Friday, 13 March 2015

The Case for Economic Growth

We released the piece at this year's New Zealand Initiative annual retreat last night in Auckland, with Finance Minister Bill English discussing economic growth as part of the launch. 

An excerpt from our essay:
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.


  1. Nice paper. Congratulations. It is rather unfortunate that you have to actually make the case for economic growth but such is the Twitter Left and the persuasive influence of their pessimism on politics.