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2 Environment-growth interactions: theory & evidence

1. The Environmental Kuznets Curve

2. Standard model of resource allocation, production, trade and welfare

3. An open economy with pollution

4. Empirical EKC studies

5. Conclusions and discussion

6. Appendix: Measuring pollution and economic welfare

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The ‘environmental Kuznets curve’

• With economic growth, pollution intensity first rises, then declines:

z = z(Y/P)

z’ > 0; z” < 0.

Pollutionper unit of income (z)

Per capita income (Y/P)

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Components of EKC

• Scale effect (economic expansion)

• Composition effects– Relative price changes– ‘Unbalanced growth’-- from several sources

• Technique & preference effects– Production technology– Consumer preferences & policy pressures

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Factors affecting EKC shape

• Exogenous market influences (‘globalization’)

• Property rights

• Externalities

• Policy ‘accidents’(e.g ISI strategies affecting ind’l & ag growth)

* All have economy-wide implications

* Spatial dimensions may also be important

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A note on ‘micro’ vs. ‘macro’ approaches

• Agents’ behavior (e.g. firm/farm) is dynamically linked to macro level changes.– Economy-wide or global changes affect decision- making by

micro units, through prices, etc.– Behaviour of micro-units in aggregate affects macro outcomes:

outputs, prices, employment, income distribution, and environmental externalities

– Indirect and ‘loop back’ effects can be very important

• Micro and macro approaches are complementary. Both are required.

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1. A standard GE model

• Assume:– Two goods produced and consumed

– Each good is produced using two factors• Constant returns to scale

– One factor (labor) is intersectorally mobile; the others are “specific” to sectors

– Markets are complete and competitive• Prices are set in world markets

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Labor

Labor

y1

y2

ƒ1(v)

ƒ2(v)

b = (y1, y2)

a = (L1, L2)

1. General equilibrium of the 2 X 3 economy

ResourceAllocation

ProductionPossibilities

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Spot test!

1. Use the diagram to show the value of total income.

2. For a given set of consumer preferences, show the pattern of trade.

3. Demonstrate that (a, b) is an equilibrium (hint: Walras’ Law).

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Labor

Labor

y1

y2

ƒ1(v)

ƒ2(v)

b

a

General equilibrium of the 2 X 3 economy

Income (in termsof y1)

h

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L

L

y1

y2

ƒ1(v)

ƒ2(v)

b = (y1, y2)

a = (L1, L2)

c = (L1', L2')

d = (y1', y2'')

2. Production and resource allocation effects of a price change

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Spot test!

• What happens to factor returns when relative output prices change?

1. Returns to specific factors rise (fall) as sectoral output rises (falls)

2. Wage change depends on labor- intensity of expanding sector

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L

L

y1

y2

ƒ1(v)

ƒ2(v)b

a

3. Effects of an increase in the labor force

e

bf

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Spot test!

1. What happens to the structure of output as specific factor endowments increase?

2. What is the effect of technical progress in a sector?

1. The sector using that factor expands--and the other contracts

2. That sector’s output expands, and the other’s output contracts

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3. An open economy with pollution

• The Antweiler, Copeland, Taylor (2001) diagram– ‘Clean’ and ‘dirty’ goods

– Comparative advantage in dirty good

– Tariff on imports of clean good

• Effects of growth or trade:– scale, composition, technique

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A

C

B

Dirty good

zA

zC

zB

zS

z=φ1(θ)x

z=φ2(θ)x

Cleangood

pT

pW

Source: Adapted fro mAntweiler e t al. 2001

Composition

Scale Technique

Pollution

UT

UW

YT YW

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Growth and pollution

• E.g. factor endowment growth

• Scale and composition effects from growth– and factor abundance/comp. adv effects

• Technique effects dependent on institutions (among other things)

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EC

Dirty good

z=φ1(θ)x

z=φ3(θ)x

Cleangood

pW

Composition

Scale Technique

Pollution

D

zC

zE

zD

zI

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Hypothesized motives for environmental change

• Factor abundance – Comparative advantage drives NR exploitation

rates in open economies

• ‘Pollution haven’– Lack of property rights or regulations permits

‘free disposal’ of pollution

• Interactions– Openness --> pollution when prop. rts. absent.

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4. Empirical EKC studies

Most general model: yit = i + ∑jijxitj

for i in {country}, j in {explanatory variables} and t in {time}, where

yit is some measure of env/NR, xitj is an explanatory variable

Some other considerations:

• Set of non-income RHS variables

• Model specification

• Data availability (X-S, panel, quality)

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Empirical EKC ‘tests’• E.g. Panayotou 1993, SO2 emissions:

ln(S/P) = –32.56 + 8.3ln(Y/P) – 0.51[ln(Y/P)]2

• Implication: ‘turning point’ for emissions intensity -- for the average country in sample.

• Other LHS variables: CO2, water quality, deforestation, TSP, …

• Other RHS variables: additional terms & interactions (openness/trade intensity, institutions, Communist, pop. density, …)

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Is there an EKC in Asia?

• Empirical studies:– Industrial emissions-- maybe.– Deforestation, water and soil resource

depletion--no robust evidence of EKC (Cropper and Oates, Stern, Common & Barbier, …)

– Yet experience of wealthy countries suggests that EKC concept remains a useful working hypothesis.

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4. Summary and conclusions

• Assumptions about optimizing behavior• Assumptions about markets and technology• Assumptions about trade• Models must make assumptions explicit and be

demonstrably consistent• Complications can be introduced, but at a cost• Target of analysis is important. Is it the

environment only? Or a broader concept of welfare?

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For next sessions

• Review duality and basic concepts, if necessary:– Expenditure, cost and revenue functions– Trade expenditure function– “Hat” calculus

• Look at OEE Ch. 2 models, and/or Ulph (1999).

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Appendix: Environment and economic welfare

• ACT model tells us what happens to pollution.

• But consumer utility: u = u(c, -z)– Price or endowment changes affect c as well as

z: what is the change in net welfare?– example: trade liberalization

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Tariff

C- utility fromenvironmentalquality

R – value of outputWelfare

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Spot test!

Q. In the previous example, what is the optimal tariff, and how is it calculated?

A. Where absolute values of slopes of R and C are equal (marginal environmental benefit=marginal cost in terms of consumption)

B. Q. What is the optimal tariff on imports of a dirty good?

C. A. t = 0.

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