Does improved environmental quality prevent a growing economy?

Abstract

Abstract A major concern for sustainable development is how countries can lower pollution while avoiding adverse output and energy shocks. Since economic activities change with time, we develop a dynamic applied equilibrium model to study the dynamics of CO2 emissions and evaluate how the pursuit of environmental policy objectives can influence output and productivity in a surrogate country in transition. Under an optimal environmental policy which ensures mitigation between 38 and 50%, we show that productivity, projected towards the year 2075, increases slightly from between 3.8 and 6.2% to between 5.7 and 7.6%, respectively. The required carbon tax begins from $ 5.29/ton in 2020 and grows on average by 3.5% reaching up to $ 35.83 per ton carbon towards the year 2075. Even though these tax rates ensure huge benefits for mitigation, they represent marginal productivity growth and substantial output and consumption costs. In other words, improved environmental quality presents opportunities for multifactor productivity (MFP) but this productivity improvement is too marginal to offset the compliance costs of the carbon tax, thereby, causing output to decline. Hence, to ensure maximum economic dividend from carbon pricing especially in transitional economies, measures are required to improve the innovation benefits of carbon taxes towards levels that offset the compliance costs of environmental regulations. Otherwise, caution should be taken by developing countries in their environmental policy designs especially when boosting consumption and economic growth is a major priority.