Scale Effect versus Induced Policy Response in the Environmental Kuznets Curve: The Case of U.S. Water Pollution

By Lai, Ching-Yao Irene; Yang, C. C. | Contemporary Economic Policy, April 2014 | Go to article overview

Scale Effect versus Induced Policy Response in the Environmental Kuznets Curve: The Case of U.S. Water Pollution


Lai, Ching-Yao Irene, Yang, C. C., Contemporary Economic Policy


The environmental Kuznets curve (EKC) could arise from the scale effect in abatement technology as emphasized by Andreoni and Levinson (2001) or from the induced policy response as suggested by Grossman and Krueger (1995). This paper incorporates these two contrary views into a model and quantitatively evaluates their relative importance in shaping the EKC of U.S. water pollution. Our main findings include: (a) some scale effect in abatement technology must exist, otherwise the turning point of the EKC will be unreasonably high; (b) the scale effect alone is not sufficient to explain the practical occurrence of the turning point of the EKC; and (c) the scale effect features critically in the induced policy response as well. (JEL H41, O40, Q20)

I. INTRODUCTION

Kuznets (1955) studied the relationship between income inequality and economic growth, showing that income inequality set against income per capita exhibits an inverted-U shape: increases in incomes will be associated with a deterioration in income inequality when incomes are low, but with an improvement in income inequality when incomes become high. This relationship is known as the "Kuznets curve." Starting with the seminal work of Grossman and Krueger (1993), many studies have found that pollution set against income per capita for various pollutants also exhibits an inverted-U shape, and so this relationship has been dubbed the "environmental Kuznets curve" (EKC). (1)

The existence of the EKC implies that economic growth may be a remedy for environmental problems because it will level off pollution and eventually bring about environmental improvements. Andreoni and Levinson (2001) provided a case for this possibility. They argued for increasing returns in pollution abatement technology (doubling the environmental efforts more than doubles the pollution abatement) and showed that the scale effect alone is sufficient to generate the EKC. By contrast, Grossman and Krueger (1995) emphasized that the eventual decline in pollution as income rises is not automatic or inevitable; instead, they suggested that "the strongest link between income and pollution in fact is via an induced policy response" (p. 372).

In this paper, we incorporate these two contrary views into a model, allowing for the occurrence of the EKC via the scale effect in abatement technology as emphasized by Andreoni and Levinson (2001), and via the induced policy response as suggested by Grossman and Krueger (1995). Our main purpose is to quantitatively discern the relative importance of the scale effect versus the induced policy response in shaping the EKC. Water pollution in the United States will be our case study. (2)

Besides the main purpose stated above, we also address several related issues. Kristrom and Riera (1996) reviewed contingent valuation studies and evaluated the evidence on the income elasticity of people's willingness-to-pay for environmental improvement (wtp). They concluded that the value of this parameter is positive, but is consistently found to be less than 1. Later studies, including Aldy, Kramer, and Holmes (1999), Ready, Malzubris, and Senkane (2002), and Hokby and Soderqvist (2003), also confirmed this conclusion. However, Pearce and Palmer (2001) documented the Organization for Economic Cooperation and Development (OECD) public expenditures on pollution abatement and control and found that the income elasticity of these expenditures is close to 1.2. One may thus wonder if there is an inconsistency between Pearce and Palmer's "luxury good" finding and Kristrom and Riera's "normal good" finding. Kristrom and Riera (1996, 45) at the beginning of their paper remarked: "most economists would argue intuitively that environmental quality is a luxury good, [but] our results do not support this intuition." Pearce and Palmer (2001, 426) commented on Kristrom and Riera's finding: "If they are right, then the 'environment' is a normal good but not a luxury good, contradicting the usual intuition about the demand for environmental quality. …

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