The Case for Economic Growth

By Eric Crampton 16/03/2015 14


We released the piece at this year’s New Zealand Initiative annual retreat Thursday night in Auckland, with Finance Minister Bill English launching the report and discussing some myths about economic growth. 

An excerpt from our essay:

3.1 GROWTH AND THE ENVIRONMENT: RICHER AND CLEANER 

For most pollutants, it got worse before it got better. 

Before the Industrial Revolution, the environment was far from pristine. Rivers were used as sewers. Indoor air pollution was particularly bad. Chimneys were not always particularly efficient, and open fires made for very smoky interiors. Rather than find a time machine, we can look to Tibetan nomadic tribes who use yak dung as winter fuel. Traditional cookstoves there make indoor air a health hazard and an underappreciated source of black carbon, which contributes to global warming.43 Early industrialisation made things worse: the outdoor air became smokier and rivers bore more sewage and waste to the sea. Economic growth brought greater prosperity but worse environmental conditions – especially in the cities. London’s pea-soup fogs became legendary but were not fantasy. Coal fires within the city, combined with industrial smoke, made for deadly conditions. 

Poor conditions were not limited to London. The New York Times of 9 December 1900 quotes Dr A.R. Edwards as being able to discern Chicago residents from those in the countryside, in post-mortem examination, by the condition of the lungs: “To lay the hand across the new-cut surface … of the lung would blacken the palm almost as black as to put it wet in a pan of soot”.44 

You can still see similar conditions today – not in London or Chicago or Pittsburg but in Beijing and China’s industrial cities. Historian Stephen Mihm draws strong parallels between the current industrial cities in China and the Western cities of the early- to mid-twentieth century.45 

This first-worse-then-better U-shaped relationship between economic growth and environmental quality is called the Environmental Kuznets Curve.

The curve was first described in 1991 by economists Gene Grossman and Alan Krueger, who wanted to test whether free trade between Mexico and the United States was likely to worsen or improve environmental quality in Mexico.46 Trade opponents argued that American industrialists would set up factories in Mexico to take advantage of less restrictive environmental regulations, exporting pollution. Grossman and Krueger argued instead that free trade would increase incomes in Mexico and consequently reduce pollution. 

Grossman and Krueger found that when per capita GDP reached US$4,000– $5,000 in 1985 dollars, or about US$10,000 today, sulphur dioxide and smoke levels started improving with economic growth rather than worsening. Mexican per capita GDP rose in real terms from about US$4,000 in 1992 to about US$10,000 in 2013. In 2010, a Washington Post headline announced: ‘Mexico City Drastically Reduced Air Pollutants Since 1990s’.47 If anything, Grossman and Krueger were too pessimistic about how long it would take for outcomes to improve. 

For pollutants with strong local effects, like nitrogen oxide, sulphur dioxide, and particulate matter like fine soot, the relationship holds well. For pollutants whose effects are less noticeable in the area generating the pollution, the effect is weaker.48
Environmental economist Susmita Dasgupta and co-authors reviewed the overall performance of the Environmental Kuznets Curve literature and, with some reservations, ultimately sided with the optimists.49 Dasgupta, et al. argued that the most plausible long-run forecast is for improved environmental quality in both high- and low-income economies. Economic liberalisation, improved information, better technology, and more stringent and cost-effective approaches to regulating pollution in developing countries have begun to ‘flatten’ the Environmental Kuznets Curve.

In short, economic growth now brings improved environmental quality earlier in a country’s development than it did when pollution control technologies were first being developed. 

It is easy to see how the Environmental Kuznets Curve effect works, and when it does not. When a city’s air is unbreathable, and when the city’s residents are rich enough to switch from coal heating, government regulation becomes an easy and effective way to solve the problem. Any one household switching away from coal heating to, say, gas heating, would experience all the costs of the switch, but because the problem is so vastly bigger than that one household, it would not notice any improvement in outdoor air quality. Things like the deadly London fog can spark change through policy – when city residents can afford alternatives. Economic growth both makes alternatives cheaper, through improved technology and widespread use, and encourages households rich enough to afford to do better. By contrast, a town with high greenhouse gas emissions is not necessarily a worse place to live than one with lower emissions: you cannot smell or taste the difference. Solutions then require national or international agreements rather than local action: any town, city or small nation imposing strong local restrictions would be in the same position as a London household choosing not to burn coal in the early 1950s, bearing all the local costs but not reaping any of the benefits. 

London’s smog led to a ban on coal-based heating. If Chinese carbon dioxide emissions drop with the Chinese government’s promise to reduce emissions from 2030 onwards,50 it will more likely be due to pressure on the government to deal with the effects of urban coal-burning than from any general commitment to climate change.
On the whole, then, the evidence on the Environmental Kuznets Curve is mixed. While economic growth reduces ‘local’ pollution, it does not mitigate pollution felt farther afield. 

And, as economist Bruce Yandle explains, strong property rights help make the link from economic growth to improved environmental quality.51 Strong property rights both increase income and provide ways for those affected by pollution to sue polluters for the damages caused. Yandle cites research showing that economic growth turns more quickly into improved environmental outcomes in countries with strong property rights. Would you rather be downstream from a factory making a mess of the river in New Zealand, or from a state-owned enterprise in China doing the same? 

The link between economic growth and environmental quality depends on strong property rights and a political system that lets individuals ‘buy’ better environmental quality as they get richer and can afford it. It is entirely right to worry about the effects of environmental regulation on economic growth, as it is possible to spend too much on anything – and doubly so when the government is doing the buying on our behalf. But the right amount of environmental quality does go up as people get richer and can afford it, both in their private decisions and policy preferences. 

The ongoing risk is in striking the right balance. Consider climate change and economic growth. While richer countries get a lot more economic output for every tonne of carbon dioxide released into the atmosphere, greenhouse gas emissions in total show little sign of reducing with economic growth. Or, at least, the world has not yet seen income levels at which the curve bends downward. Reducing greenhouse gas emissions may pass cost-benefit analyses, especially where it is viewed as buying insurance against the kinds of outcomes that, while unlikely, would be very harmful.52 Such reductions will come at a cost for economic growth. 

Substantial greenhouse gas abatement may be worth that cost, but it is critically important that we weigh the case fully. Wealth provides us a general purpose ability to deal with harmful outcomes. Curbing economic growth to reduce global warming necessarily leaves the world more vulnerable to other risks not associated with greenhouse gas emissions. 

We can think about it this way. Imagine you could either buy a house insurance policy that gives less-than-full protection against a range of threats such as fire, earthquake, typhoon, tornado, flood or landslide, or you could buy an insurance policy that makes sure you never suffer any damage from flooding but does not help you in case of anything else. Do you feel lucky?

I hope you enjoy it.


14 Responses to “The Case for Economic Growth”

  • “The link between economic growth and environmental quality depends on strong property rights and a political system that lets individuals ‘buy’ better environmental quality as they get richer and can afford it…. Would you rather be downstream from a factory making a mess of the river in New Zealand, or from a state-owned enterprise in China doing the same?”

    Which begs the question why, for example, is the Tarawera River still a highly polluted toxic wasteflow from Kawarau’s paper mill? The answer of course being that the property rights the mill owners have bought (or, more correctly, extorted) ursurp the property rights of the downstream river users.

    http://en.wikipedia.org/wiki/Tarawera_River

    And a “rebalanced” RMA means this will likely be a situation more, not less, prevalent.

    • Only thing I know about the Tarawera River comes from your link; your link says that the water quality there has improved. I don’t know whether there was any tightening of environmental conditions on the latest consent, but I’d expect that the next one has a better chance of being tighter if New Zealand’s a richer place when that time comes.

  • Its debatable that the river’s water quality has improved because of economic growth – in part the water quality will probably have improved because production has reduced due to poor economic returns for pulp and paper…

    Since the last consent was for 25 years, the reality is that the consent is running through to the effective end of life of the plant any environmental win after that is likely to by Pyrrhic.

    So, property rights are all well and good, but where the rights of a business are in conflict with moral (but not legally recognised) rights of individuals and small groups, guess who is going to come out better off?

    I suspect at this point we move to where this quote becomes relevant “While economic growth reduces ‘local’ pollution, it does not mitigate pollution felt farther afield.” Except that, the “local” is North America where many pulp and paper mills have closed partly due to strict environmental requirements, and “far afield” is our back yard.

    There are therefore very good reasons that local societies shouldn’t have to wait for a miracle of economic improvement to bring environmental wellbeing. If a business cannot, over a 60 year run, afford to correct or eliminate the damage it causes, surely its reasonable to force that business to change its model or kill it off. Anything else is a form of corporate welfare.

  • Eric I think you present a one sided and self serving view of history here. Certainly, as scientific knowledge grew, engineering practice improved, civil society became more effective and policy makers became more responsive, society made better choices. To conclude that economic growth is the single most important factor is not my conclusion from the history.

    Not only that, certainly when we introduce Environmental Kuznets Curves the example given is coal fire air pollution but generally the discussion goes on to say that the analysis is not so simple in practice and that other types of pollution don’t support the model. The example usually given is solid waste which goes up with economic growth (affluence, consumption) and not a sign of a downward trend has been found to date. In addition, Aston is right, we need to take care with cases where the environmental impact is simply shifted off shore. My example of this would be mining rare earth elements, not causing environmental harm in USA but certainly is in China.

    Then the note moves onto climate change, taking the view that we (and policy makers) must assess all factors (not just the economics). This off course has already been done. The third IPCC working group 2014, concluded that the costs of mitigating and abating climate change was acceptable if we begin now but that the risks and costs increase markedly if we delay. Better than that, last year the Global Commission on the Economy and Climate published their report Better Growth Better Climate. This group is a UN led group of economists and policymakers looking a growth and climate change. (Nick Stern is one lead author). That group concluded that moving to a reduced carbon economy represented an opportunity. Your comments on a broad as opposed to specific insurance are mischievous. Moving forward on climate change does address many of the other challenges we face.

    That leads to my final comments. No single factor approach will lead New Zealand forward, certainly not focusing primarily on economic growth to the detriment of environmental and social factors. Policy makers are more effective when they balance these in their decision making. Economists are only one group informing decision making.

    What is more, (paraphrasing Peter Drucker) environmental and social challenges are opportunities for innovators and business people. My concern with the “she’ll be right attitude” you express is that NZ is missing opportunities, quite at odds with your intentions.

    • Maurice,

      I don’t think we’re really that far apart here. In section 3.1 of the report, we wrote, “It is easy to see how the Environmental Kuznets Curve effect works, and when it does not.” And then we listed the areas where growth hasn’t yet reduced pollution. I didn’t mention solid waste because it just doesn’t seem to be any kind of substantive environmental problem. Dig a hole, line it properly, capture any methane, charge people to dump in it, and all’s well.

      On climate change, I’ll make two points. First, unless the big emitters are onside for a carbon abatement regime, there’s little point in New Zealand’s going that alone – local abatement would be too small relative to the scale of the problem. Like, if NZ stopped emitting entirely, you might delay the world’s reaching any given level of CO2 by maybe a couple of days over the century. In that case, investments in ag biotech to reduce methane emissions might be a better bet – a small chance of making a real difference versus a good chance of making too little difference to matter. Second, on Stern’s work – I just don’t buy it. When he ran his cost-benefit assessment, he threw a thumb on the scales in choice of discount rate and coefficient of inequality aversion to ensure that things looked cost-effective. See Nordhaus’s critique. I do buy the insurance arguments, like Weitzman’s, but with the caveat that there are lots of things against which we might insure. You think it’s mischievous because warming can make lots of other problems worse – I certainly agree that warming makes other problems worse, but so does a house fire (as per my example).

      I think it is worth spending *some* amount on abatement. I think, in NZ, in the absence of a global agreement, NZ does better in ag tech investment where it precommits to free distribution without patent of all resulting abatement-tech.

      Finally, you might re-read 3.1. “The link between economic growth and environmental quality depends on strong property rights and a political system that lets individuals ‘buy’ better environmental quality as they get richer and can afford it. It is entirely right to worry about the effects of environmental regulation on economic growth, as it is possible to spend too much on anything – and doubly so when the government is doing the buying on your behalf. But the right amount of environmental quality does go up as people get richer and can afford it, both in their private decisions and policy preferences.”

      Where in there are you reading “focus on economic growth to the detriment of environmental and social factors”?

  • The issue of the gross scale on NZ’s carbon emissions is a real one and the point you make is valid to the extent you make it Eric.

    However, it is difficult to advocate for policies that you are not prepared to practice yourself. On that basis, we should be taking all reasonable actions to reduce our carbon outputs to give credibility to any pressure (such that we can exert…) we can put on large emitters.

    We have a history of this approach in both nuclear disarmament and economic reform, having led (at great national cost) from a position of principled policy application at home.

    To answer for Maurice – I think the bit where you state that “individuals (can) ‘buy’ better environmental quality as they get richer and can afford it.” implies that the economic outcome precedes the environmental and additionally that the environmental improvement (or more correctly the environmental remediation) is not only predicated on economic growth, but is optional – its allowed for, but is not a certainty.

    Its interesting to note that you present this as a choice by an individual when, largely, environment in the big E form is a societal good. How does that reconcile?

    • Yes. Being rich enough to afford something nice is a prerequisite for buying something nice. Wealth lets us afford to purchase better environmental quality both directly in our own consumer choices and indirectly where parties compete for votes and voters have greater demands for environmental quality when other problems are less pressing.

  • It is a sad story. I give examples of two international reports making the point that climate change is an opportunity for innovation and growth and the reply is two excuses (no matter how “realistic”). I think we need more STEAM entrepreneurs willing to explore and act to develop opportunities.

  • A person who destroys their health chasing wealth is rightly considered a fool. If a country does it, there will be an economist cheering them on.

    We need a balanced growth, one that balances: economic, social and environmental factors; just like an individual needs to balance: work, family and exercise.

  • “Yes. Being rich enough to afford something nice is a prerequisite for buying something nice. Wealth lets us afford to purchase better environmental quality both directly in our own consumer choices and indirectly where parties compete for votes and voters have greater demands for environmental quality when other problems are less pressing.”

    Newsflash – the environment of the river was doing just fine before Tasman P&P decided (and was allowed) to degrade it. Similar arguments can be made for the vast majority of industrial environmental degradation, urbanisation etc.

    We are not “buying something nice”. We are reclaiming the nice stuff we had before an under-mitigated profit motive took it away.

  • “Newsflash – the environment of the river was doing just fine before Tasman P&P decided (and was allowed) to degrade it. Similar arguments can be made for the vast majority of industrial environmental degradation, urbanisation etc.”

    And that argument works just fine so long as you ignore all the economic gain that came from that factory. In fact it works fine for shutting down the entire industrial complex. Sure a few billion people would have to starve to death because we could no longer feed them but lets all go back to 17th century technologies.

    As Eric pointed out, the innovations that are now helping the environment are incredibly expensive. Have you priced a high powered windmill? Then add all the back up capacity needed since windmills aren’t always able to run. Oh yes, and lets not forget the cost of all the R&D needed to improve those environmental technologies. All the money that pays for all that comes from other peoples profits. Profits we wouldn’t have if those factories were not built in the first place.

    As Maurice pointed out, what we really need is many more entrepreneurs figuring out how to counterbalance all the factors to find a solution that works. But never forget, all those entrepreneurs are very expensive also. Many have to fail before one comes up with a solution that truly works. All those failures add to the financial and environmental costs. Good thing all those factories are cranking out enough money to pay for it all.

  • You comment as if there are only two choices – economic growth with pollution until it becomes economically unsustainable to do otherwise, or no growth at all.

    This is clearly not the case and is a classic straw man. No one has mentioned a luddite-like move beck to the 17th century – or not until you mentioned it.

    Which particular innovations are you talking about that are so expensive (apart from windmills which are a surprise new entrant to the discussion)? Stream fencing and planting along boundaries of dairy units? The price of environmental mitigation can be relatively cheap and certainly doesn’t need to add significantly to unit prices of outputs.

    Further, the R&D, design, implementation and maintenance of these mitigations all create economic output… Or are you choosing not to count that for reasons that are not economics-based? Yes it comes out of profits – but the profits would otherwise not be economically sound since they derive from an incomplete accounting of costs ie someone else is bearing the environmental cost of production.

    I’m beginning to suspect you used to work for Union Carbide.

    Factories don’t “crank out money” as you so vividly put it. Factories take in resources across the entire span including land, water, labour, capital and production inputs. If they get it right, and depending on how those resources are accounted for, the factory may produce items that have a value benefit that exceeds the input values.

    Conversely, they may not, for reasons including that the consumed resources were incorrectly valued in the first instance.

    Eric is entirely correct – as we become wealthier, we have greater ability to rectify the environmental damage already done. I’d argue that the better way to do it is to require real environmental accounting at the front end and then require the costs to be borne by the polluter before or as they occur – not left to society to clean up after the fact and once the profits have been taken.

  • …and a current case in point where, God bless him, Len Brown writes almost word for word what I have “We have a good understanding of the benefits of the port from previous studies. What we don’t understand so well is the cost side of the equation.”