Total factor productivity and the environmental Kuznets curve

Abstract

Empirical studies support the environmental Kuznets curve hypothesis (EKC) for some pollutants—as income increases pollution increases, reaches a peak and eventually decreases. While relying mostly on cross-sectional data, the interpretations assert that the EKC is a by-product of economic growth over time. In doing so, and in neglecting the role of important country-specific characteristics, these studies overlook potential econometric problems and introduce policy misconceptions. Differences in total factor productivity (TFPs) account for much of the variation in income across countries, with important implications for environmental quality. We develop a theoretical model where different TFPs produce a cross-sectional EKC, even if the dynamic path of environmental quality to its steady-state in individual countries suggest otherwise. The cross-sectional EKC depends on diminishing returns to scale in environmental protection, on the curvatures of the utility function with respect to consumption and of the environmental protection function, and the elasticities of steady-state consumption and environmental expenditures with respect to variation in TFPs.