Academic journal article International Journal of Economic Development

Economic Development and Sustainability in an Aggregative Model Incorporating the Environment

Academic journal article International Journal of Economic Development

Economic Development and Sustainability in an Aggregative Model Incorporating the Environment

Article excerpt

Abstract

We investigate an infinite horizon aggregative closed economy in which production depends essentially on physical capital, natural capital and labour. The natural capital stock is modelled as a renewable resource. The change in the stock of natural capital depends on its autonomous evolution, production and consumption externalities, and environment maintenance programs. The economy is shown to be sustainable only if, for any marginal propensity to consume (MPC, the rate of taxation to maintain the environment exceeds a critical level, or equivalently, for any tax rate, the MPC is below a critical value. If human activities have a net beneficial effect on the environment, the economy will converge to a unique and stable steady state, which can be viewed as a generalized Solow-Swan balanced path. The condition for such a steady state to be sustainable is derived. In a sustainable steady state, the tax rate and MPC can be chosen to maximize per capita consumption.

Introduction

It is now generally acknowledged that the aggregate output of an economy and, hence, its economic development path, depend ultimately on how it make uses of its physical, human, social and environmental capital. The accumulation of physical capital as a determinant of economic growth features prominently in the Solow-Swan model (see Solow, 1956; Swan, 1956). This model provides simple testable propositions about how the exogeneously given rates of saving, population growth and technological innovation influence the steady-state level of per capita income

More recently, Mankiw, Romer and Weil (1992) incorporated human capital into the textbook Solow-Swan model and demonstrated that the augmented model provides an excellent explanation of the international variation in the standard of living. In a separate development, economists have turned increasingly to endogenous-growth models which go beyond the Solow-Swan model to argue for externalities in the generation of both human capital and technological innovations, and for profit as the driving force behind innovation. Various strands of the endogenous growth literature, which dates back to the work of Uzawa (1965), are summarized in Romer (1994).

Social capital, alternatively called social capabilities, is a more elusive concept, which does not render itself easily to formal analysis. It includes such factors as openness and competitiveness of the economy, institutional arrangements, secure property rights, honesty, trust and interpersonal networks. In short, social capital represents a set of any intangible things that reduce transaction costs and, thus, help markets operate more smoothly. The role of social capital as an input in the production process has been considered mainly by development economists in connection with developing or transitional economies (see, for example, Hasson and Henrekson, 1994).

The natural capital stock refers to the totality of all ecosystems, which include, for example, water, soil, forest cover, the atmosphere, minerals, ores and fossil fuels. While a complete theory of the mining firm was first formulated by Hotelling (1931) more than sixty years ago, economists only began constructing general equilibrium models to accommodate resource exhaustibility in the early 1970s. This effort, triggered by the Report for the Club of Rome (see Meadows et al., 1972) and the oil shocks, has resulted in a substantial expansion of the literature on exhaustible resources (see, for example, Dasgupta and Heal, 1979; Kemp and Long, 1980). A large part of this vein of literature is concerned with the optimal depletion of nonrenewable resources.

More recently, research on the environment has focused on biodiversity and renewable natural resources (see, for example, Pearce and Turner, 1990; Perrings, 1994; Dasgupta, 1996). The major theoretical issues in this new wave of literature include intergenerational incidence of costs and benefits, causes of environmental degradation, valuation of environmental resources, property rights and economic instruments, and international governance and the global commons. …

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