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2 Environment-growth interactions: theory & evidence

1. The Environmental Kuznets Curve2. Standard model of resource allocation, pro

duction, trade and welfare3. An open economy with pollution4. Empirical EKC studies5. Conclusions and discussion6. Appendix: Measuring pollution and econo

mic 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

CB

Dirty good

zA

zC

zB

zS

z=φ1(θ)x

z=φ2(θ)x

Cleangood

pT

pW

Source: Adapted from Antweiler et al. 2001

Com position

Scale Techniθue

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

Com position

Scale Techniθue

Pollution

D

zC

zEzD

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 studiesMost general model: yit = ai + ∑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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