An Endogenous Growth Model With Environmental Quality Involved

The link between environment quality and economic growth is a controversial issue. Industrialists typically argue that environment policy harms growth by raising production costs. Environmentalists, in contrast, maintain that environmental policy is needed to ensure that growth is sustainable. One of the main questions is whether economic growth and environmental care can go together or are two competitive goals. In order to investigate the connection between environmental quality and growth, we develop a two-sector endogenous growth model in which economic activity depends on the extractive use of the natural environment, which is modeled as a renewable resource. On the one hand the environment influences production possibilities and welfare, while on the other hand production diminishes the quality and quantity of environmental resources, by the use of resources and through pollution. A continuously decreasing quality and quantity of environmental resources cannot support growing or even constant levels of physical economic output in the distant future. We find that under certain conditions with respect to production and substitution elasticity, there exists a feasible and optimal sustainable balanced growth path on which the economy grows at a constant positive growth rate, keeping environmental quality at a constant level. Growth in technology and abatement activities now compensate for the growing use of natural resources in production, so that environmental quality remains constant on the optimal growth path. It must be noted that on such a growth path, with net use of environmental resources constant, input of materials in production relatively decreases. Material production in total production also decreases, as it is not possible to produce an ever increasing amount of physical output out of a constant amount of physical input. In other words the resulting growth path of the economy must be interpreted as one where non-physical products (such as information) take a growing share in total production.