Pollution Externalities in a Schumpeterian Growth Model

Global warming, the pollution of the seas or a continuously increasing noise level are just a few examples of environmental issues that have alerted the global public in recent years. As a consequence, more and more scientific bodies and environmental groups are discussing whether the emission of pollution as a by-product of modern economic activity may endanger the exceptional economic growth path, the world has experienced during the last one and a half centuries. To shed further light on this question, a standard Schumpeterian growth model is enlarged to include an environmental dimension. Thereby it explicitly links the pollution intensity of economic activity to the overall level of technological progress. More precisely, it is assumed that pollution arises as an externality of the intermediate good production process and the amount of pollution created in the production process crucially depends on the overall level of technological progress. Within the framework of the model, pollution has different effects on the agents present in the economy. In the basic model solely the households are directly affected by pollution. In a first extension, the model is enlarged to feature a pollution threshold above which no research is possible. A second extension enlarges the choice set of the households and allows for private pollution abatement. In equilibrium, the economy follows a balanced growth path where output, research investment, consumption, as well as the level of technological progress grow at a constant and positive rate. The effect of pollution on the economic growth rate vitally depends on the households' degree of pollution aversion and even more on the link between pollution intensity and the technology level. All in all, pollution dampens the economic growth rate if a rise in the level of technological progress does not imply a big enough decrease of the pollution intensity. It fosters growth if the pollution intensity falls disproportionately fast when the economy advances. Pollution growth is proportional to the growth rate of the economy and also crucially depends on how the pollution intensity of the production process is linked to the level of technological progress. If the pollution intensity declines fast enough when the level of technological progress increases over time, pollution declines. Otherwise pollution grows continuously or is constant. Due to four types of deviations, namely monopolistic pricing, the appropriability effect, the business stealing effect and pollution externalities, the decentralized solution does not meet the social optimum. But, the social optimum can be implemented through the introduction of a subsidy to the final good sector, a subsidy towards the research sector and tradable pollution permits. Given a pollution threshold above which no research is feasible, sustained economic growth is only possible if pollution does not increase over time. This implies that the pollution intensity must be decoupled from technological progress. Otherwise, at some point in time pollution will stall growth in the economy. The possibility of private pollution abatement enables the households to cope better with the pollution emitted during the production process and allows the economy to grow at a higher rate.

Koesler, Simon (2010), Pollution Externalities in a Schumpeterian Growth Model, ZEW Discussion Paper No. 10-055, Mannheim.