2 Environment-growth interactions: theory & evidence

1. 875-2 2 Environment-growth interactions: theory & evidence • The Environmental Kuznets Curve • Standard model of resource allocation, production, trade and welfare • An open economy with pollution • Empirical EKC studies • Conclusions and discussion • Appendix: Measuring pollution and economic welfare

2. 875-2 The ‘environmental Kuznets curve’ • With economic growth, pollution intensity first rises, then declines: z = z(Y/P) z’ > 0; z” < 0.

3. 875-2 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

4. 875-2 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

5. 875-2 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. TOC

6. 875-2 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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8. 875-2 Spot test! • Use the diagram to show the value of total income. • For a given set of consumer preferences, show the pattern of trade. • Demonstrate that (a, b) is an equilibrium (hint: Walras’ Law).

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11. What happens to factor returns when relative output prices change? Returns to specific factors rise (fall) as sectoral output rises (falls) Wage change depends on labor- intensity of expanding sector 875-2 Spot test!

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13. What happens to the structure of output as specific factor endowments increase? What is the effect of technical progress in a sector? The sector using that factor expands--and the other contracts That sector’s output expands, and the other’s output contracts 875-2 Spot test! TOC

14. 875-2 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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16. 875-2 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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18. 875-2 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. TOC

19. 875-2 4. Empirical EKC studies Most general model: yit = i + ∑jijxitjfor i in {country}, j in {explanatory variables} and t in {time}, whereyit 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)

20. 875-2 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, …)

21. 875-2 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. TOC

22. 875-2 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? TOC

23. 875-2 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). TOC

24. 875-2 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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26. 875-2 Spot test! Q. In the previous example, what is the optimal tariff, and how is it calculated? • Where absolute values of slopes of R and C are equal (marginal environmental benefit=marginal cost in terms of consumption) • Q. What is the optimal tariff on imports of a dirty good? • A. t = 0. TOC