Total factor productivity and the environmental Kuznets curve☆
Introduction
This paper investigates how differences in total factor productivity (TFP) affect environmental quality in different countries. We develop a theoretical model where different TFPs produce a U-shaped relationship between environmental quality and income in a cross-section of countries, even if the path of environmental quality to its steady-state value is monotonic in individual countries. This relationship is implied by the environmental Kuznets curve (EKC), an inverted U-shaped relationship between pollution and income.1 We conduct the analysis by performing comparative statics in the Pareto optimal steady-state of a dynamic economy where different TFPs are considered.
The EKC is often interpreted as a by-product of economic growth, implying that the decline and subsequent recovery of environmental quality is a matter of time reflecting the natural path of economic development. For example, Grossman and Krueger [12, p.372] state that “(...) air and water quality appear to benefit from economic growth once some critical level of income has been reached.” In a similar empirical paper, Selden and Song [22, p.147] write that “(...) it is reasonable to expect that economies would pass through `stages of development', in which at least some aspects of environmental quality first deteriorate and then improve.” However, since time-series data on pollution and environmental quality are generally short and variable in quality, evidence on the EKC relies heavily on cross-sectional observations. The use of cross-sectional data raises the question of whether country-specific characteristics matter when explaining the EKC. If this is the case, as this paper suggests, the time-series interpretation bears an extra burden of proof.
In addition to neglecting the importance of country-specific characteristics in the explanation of the EKC, a potential estimation problem arises as most empirical studies on development and the environment use panel data. With panel data analysis, the effect of country-specific characteristics can be explored by estimating fixed or random effects models. However, when country-specific characteristics are correlated with income, the estimates of the relationship between growth and the environment are subject to bias and inconsistency [13]. This paper provides theoretical support for these qualifications by considering the environmental implications of different TFPs in different countries.
Prescott [20] argues that neoclassical growth models fail to account for the great disparity in incomes across countries unless we are willing to consider TFP differences as a key determinant. According to Parente and Prescott [18], [19], although knowledge and technologies are fairly easily transferable, especially given the widespread presence of multinational firms around the world, institutions determine how costly it is for firms within a country to adopt new technologies.2 At the macroeconomic level, these institutions map into the nation's TFP.3
These insights about the importance of TFPs in economic growth have yet to penetrate work on the EKC. Following the initial studies that observed the EKC in panel data, several scholars contributed to a theoretical understanding of the phenomenon, most often focusing on the dynamics of pollution, most notably John and Pecchenino [14], Jones and Manuelli [15], Selden and Song [23], and Stokey [25]. Copeland and Taylor [7], [8] have broadly analyzed the multiple sources of economic growth and their effects on the EKC. Their work motivates our analysis. They argue that, because income and pollution are both endogenous, there is no reason to expect a stable EKC if different countries grow differently. We show, in particular, that there is no reason to expect the cross-section and time-series relations between income and pollution to be the same, because the sources of differences across countries in income are different than the sources of differences in income within a country over time.4
Our analysis addresses whether the EKC can result from comparative statics in the steady-state of a dynamic economy. The advantage of focusing on the steady-state of a dynamic economy rather than a simpler static model is that we can put the cross-sectional EKC in stark relief by analyzing economies whose environmental quality exhibits a monotonic path to the steady state. Andreoni and Levinson [1], Stokey [25], and López [17] are the leading studies to have also used comparative statics to analyze the effects of income growth on the environment. To generate the EKC, their analysis depend, respectively, on increasing returns to pollution abatement, a tradeoff between productivity and pollution intensity of production techniques,5 and either non-homotheticity of preferences or changes in the internalization of resource stock values. Our formulation differs most sharply from that in Andreoni and Levinson in the characterization of environmental protection efforts. In our case, environmental improvement is a function of not only pollution abatement and prevention effort, but also expenditures that increase the stock of environmental quality. These include investments in the creation of natural reserves, recovery of ecosystems, species reintroduction and the like.
The study by López [17] is closest in spirit to ours. López considers the implications of economic growth for environmental quality when income is fully spent on consumption.6 This paper takes a different approach from that in López [17]. First, we allow income to be spent on capital accumulation and environmental protection, as well as consumption. Second, we do not restrict preferences to be non-homothetic. Finally, rather than modeling institutions as changing over time to accomplish greater internalization of resource values within a country, we take institutions as given within but varying across countries. In this way, we show how an EKC can emerge across countries even though it need not characterize the growth path of a single economy.
Section snippets
Model
Consider a dynamic economy with environmental quality treated as a stock variable and a public good. Examples of environmental phenomena best characterized as stocks include depletion of the stratospheric ozone layer, the greenhouse effect, deforestation, and biodiversity loss. Focusing on environmental stocks is less restrictive than it may appear at first because pollution flows can pose long-lasting damages to the quality of the environment. Therefore, we focus on the state of the
Numerical analysis
This section reports numerical analyses of the model, with attention to the comparative statics of the steady-state. The numerical results are based on the following functional forms:9
Conclusion
This paper is motivated by the contrast between the rhetoric and the empirical evidence behind the environmental Kuznets curve conjecture. The rhetoric emphasizes economic development and environmental trends over time while the evidence is largely cross-sectional. We establish the link between total factor productivity and the environmental Kuznets curve in an economy where individuals value consumption and the public good environmental quality, pollution results from capital and degrades the
Acknowledgments
The authors thank Stephen Parente, Dan Bernhardt and Jan Brueckner for comments and suggestions on previous versions of this paper. We thank Co-Editor Brian Copeland and two anonymous referees for valuable suggestions. Any remaining errors and omissions are our sole responsibility.
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This material is based upon work supported in part by the Brazilian Conselho Nacional de Desenvolvimento Científico e Tecnológico under Award No. 200121/95 (Chimeli), Fundação de Desenvolvimento da Pesquisa (Chimeli), the US National Science Foundation and US Environmental Protection Agency Water and Watersheds Program under Award No. BCS 00-03208 (Braden), and project 0305 of the Illinois Agricultural Experiment Station and Cooperative States Research, Education, and Extension Service, US Department of Agriculture under Project No. 0305 (Braden). Any opinions, findings, and conclusions or recommendations expressed in this publication are those of the authors and do not necessarily reflect the views of the supporting agencies.