Growth and Sustainability in the Twenty-First Century - EKC Hypothesis

The environmental Kuznets curve (EKC) hypothesis posits an inverted U-shaped relationship between economic development and environmental damages.† It states that environmental damage per capita increases in the early stages of economic development as a country transitions away from an agricultural-based economy to an economy with more manufacturing, energy use, transportation network, etc. Eventually, however, damages reach a maximum and then diminishes as a country attains even higher levels of income, allowing it to invest in cleaner production methods. If the evidence supports this hypothesis, it would imply that policies that foster macroeconomic growth will eventually promote a cleaner environment as well. Does this principle really work? The EKC relationship does seem to hold for some pollutants. Figure 7 shows the findings of a study that estimated the relationship between the average particulate matter (PM10) concentration in a country and a country’s per capita income. We see that at very low levels of income the expected PM10 concentration tends to rise quickly as a country develops economically. But the PM10 concentration peaks when a country reaches an average income of around US$1,300 per person. Air pollution levels then fall steadily with further economic advancement. As noted earlier in the module, the World Health Organization has recommended that PM10 levels be below 20μg/m3. On average, countries achieve this standard when income per person rises above US$17,000 per person. Evidence supporting the EKC hypothesis has also been found for municipal solid waste and other air pollutants such as sulfur dioxide and carbon monoxide.39 Figure 7. Environmental Kuznets Curve for Particulate Matter Source: Mazurek, 2011. 39 Ichinose et al., 2015; Georgiev and Mihaylov, 2015. † This hypothesis was not devised by Simon Kuznets but is similar to his hypothesis that inequality first increases, then decreases with growing national wealth. However, the EKC relationship does not appear to hold for all environmental problems. Perhaps most importantly, CO2 emissions show a positive relationship with average income, as shown in Figure 8. A simple statistical test to fit an inverted-U curve through the data in Figure 8 finds that there is no turning point—per-capita CO2 emissions continue to rise as GDP/capita increases. A more sophisticated analysis in 2015 reached a similar conclusion, that “rising income is associated with an increase in [CO2] emissions. No income turning points are found for the observed sample of countries.” Thus, promoting economic growth does not appear to be an effective means to address the issue of global climate change. The relationship between economic growth and the environment is, in reality, more complex than implied by the EKC hypothesis. As a 2014 paper concludes: it would be misleading to follow the policy of polluting first and cleaning later as espoused by proponents of EKC. It does not make much sense to “do nothing” and wait for the magic-wand of economic growth to cure environmental problems. Proactive policies and measures are required to mitigate the problem.40 Figure 8. Relationship between Carbon Dioxide Emissions and GDP per Capita, 2014 Source: World Bank, World Development Indicators database. 5.2 Does Protecting the Environment Harm Employment and Economic Growth? Policies that increase environmental protections are sometimes criticized for causing decreases in employment or harming economic growth. What is the evidence on this subject? 40 Akpan and Abang, 2014, p. 16. Several research studies have explored the relationship between employment and environmental regulation. The overall conclusion is that while increased environmental spending leads to the loss of certain jobs, it creates other jobs. These effects may cancel out or actually result in a net gain of jobs. For example, a 2008 analysis of the U.S. economy tested the notion that environmental protection results in job losses. The study estimated the impact of environmental spending and regulation on employment in various industries and found that: contrary to conventional wisdom, [environmental protection (EP)], economic growth, and jobs creation are complementary and compatible: Investments in EP create jobs and displace jobs, but the net effect on employment is positive.41 A 2009 review of the literature on the relationship between environmental policies and employment reached the conclusion that strong environmental policies will change the distribution of jobs in society but have little effect on the overall level of employment.42 Focused on Europe, the study found that well-designed environmental policies can sometimes result in net job gains. For example, the additional revenue from higher environmental taxes could be used to reduce the taxes on labor, thus reducing the cost of hiring workers and leading to higher overall employment. A similar conclusion was reached by a 2016 analysis which estimated the employment impacts of various potential policies to reduce carbon emissions in the United States. For each policy analyzed, the authors’ model predicted that job losses in “dirty” sectors such as coal mining were essentially offset by job gains in cleaner sectors such as renewable energy. They concluded that the “overall effects on unemployment should not be a substantial factor in the evaluation of environmental policy” because the net effects are likely to be quite small.43 According to a 2012 paper, public investments on clean energy sources in the U.S. create about three times as many jobs as similar spending on fossil fuel energy sources. The reasons are that clean energy sources tend to be more labor intensive, and the money invested is more likely to be spent domestically as opposed to funding imports. Worldwide, renewable energy sources employed nearly 10 million people in 2016—more than one million each in solar photovoltaics, liquid biofuels, and wind energy. More than half of these jobs are in low- and middle-income countries, mainly China and India. Solar and wind technologies have advanced rapidly, making these sources economically competitive with fossil fuels for new power installation.44 Another criticism of environmental protection based on the results of some studies is that environmental regulations reduce GDP growth rates. For example, a comprehensive analysis of the Clean Air Act in the United States estimated that GNP in 1990 was about 1 percent lower than it would have been without the policy. The aggregate macroeconomic loss from the Act over the period 1973–1990 was estimated to be about $1 trillion. Analysis of the economic impact of major environmental regulations in Europe suggests an aggregate economic loss of about 0.2 percent of GDP.45 41 Bezdek, et al., 2008. Rayment, et al., 2009. 43 Hafstead and Williams, 2016. 44 Pollin, 2012; IRENA, 2017; U.S. Energy Information Administration, 2017. 45 Commission of the European Communities, 2004. 42 But these macroeconomic costs must be assessed against the benefits of the regulations. When an estimate of the Clean Air Act benefits was made, it was found that the central estimate of the 1973– 1990 benefits was $22 trillion, or a benefit cost ratio of 22:1. So while there appears to be a slight negative impact of environmental regulation on economic growth as traditionally measured, we need a more complete analysis to determine its effect on social welfare. GDP was never intended to measure social welfare, and economists have developed alternative national accounting approaches to supplement or replace GDP. These alternatives may present a better framework for fully assessing the impacts of environmental regulations on social welfare. 5.3 Economic Perspectives on the Transition to a Sustainable Economy We have just seen that protecting the environment does not necessarily reduce employment and that its economic benefits can significantly outweigh its costs. We now consider a broader question: Is continued macroeconomic growth compatible with a sustainable national or global economy? Some economists studying this topic believe that, at least for the foreseeable future, further economic growth is acceptable or desirable as we transition to a more sustainable economy. Other economists, who believe that we have already exceeded the planet’s carrying capacity, advocate for a transition to a “no growth” economy, perhaps requiring a period of de-growth during that transition. Among those economists favoring “better” growth rather than no growth is Nicholas Stern, whom we discussed above. While Stern believes significant policy changes are required to address climate change, he argues that “...the economic opportunities of the transition to the low or zero carbon economy are real and very attractive: it is a story of sustainable growth.”46 Another proponent of this perspective is the United Nations. The UN’s Green Economy Initiative, launched in 2008, seeks to promote an economy that “results in improved human well-being and social equity, while significantly reducing environmental risks and ecological scarcities.” The Initiative proposed an annual investment of 2 percent of global GDP over 2010–2050 to fund sustainable technologies and practices. The UN developed a macroeconomic model to estimate the short-term and long-term effects of this investment, relative to a business-as-usual (BAU) scenario. Their results found that while in the first few years the additional investment reduced global GDP/capita by about one percent, by 2030 global GDP/ capita would be 2 percent higher in the Green Economy scenario. And by 2050, global GDP/capita would be 14 percent higher as a result of sustainable investments.47 Further, the Green Economy scenario resulted in dramatic reductions in environmental impacts. Relative to the BAU scenario, by 2050 global energy demand is reduced by 40 percent, water demand is reduced by 22 percent, total forested land increases by 21 percent, and the global ecological footprint is reduced by 48 percent. 46 Fankhauser and Stern, 2016, p. 22. UNEP, 2011, https://www.unenvironment.org/explore-topics/green-economy/why-does-greeneconomymatter/what-inclusive-green-economy. 47 Economist Robert Pollin, in his 2015 book Greening the Global Economy, also advocates for an investment of 1.5 percent of global GDP in renewable energy and energy efficiency to fund a transition to a sustainable, low-carbon economy. His analysis concludes that green investments expand employment and economic growth, as jobs in renewable energy and energy efficiency tend to be more labor intensive than jobs in the fossil fuel sector, as shown in Figure 9. In each country, investments in green energy result in higher job creation, yielding 75–135 percent more jobs per dollar than fossil fuel investments. To assist displaced fossil fuel industry workers, Pollin argues for job retraining programs and policies promoting full employment.48 Figure 9. Jobs Generated by Investing One Million Dollars in Clean Energy versus Fossil Fuel Production, Selected Countries Source: Pollin, 2015. Analyses such as Pollin’s book and the UN’s Green Economy Initiative suggest that not only is sustainability compatible with economic growth, green investments can actually increase rates of economic growth. But other economists argue that continual economic growth is incompatible with long-term sustainability. As we saw earlier in the module, economist Herman Daly has noted that indefinite expansion of the macroeconomy within a finite biosphere is physically impossible. Since the 1970s Daly has advocated for a transition to a steady-state economy in which population and the stock of physical capital is held constant. A steady-state economy would not hold human well-being constant, as things such as technology, information, fairness, and wisdom could continue to improve. Also, activities that do not involve resource consumption, and are environmentally neutral or environmentally friendly, could 48 Pollin, 2015. continue to grow. Such activities could include services, arts, communication, and education. But Daly maintains that consumption levels should be kept “sufficient” but not extravagant. After basic needs are met and reasonable levels of consumption achieved, the concept of a steady-state economy implies that economic development should be increasingly oriented toward these kinds of inherently “sustainable” activities. Thus, Daly distinguishes between growth and development—the steady-state economy “develops but does not grow, just as the planet earth, of which it is a subsystem, develops without growing.”49 A similar viewpoint is espoused in Tim Jackson’s book Prosperity Without Growth. Jackson calls for an ecological macroeconomics which maintains economic stability without a reliance on traditional growth. He proposes that three macroeconomic interventions are necessary to transition to a sustainable economy: 1. A structural transition toward service-based activities. Like Daly, Jackson advocates for a shift of economic activity away from resource-intensive goods toward “dematerialized” services such as education and the arts. 2. Investment in ecological assets. Jackson notes that the definition of a “productive” investment would need to change under ecological macroeconomics. Ecological investments may provide lower financial returns, as traditionally measured, but can provide greater social value due to increases in resource efficiency and the enhancement of ecological functions. 3. A working time policy to maintain employment levels. Given that in a no-growth scenario total hours worked would likely fall, Jackson proposes that working hours per week (or per job) decline to prevent unemployment, leaving people more leisure time. Labor productivity could continue to increase due to improvements in technology, potentially further reducing working hours per week.50 Peter Victor, a Canadian economist, has developed a macroeconomic simulation model to explore how a national economy would perform during a transition to a sustainable, low- or zero-growth future. Figure 10 shows Victor’s model applied to the Canadian economy. In this scenario the Canadian government is assumed to introduce a tax on greenhouse gas (GHG) emissions, creating incentives to switch from high GHG energy sources to low-carbon sources, making energy in general more expensive (at least in the short term) and encouraging conservation and efficiency. The revenues from the GHG tax are used to reduce other taxes, so that the net effect on government revenues is zero. The model shows that GDP per capita stabilizes after 2025, and GHG emissions decrease by 22 percent by 2035. Poverty levels as well as unemployment decrease significantly, and fiscal balance is reached, with a steady decrease in the debt to GDP ratio. A shorter working week allows for full employment, with less growth in material consumption but more spending on health care and education. 49 50 Daly, 1973, p. 330. Jackson, 2011. Figure 10. A No-Growth Scenario for the Canadian Economy Source: Adapted from Victor, 2008, p. 182. 6. POLICIES FOR SUSTAINABLE DEVELOPMENT Much of macroeconomic theory and policy is currently oriented toward promoting continuous economic growth. But an over-emphasis on policies that promote growth can result in outcomes that severely degrade natural resources and lead to environmental problems such as global climate change. What kind of policies would be required to promote ecological sustainability, whether defined as weak or strong sustainability? How can these policies be designed such that they also enhance well-being and promote human development? 6.1 Rethinking Employment and Production Designing macroeconomic policies that are compatible with sustainability requires some fundamental rethinking about economic goals. Specifically, what do we want from employment and production? There is no doubt that employment contributes to people’s well-being, and not only as a source of income. People’s satisfaction with their jobs is an important predictor of their overall life satisfaction, while unemployment is a significant cause of family stress and other problems. About one in five suicides are linked to unemployment, and suicide rates increase during recessions.51 Thus, maintaining employment levels is important, but people also benefit from time that they spend away from paid employment, to do unpaid work, including family care, and pursue leisure 51 Unanue et al., 2017;Nordt et al., 2015. activities. As we saw in the previous section, working time policies have been proposed to maintain employment levels, while providing workers with more time for leisure and other activities. Several European countries have instituted labor policies that mandate comparatively short working weeks for most employees. France instituted a maximum 35-hour working week in 2000, and most German workers also have a standard 35-hour working week. In 2018, workers in Germany’s largest labor union won the right to work a 28-hour working week for up to two years.52 Research suggests that policies mandating shorter working weeks are not necessarily effective at reducing unemployment rates. But two positive effects have been identified. First, people working shorter weeks tend to be more productive per hour. Based on a sample of OECD countries, GDP per hour worked declines as the hours worked per worker increases. Second, shorter working weeks tend to be correlated with lower greenhouse gas emissions. According to one study, policies to reduce annual work hours by 0.5 percent per year could mitigate one-quarter to one-half of future global warming.53 Traditional macroeconomic models also assume that more production is always preferable. These models may focus only on the level of output, Y, and say nothing about the composition of output. From a sustainability perspective, however, the composition of output makes a very big difference. Some things that we produce require relatively little use of material and energy inputs. Eating locally-grown produce, taking a bike ride with friends, or engaging in educational and cultural activities, for example, puts little stress on the natural environment. Other activities, such as heating and furnishing a very large house, driving an SUV, or maintaining a perfect lawn using chemical fertilizer, have more negative impacts. Shifting away from producing goods and services that are most damaging to ecological systems and toward producing goods and services that are less destructive—or even environmentally beneficial—could allow an economy to maintain consumption, investment, and employment in a less environmentally damaging way. Rethinking employment and production for a sustainable economy means that traditional macroeconomic indicators, such as the unemployment rate and GDP growth rate, are no longer sufficient. We would want to measure employment quality, not just quantity. The OECD has developed a framework for assessing job quality in a country by considering three dimensions: earnings, labor market security, and the quality of the working environment.54 And of course we would want to adjust GDP to account for resource degradation and pollution. 6.2 Rethinking Economic Incentives Green Taxes Fiscal policy affects economic behavior by setting taxes that discourage certain actions and subsidies that encourage other choices. Taxes have traditionally been placed on income and profits, an approach which is criticized by some economists for creating a disincentive for employment and entrepreneurism, and consequently reduces economic growth. An alternative is to shift 52 Huggler, 2018. Estev.o et al., 2008; Anonymous, 2013; Rosnick, 2013. http://www.oecd.org/statistics/jobquality.htm. 54 OECD, Job Quality, http://www.oecd.org/statistics/job-quality.htm. 53 taxation away from income and profits in favor of higher taxes on negative externalities such as pollution. “Green” taxes make it more expensive to undertake activities that deplete important natural resources or contribute to environmental degradation. They discourage energy- and materialintensive economic activities, while favoring the provision of services and labor-intensive industries. One example of a green tax, as discussed above, is a tax on carbon emissions, favoring renewables and efficiency over carbon-based fuels. All countries have implemented environmentally-based taxes to some extent. As shown in Figure 11, environmental taxes in industrial countries can range from less than 3 percent of total tax revenues (in the United States) to around 10 percent. A shift toward higher reliance on environmental taxes does not seem to be occurring, with the OECD average remaining around 6 percent of all tax revenues since the mid-1990s.55 Figure 11. Environmental Taxes, as a Percent of Total Tax Revenues, Selected Countries, 2015 Source: OECD, OECD.Stat, “Environmentally related tax revenue.” Green taxes are strongly supported by economic theory as a means of internalizing negative externalities. When a negative externality such as pollution exists, an unregulated market will result in an inefficient allocation. Because all taxes, in addition to raising revenue, discourage the “taxed” activity, it is economically and socially desirable to discourage “bads” such as environmental pollution and natural resource depletion by placing taxes on them, rather than on positive economic activities like investment and the earning of income. 55 OECD Statistics Database (OECD.Stat), Environmentally related tax revenue. Two common objections to green taxes frequently arise. First, it is likely that green taxes would fall disproportionately on lower-income households. But as noted earlier with respect to carbon taxes, a rebate or credit to these households could be implemented to avoid making green taxes regressive. The other criticism is that green taxes are politically unpopular—no one wants higher taxes. Increases in green taxes can be offset, however, by reductions in other taxes (such as income taxes) so that the tax burden on a typical household remains unchanged. Also, households and businesses would have the option to lower the amount of green taxes they pay by undertaking energy conservation measures and other environmentally friendly practices, which is not the case with income or business taxes. Eliminating Damaging Subsidies While subsidies for renewable energy can encourage a transition to a more sustainable economy, many current subsidies actually increase environmental damages. Agricultural and energy subsidies that encourage the overuse of energy, fertilizer, pesticides, and irrigation water could be reduced or eliminated. This would reduce government expenditures, and the money saved could be used to lower taxes or to promote more sustainable agricultural systems that rely on the recycling of nutrients, crop diversification, the use of natural pest controls, and minimizing the use of artificial chemicals and fertilizer. Such systems also tend to be more labor-intensive, so they also have the potential to boost employment. The fossil fuel industry receives the largest share of perverse subsidies. According to a 2017 journal article, fossil fuel subsidies amount to about 6.5 percent of global GDP. This not only includes direct payments by governments to fossil fuel companies, but also the implicit subsidy when negative externalities are not included in market prices. This mispricing of goods and services effectively permits producers to transfer the costs of environmental damage onto society. A broader estimate of the global environmental externalities imposed on society from economic activity is about 11 percent of global GDP. These damages are expected to increase to 18 percent of world GDP in 2050.56 6.3 Green Keynesianism Keynesian economics focuses on using monetary and fiscal policy to spur aggregate demand during economic downturns. In response to the global financial crisis of 2007–2008, some economists proposed implementing Keynesian macroeconomic policies to both promote an economic recovery and meet sustainability objectives. In fact, stimulus packages passed in several countries in response to the crisis included significant public investment in green projects. For example, over 10 percent of the 2009 stimulus package passed in the U.S. (the American Recovery and Reinvestment Act) was directed toward investment in energy efficiency, renewable energy, and other green spending. Green stimulus government spending in China was even higher, at over US$200 billion.57 56 57 Coady et al., 2017; UNEP Finance Initiative and PRI, 2011. Tienhaara, 2018; http://www.wri.org/resources/charts-graphs/green-stimulus-spending-country. Some critics have argued that there is a contradiction between the “green Keynesian” goals of economic growth and environmental protection.58 But it is possible to direct policies towards different kinds of growth. Instead of just thinking of consumption (C), investment (I), and government spending (G), we can divide each of these terms into environmentally harmful and environmentally positive activities. Thus, it should be possible to achieve growth in employment and well-being while reducing throughput—the flow of inputs into the economy and outputs of wastes and pollution. According to one “green Keynesian” analysis: we can distinguish between those macroeconomic aggregates that should be strictly limited—resource-intensive consumption and investment, and energy-intensive infrastructure—and those that can expand over time without negative environmental consequences. The latter would include large areas of health, education, cultural activity, and resource- and energy-conserving investment ... there is plenty of scope for growth in economic activity concentrated in these categories, without growth in resource throughput, and with a significant decline in the most damaging throughput, that of carbon-intensive fuels.59 7. CONCLUDING THOUGHTS Throughout the twentieth century, the main objective of macroeconomics was steady, strong economic growth. Considering the social and environmental challenges that we face in the twentyfirst century, macroeconomics will need to adapt to new realities. Employment, price stability, and GDP growth will continue to be issues of great importance—not as ends in themselves, however, but as the means to the broader goals of human development and sustainability. Keeping ultimate well-being goals in mind, macroeconomics must look beyond the experience of the past and ask new questions. A fundamental question confronting macroeconomics in the twenty-first century is how the majority of people in the world, currently at relatively low standards of living, can improve their well-being. The issues of “human development” involve a combination of traditional economic growth and new approaches that are more oriented toward dealing with problems of poverty, inequality, and ecological sustainability. Economic analysis needs to take into account the need for technologies that can provide energy, food, and other materials for human consumption in ways that are ecologically sound, and that help to remedy past damages. The transition to a more sustainable economy will have economic costs, but also significant benefits, such as increased employment and improved quality of life. If the true goal of economics is to enhance well-being, then we need to realize that the economic goals and policies of the future may differ significantly from those of the past. This was recognized by John Maynard Keynes nearly a century ago. Even during the Great Depression in the 1930s, Keynes looked into the future and imagined a world of relative affluence, where humanity’s 58 59 Blackwater, 2012. Harris, 2013. “economic problem may be solved,” creating little need for traditional economics, and where people will instead be able to focus on how to live “wisely and agreeably and well.” (See Box 3.) A macroeconomics of sustainability is possible. Policies are available to address all the major environmental problems discussed in this module. These will need to be combined with our earlier analyses of issues concerning national income, fiscal and monetary policy, unemployment and inflation, and economic development. This effort can generate a new macroeconomics capable of responding to the challenges of our current era. BOX 3: ECONOMIC POSSIBILITIES FOR OUR GRANDCHILDREN Looking beyond the dire conditions during the Great Depression, John Maynard Keynes imagined what the world, and economics, might be like 100 years into the future (in 2030). Considering what would be the “economic possibilities for our grandchildren”, Keynes’ main conclusion was that as people’s needs and goals changed with further affluence, so should economics. Writing in 1930, Keynes suggested that: a point may soon be reached, much sooner perhaps than we are all of us aware of, when [basic] needs are satisfied in the sense that we prefer to devote our further energies to noneconomic purposes.... I draw the conclusion that, assuming no important wars and no important increase in population, the economic problem may be solved, or be at least within sight of solution, within a hundred years. This means that the economic problem is not— if we look into the future—the permanent problem of the human race. Thus, for the first time since his creation man will be faced with his real, his permanent problem— how to use his freedom from pressing economic cares, how to occupy the leisure, which science and compound interest will have won for him, to live wisely and agreeably and well. When the accumulation of wealth is no longer of high social importance, there will be great changes in the code of morals.... The love of money as a possession—as distinguished from the love of money as a means to the enjoyments and realities of life—will be recognized for what it is, a somewhat disgusting morbidity, one of those semi-criminal, semi-pathological propensities which one hands over with a shudder to the specialists in mental disease. All kinds of social customs and economic practices, affecting the distribution of wealth and of economic rewards and penalties, which we now maintain at all costs, however distasteful and unjust they may be in themselves, because they are tremendously useful in promoting the accumulation of capital, we shall then be free, at last, to discard. Of course there will still be many people with intense, unsatisfied purposiveness who will blindly pursue wealth—unless they can find some plausible substitute. But the rest of us will no longer be under any obligation to applaud and encourage them. Source: Keynes, 2009 (original publication 1930). KEY TERMS AND CONCEPTS ecological footprint: a measure of the human impact on the environment, measured as the land area required to supply a society’s resources and assimilate its wastes and pollution environmental Kuznets curve (EKC) hypothesis: the theory that as a country develops economically environmental damages per capita initially increase, then peak and eventually decrease non-renewable resources: resources that do not regenerate through natural processes, at least on a human time scale, such as oil, coal, and mineral ores renewable resources: resources that are regenerated over time through natural and biological processes, such as forests, fisheries, and freshwater social cost of carbon: a monetary estimate of the discounted long-term damages from emitting a ton of CO2 in a given year social discount rate: a discount rate that reflects social rather than market valuation of future costs and benefits; usually lower than the market discount rate steady-state economy: an economy in which population and the stock of physical capital is held constant. A steady-state economy would not hold human well-being constant, as things such as technology, information, fairness, and wisdom could continue to improve. strong sustainability: an analytical perspective suggesting that natural capital depreciation is justified only if it is compensated for with adequate restoration of other natural capital throughput: the flow of raw materials and energy through the economy, leading to outputs of waste weak sustainability: an analytical perspective suggesting that natural capital depreciation is justified as long as it is compensated for with adequate increases in other types of capital