are effectively recognized and preserved under international trade law.