Environment and Economic Development

1. Environment and Economic Development Topics The concept of sustainable economic growth and development  Environmental sustainability, steady-state growth and development Sustainable growth and environmental taxes The relation between environmental quality and economic development The Environmental Kuznets Curve (EKC) Economic explanations of the EKC Environment and Less Developed Countries (LDC)

2. Environmental resources and economic growth The key-issue, so far, has been to find a way, even through appropriate policies, to achieve the optimal allocation of environmental resources, either in the form of optimal pollution level or optimal extraction of natural (renewable or not) resources. This analysis of optimal allocation have been carried out using the classical concepts and instruments of welfare economics: take into account current (or discounted) benefits and costs associated to the use of the resource by the different components of the society and maximize the difference. This is, however, a microeconomic perspective in the sense that it concerns interests and utility of individuals using the resource or bearing negative externalities. The same kind of problem, however, could be also seen from an aggregate perspective, dealing with the whole economic system and the its use of resources: that is, a Macroeconomic perspective. The macroeconomic question arises because in all cases considered so far, the optimal solution implies some limitation of production if compared to a private perspective. In aggregate terms this would imply to limit the whole aggregate output production, therefore, limit economic (GDP) growth (Meadows et al., “The Limits to Growth”, 1972).

3. Environmental sustainability and economic growth - 1 Let’s start from a reductive and reductionist point of view, that is, from the naive idea that economic development corresponds to economic growth. Therefore, focus the attention on the relation occurring between the use of an environmental resource (E; e.g. fossil energy) and the real GDP of a given country. Conservation of this environmental resource may be intended as a constrain to private good production as the production function of aggregate output uses the environmental good as a production factor together with a conventional factor, namely capital (K). Let’s assume, for instance, a Cobb-Douglas production function: Dividing by E we obtain the output intensity, that is, per unit of use of environmental good E (Y/E = y), expressed as function of capital intensity (K/E = k): Environmental sustainability, in its restrictive definition (strong sustainability), implies: Et=Et+1=E*. Furthermore, let’s assume that investments in new-vintage capital is a fixed proportion of output (savings s): Kt+1 - Kt = s Yt

4. We can divide this saving equation by E* to obtain: Environmental sustainability and economic growth - 2 and dividing by kt: • This equation shows that under environmental sustainability (Et=Et* t) k can grow, thus K and Y as well. Therefore, environmental sustainability does not impede economic growth. • Nevertheless, as  < 1, i.e. decreasing marginal returns of capital, K and Y do grow but at a decreasing rate over time, thus tending to a steady-state of K and Y. In the long-run, therefore, environmental sustainability seems to imply stead-state, namely zero-growth: the sustainable equilibrium tends to be a steady-state equilibrium (N.B.: not steady-state growth). • Under this perspective, environmental sustainability does appear a major constraint to economic growth (“Limits to growth”) as it tends to zero-growth. If we thus identify economic development simply with economic growth, then the idea of sustainable development becomes a contradictory concept. • In practice, however, as well as in economic theory, non-zero steady-state growth remains possible. Let’s see how:

5. How can we maintain a constant level of E* making, at once, Y grow at a positive and non-decreasing rate? The key-idea is the environment saving technical change, that is, technical change allowing for productivity of E, (Y/E), to regularly and continuously grow over time. Environmental sustainability and economic growth - 3 • This can only occur whenever we assume that new-vintage capital, namely investments, do contain a better technology, making possible to obtain the same output level Y with a lower use of E (environmental friendly technology). Such concept can be made explicit by introducing a new variable, ht,that improves E productivity as follows: and that is also expressed as a quota  of past investments, ht =  Kt. Therefore: • By repeating previous analysis we can easily demonstrate that, with E constant (E*), we have: That is, a positive and non-decreasing sustainable growth rate.

6. Sustainable growth and environmental taxes - 1 There is a major problem, however, in viewing sustainable growth in a such straightforward way. In fact, even if it were possible to maintain a non-decreasing growth rate maintaining E constant, it would remain open the question on how to make E remain constant. As E productivity, (Y/E), is expected to grow more than K productivity, if the price of E (pE) does not increase rapidly enough, producers will tend to use an higher amount of E (more than E*, eventually exhausting it). It is thus necessary that price of E increases at least at the same rate of E productivity. If E is a public good, this may be achieved by appropriate policies for instance introducing an environmental tax on any unit of E (tE). Therefore, to maintain the use of E at the constant level E* is must be: where Pm(E) is the marginal productivity of E (expressed in unit of Y).

7. Sustainable growth and environmental taxes - 2 • Conditions to achieve sustainable growth in the presence of natural resources: • Environment saving technical change, that is high (perfect) substitutability between artificial and natural capital, in such a way the latter becomes unessential • The price of natural resources increasing at least at the same rate of economic growth (i.e., of K and Y) so that the demand (use) of the resources themselves remain constant: • If the resource is “public” then it will be necessary to impose a tax whose size increases at the same rate of economic growth and whose revenue is then reinvested in artificial capital substituting the natural resource • If the resource is exhaustible and “private” (e.g., oil) the price increase (scarcity rent) will have to be reinvested in artificial capital (the Hartwick rule).

8. A wider concept of sustainable development Economic development is a much wider concept that economic growth. The former incorporates the latter but also takes into account all those processes usually accompanying economic growth: change in technology, preferences, institutions, human capital, sectoral composition etc. If with “development” we mean higher level of welfare and well-being, this does not only depends on the available amount of natural resources, but also and mostly on the quality of their management in terms of equal distribution, conservation-restoration and substitution: “sustainability” can not simply mean to maintain a constant quantity of natural/environmental resources. Therefore, to combine the concepts of economic development and environmental sustainability we need a wider (and necessarily more generic and vague) perspective than the simple idea of sustainable growth. This is sustainable development: “development that meets the needs of the present generation without compromising the ability of future generations to meet their own needs” “We do not inherit the Earth from our parents, we borrow it from our children“ (Native American saying)

9. Relation between environmental quality and economic development - 1 This definition of sustainable development has become widely used and accepted since 1987, when it was firstly proposed within the famous document Our Common Future (Bruntland Report) of the World Commission on Environment and Development (UN). This document pioneered numerous political initiatives within the UN on several environmental issues. It also raised the interest of many economics on the actual relation occurring between environmental (its quality and degradation or depletion) and economic development Over recent decades, in fact, such relation turned out to be much more complex than expected revealing that both “pollution of affluence” and “pollution of poverty” could actually co-exist and even reciprocally reinforce. In particular, the empirical evidence demonstrated that, in many cases environmental degradation and poor environmental performance (E) is not necessarily proportional to economic growth (Y). It is the quality of growth (Y) rather that its quantity that has to do with E.

10. Two empirical facts related to this: 1) the so-called Environmental Kuznets Curve (EKC); 2) the poor environmental performance of poorer and low-growth countries (Less Developed Countries, LDC): the “poverty trap”. The consequent practical implications for the idea itself of sustainable development are opposite to the “limits to growth” perspective: 1) environmental sustainability is a “natural” consequence of higher levels of economic development 2) from the environmental perspective, the most urgent question is not how to achieve a sustainable economic development but how to prevent an unsustainable economic underdevelopment Relation between environmental quality and economic development - 2 • The real world, however, provides contrasting evidence, as usual, on the actual relation between economic growth and the environment: • On the one hand, during the last half century in developed countries emissions per GDP unit of many air pollutants (SO2, NOX, CO, PM10, etc.) did actually decrease. • On the other hand, GDP has grown even more intensively such that, eventually, the total amount of emissions for many of these pollutants did increase.

11. The Environmental Kuznets Curve (EKC) The original Kuznets curve is the inverted U-shape relation between economic development (growth) and economic inequality studied by this economist mostly in ’50s. Questions about its empirical validity and theoretical foundations are still open. POLLUTION POST-INDUSTRIAL ECONOMY • The EKC is the inverted U-shape possibly occurring between economic development (growth) and environmental degradation (pollution). Starting from early ’90s, such relation has been empirically observed for some phenomena mostly concerning air pollution (SO2, NOX, CO, Particulate Matter) and water pollution. • For instance, CO2 emissions in Italy and Sweden (Fonte: Lobianco)

12. Explanations of the EKC The validity of the EKC is still under empirical investigation for several cases of pollution or environmental degradation. Nonetheless, it remains and interesting hypothesis for two major reasons: It rules out both “pollution of poverty” and “pollution of affluence” in favour of a sort “pollution of transition” It is supported by sound theoretical justifications relating pollution with quantity and quality of economic growth (economic growth uses E but also induces a lower pollution intensity (E/Y)). Let’s see the fundamentals: CHANGE IN CONSUMER PREFERENCES: environmental quality can be viewed as a good behaving as a substitute of material (conventional) goods (the latter are produced consuming the former). At the same time, environmental quality behaves as a luxury (or superior) good: its demand shows higher than 1 (and higher than material goods) income elasticity. Therefore, the richer they are the more consumers want to replace material goods with environmental quality. CHANGE IN THE TECHNOLOGY: as seen, economic growth typically occurs with a decreasing per unit use of E due to two major reasons: firstly, technical change; secondly, for the increasing “immateriality” of output (change in sectoral composition) as Y/E is higher for material goods (e.g, steel) than for immaterial goods (e.g, bank services). CHANGE IN INSTITUTIONS: economic growth usually brings about an increasing capacity of formal and informal political, social and economic institutions to pursue and impose a more rational use of environmental resources. LET’S SEE WHAT THEORY SUGGESTS

13. Where do pollution “demand” and “supply” come from? PRODUCTION FUCTION UTILITY FUNCTION (at time t) m = material goods e = pollutant emissions due to production of m m = material goods tec = techn. level (proxied by t) e = pollutant emissions

14. The development path UTILITY MAXIMIZATION under PRODUCTION (technology) CONSTRAINT Here it is, the EKC: Emissions Material goods (GDP)

15. Contrasting effects LATE STAGES OF ECONOMIC DEVELOPMENT: COMPOSITION EFFECT -> income effect (from E to F) prevails on substitution effect (from D to E) EARLY STAGES OF ECONOMIC DEVELOPMENT: SCALE EFFECT -> substitution effect (from A to B) prevails on income effect (from B to C)

16. Poverty (LDC) vs. environment Unfortunately, for many different kinds of environmental degradation the EKC does not seem to hold true. Not only because higher income does not necessarily correspond to higher environmental performance. The problem rather becomes that it is not necessarily true that low income (pre-industrial economies, LDC) corresponds to high environmental performance. On the contrary, several environmental emergencies of the last decades stress the role of poverty as one of the major cause of environmental degradation. It is the “poverty trap” underlying many current global environmental issues: “In LDC the major cause of environmental degradation is poverty and the major cause of poverty is environmental degradation“ • In such cases, poverty and environmental degradation reciprocally reinforce: to escape poverty populations make choices that destroy environmental goods and, so doing, deplete the most important potential resources (the agricultural and natural ones) on which their own development should be based. • Many can be the examples of such perverse mechanisms: • “Land hunger”: deforestation, desertification, loss of biodiversity… • Massive Rural-Urban migration: AIDS/HIV epidemic, water crisis, change of food habits…