Economic Growth and the Environment

Will the world be able to sustain economic growth indefinitely without running into resource constraints or despoiling the environment beyond repair? What is the relationship between a steady increase in incomes and environmental quality? Are there trade-offs between the goals of achieving high and sustainable rates of economic growth and attaining high standards of environmental quality. For some social and physical scientists, growing economic activity (production and consumption) requires larger inputs of energy and material, and generates larger quantities of waste byproducts. Increased extraction of natural resources, accumulation of waste, and concentration of pollutants would overwhelm the carrying capacity of the biosphere and result in the degradation of environmental quality and a decline in human welfare, despite rising incomes. Furthermore, it is argued that degradation of the resource base would eventually put economic activity itself at risk. To save the environment and even economic activity from itself, economic growth must cease and the world must make a transition to a steady-state economy.

At the other extreme, are those who argue that the fastest road to environmental improvement is along the path of economic growth: with higher incomes comes increased demand for goods and services that are less material-intensive, as well as demand for improved environmental quality that leads to the adoption of environmental protection measures. The strong correlation between incomes, and the extent to which environmental protection measures are adopted, demonstrates that in the longer run, the surest way to improve your environment is to become rich, Some went as far as claiming that environmental regulation, by reducing economic growth, may actually reduce environmental quality.

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As agriculture and resource extraction intensify and industrialization takes off, both resource depletion and waste generation accelerate. At higher levels of development, structural change towards information-based industries and services, more efficient technologies, and increased demand for environmental quality result in leveling-off and a steady decline of environmental degradation (Panayotou 1993), as seen in the Figure 1 below:

The issue of whether environmental degradation (a) increases monotonically, (b) decreases monotonically, or (c) first increases and then declines along a country’s development path, has critical implications for policy. A monotonic increase of environmental degradation with economic growth calls for strict environmental regulations and even limits on economic growth to ensure a sustainable scale of economic activity within the ecological life-support system (Arrow et al. 1995) A monotonic decrease of environmental degradation along a country’s development path suggests that policies that accelerate economic growth lead also to rapid environmental improvements and no explicit environmental policies are needed; indeed, they may be counterproductive if they slow down economic growth and thereby delay environmental improvement.

Finally, if the Environmental Kuznets Curve hypothesis is supported by evidence, development policies have the potential of being environmentally benign over the long run, (at high incomes), but they are also capable of significant environmental damage in the short-to-medium run (at low-to-medium-level incomes). In this case, several issues arise: (1) at what level of per capita income is the turning point? (2) How much damage would have taken place, and how can they be avoided? (3) Would any ecological thresholds be violated and irreversible damages take place before environmental degradation turns down, and how can they be avoided? (4) Is environmental improvement at higher income levels automatic, or does it require conscious institutional and policy reforms? and (5) how to accelerate the development process so that developing economies and economies in transition can experience the same improved economic and environmental conditions enjoyed by developed market economies?

Policy Response

In the OECD countries we observe a strong decoupling of emissions of local air pollutants from economic growth. OECD countries have achieved a strong decoupling between energy use and economic growth over the past 20 years, with the economy growing by 17% between 1980 and 1998 and energy use falling by the about the same percentage. Water and resource use continued to grow but at a rate slower than GDP growth reflecting a weak decoupling of the two. Thus decoupling of emissions in OECD and generally the developed ECE countries has been accomplished through a combination of technological change and a strong environmental policy. The latter consisting of “greening” of fiscal policy, removing subsidies to environmentally harmful activities and the use of economic instruments to internalise environmental cost.

A number of EU policy initiatives, such as the Broad Economic Policy Guidelines 2001, among others have promoted a gradual but steady and credible change in the level and structure of the tax rates until external costs are fully reflected in prices, to cope with most of the fundamental structural problem in all developed countries, the unsustainable patterns of production and consumption. In the energy markets these guidelines aim to uses taxes and other market-based instruments to rebalance prices in favour of reusable energy sources and technologies. Other EU initiatives in this direction are the European Climate Change Programme (ECCP), the directive establishing an EU framework for emissions trading, and the Integrated Product Policy (IPP) all of which aim at realigning price relations and stimulating investments in new technologies that promote sustainable development. Member states are encouraged to improve market functioning by addressing market failures such as externalities through “increased use of market-based systems in pursuit of environmental objectives as they provide flexibility to industry to reduce pollution in a cost effective way, as well as encourage technological innovations”. Economic instruments such as gradual but steady and credible change in the level and structure of tax rates until external costs are fully reflected in prices are promoted as the most efficient means of decoupling economic growth from pollution, as they alter price relations and thereby also drive changes in technology and consumer behaviour (preference) that lie behind the growth-environment relationship. As exemplified by the energy and transport sectors, the EU decoupling policy consists of demand management through full-cost pricing and development of more environmentally friendly alternatives by promoting technological innovations.

Since 1990 all economies in transition have made efforts to restructure their energy and transport sectors along market principles and to raise energy prices closer to economic and international levels. However because of the political sensitivity of energy pricing and the lagging reforms in many transition economies a gap of 20-85% continues to persist between energy prices in economies in transition. For example electricity prices for households in Eastern Europe are only 50 percent of those of the European Union; for industrial consumers, electricity prices are closer to their economic and international levels being 20% lower than those of the EU. The United Nations Economic Commission for Europe has repeatedly called upon its members to raise the prices of various energy sources to their full economic costs and adapt economic instruments to internalise the costs to human health and the environment associated with energy production and consumption. The aim is to decouple emissions from energy use and energy use from economic growth.

Despite significant progress towards sustainable development developed countries are still experiencing unsustainable consumption patterns as evidenced by the continued growth of municipal waste and CO² emissions. As transition economies begin to recover and grow again their emissions and resource use are also growing though less than proportionately. Their GDP energy-intensity, though declining, continues to be several times that of the developed countries while their consumption patterns are tracing the same path as that of their developed counterparts. Further decoupling of growth and environment and progress towards sustainable development calls for action on many fronts by both groups of countries as well as cooperation between them especially in technology transfer:

1. Use of an effective mix of economic instruments such as taxes, charges and tradable permits to correct market and policy failures and to internalise environmental and social costs and induce changes in the composition of consumption and production.
2. Improvement in resource use efficiency and “dematerialization” of the economy
3. Change in the content of economies growth and this involves adjustments costs which tend to be greater the faster is the rate of change in relative prices; in particular those who lose need to be compensated by those who benefit
4. Introduction of specific policies to preserve the living standards of those directly affected by the required adjustment and to avoid unemployment and social disruption; issues of inequality and social exclusion must be addressed.