Environmental Kuznets Curve

Written by Ryan McGuine //

In the 1950s, Simon Kuznets postulated that as economies become wealthier, the level of inequality there would increase, then decrease. When plotted against income per capita, this creates the inverted-U shaped curve seen below. Around 1991, Gene Grossman and Alan Krueger noted a similar inverted-U shaped relationship between income levels and environmental degradation, dubbed the Environmental Kuznets Curve (EKC).

KC Plot

EKCs appear to hold for many different types of environmental degradation. For example, local ambient air pollution has followed this pattern in most modern economies. Anecdotally, many westerners are surprised at the poor air quality of major cities in developing countries like Bejing and New Delhi, even though pollution levels there are similar to those once seen by Pittsburgh and London. Empirically, the concentration of PM2.5 in Delhi this November surpassed 100 times the WHO’s limit for long-term exposure — the health equivalent of smoking 50 cigarettes per day. Close to 670,000 of the 9.7m deaths in India during 2017 were attributable to air pollution, but there is reason to suspect India’s air will not be much worse for very long, since deaths attributable to air pollution tend to peak near the country’s current GDP per capita. The inverted-U pattern typical of EKCs can also be seen for water quality, deforestation, and total resource use.

If the structure of an economy and its embedded technology remained unchanged, environmental degradation would probably increase with economic output, but in reality these conditions are not static. As incomes rise, an economy’s structure changes away from industrial sectors toward services. Since services tend to be less energy-intensive than industry, less fossil fuels are burned, and pollution decreases. An economy’s embedded technology also changes as incomes rise, in the direction of minimizing inputs. For example, industrial automation raises manufacturing quality, lighter materials enable more fuel efficient transportation, and precision agriculture boosts crop yields. Moreover, both structure and technology respond to regulation, which tends to be stricter in wealthier countries. Environmental protection gains societal importance after basic needs have been met, and rich countries have more wealth and technical expertise for regulation enforcement and compliance.

Most environmental degradation that follows the EKC pattern are examples of local degradation, meaning that the impacts most heavily affect the immediate vicinity, and that their severity depends on the difference between their flow into and out of the environment. As such, the best way to reduce a country’s local pollution in the long run is to promote economic growth. The faster a country grows, and the stronger the forces of markets and technological progress are, the faster it will reach peak environmental impact and begin reducing its environmental footprint. Importantly, it appears that countries are reaching that peak at lower incomes than today’s wealthy nations did, since there is high demand for environmental quality in developing countries. This dynamic empowers ever-more communities to overcome the “despondency trap” and enforce higher standards themselves.

While high levels of income have tended to reduce humans’ impact to the environment in many ways, this has not been the case universally. There are also types of pollution for which rates appear to increase continuously with income levels, never forming the second half of the inverted-U. Greenhouse gas emissions do not appear to ever reach an apex, even though carbon intensity (units of carbon emitted per dollar of GDP) does appear to follow the EKC relationship with income level.

The structural shift toward services that has driven down local pollutants has also minimized global pollutants by reducing the total energy consumed per dollar of GDP. Similarly, technological progress has helped minimize global pollutant emissions. The expansion of nuclear power during the 1970s, innovations in natural gas recovery during the 2000s, and steady gains in energy efficiency have all reduced America’s carbon intensity. Unfortunately, these forces have merely prevented greenhouse gas emissions relative to business-as-usual, rather than actually reducing total emissions. Changes to the energy mix to date have amounted to meeting incremental new demand with clean energy, but a simultaneous reduction in fossil fuels’ contribution to existing demand is also needed.

Regulating global pollutants has not become a societal priority in the same way local pollutants have, because they have resulted in few directly-observable effects to date, and there remains many applications without clean energy alternatives that match the affordability and availability of fossil fuels. However, as the full price of climate effects becomes clearer and the cost of clean technology relative to fossil fuels continues to fall, pressure to adopt policies to curb emissions will probably increase. Wealthy countries should focus on decoupling economic growth from carbon emissions, while reducing inefficiency in the broadest sense — minimizing food waste, improving public transport, and lessening material consumption. At the same time, developing economies should be given some leeway to increase greenhouse gas emissions, since high non-residential energy consumption is strongly correlated with high incomes, and high incomes make it easier to adapt to climate change.

A few caveats are in order. First, accounting for a country’s environmental impact is not straightforward. As an economy’s share of employment and GDP shifts from manufacturing and industrial sectors toward services, people do not typically consume less manufactured and industrial goods. In reality, that production moves elsewhere, making it appear that companies from rich countries have a smaller environmental footprint than they actually do. Approximately 17-36% of local air pollutants in China are associated with production for export, and roughly one-quarter of global carbon emissions are emitted outside of the country where products are consumed. This effect does not explain all environmental improvements in high-income countries, suggesting much of their progress is real, but pollution offshoring does make that progress look more substantial than it is.

Second, many heavy-polluting countries today are not democracies, or at least exhibit significant amount of state control over society. It is unclear exactly what role political freedom plays in pollution reduction. It may be the case that authoritarian states can achieve rapid, nationwide change by coercing large companies to pollute less. However, non-democracies tend to be less responsive to the desires of citizens, and can also easily relax rules for heavy polluters. As Amartya Sen points out in Development as Freedom, political rights play both instrumental and constructive roles in well-being — that is, they help provide the incentives and information to meet economic needs, while informing the debate on what the economic needs are in the first place. Democracy is probably good for the environment on net.

The good news is that there is currently a global infrastructure funding shortfall on the order of $3.7tn annually through 2035. Infrastructure supports economic growth by boosting productivity growth — the main driver of overall economic growth — and reducing transaction costs. Leveraging that investment to build out low-carbon infrastructure presents a massive opportunity to both boost growth in low-income countries, and avoid much of the embedded carbon emissions associated with developed economies. Best of all, this investment could nearly pay for itself thanks to higher growth and tax receipts. One of the largest constraints to infrastructure financing is the lack of well-prepared, bankable projects that provide investors with appropriate returns, so countries should develop pipelines of such projects.

Tyler Cowen likes to say that there are two worldviews: those who believe that people mostly consume resources, creating less for everyone else, versus those who believe that people mostly generate ideas, creating more for everyone else. Economic history is largely a story of the latter overcoming the former, and market-driven growth has been good for humanity’s impact on the planet by lots of measures. Despite this, market-driven growth is not the antidote to environmental degradation, since greenhouse gases are not paid for by emitters. Markets have the unique ability to solve the same problem differently for different situations, making them crucial to the development and adoption of the widest possible range of solutions, but they will not reduce greenhouse gases absent government incentives and penalties.

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