The Environment and Macroeconomics
Environmental economics is a controversial subject because a good part of this literature believes in the phenomenon of global warming occurring through man-made climate change, and some experts including some scientists are not sure if this warming is a natural part of the weather cycle or is caused by human activity. But there is no doubt that the global environment has become very polluted and there is a lot of research that shows that much of this pollution has resulted from the burning of fossil fuels such as coal, petroleum, and gasoline. The world has rapidly industrialized to raise its economic growth and reduce poverty, but this growth means an increasing use of oil and gasoline, which in turn means polluted air especially in large cities like Los Angeles, New Delhi, Beijing, and many others.
Air is very polluted in most countries, so are rivers from the release of chemicals by many industries. Oceans are also polluted from excessive shipping that transports goods across countries. Global warming may be controversial but pollution is very real.
The pollution of the environment has been normally studied in the area of microeconomics, but recently macroeconomics has also paid attention to it. That is exactly what we study in this chapter.
4.1 GDP and GNH
The gross domestic product (GDP) has been used as a measure of economic activity and national well-being for a long time. But it is not considered the best measure; a better measure is said to be net domestic product (NDP), which is
NDP = GDP – Capital depreciation.
The idea is that the wear and tear of capital stock should be deducted from total production to get a better measure of economic activity. A new concept has become popular in recent years to measure gross national happiness (GNH), with GDP or material well-being only a part of what makes people happy, which is what everyone wants to be.
GNH is mostly a philosophical concept and is not easy to measure. It was discovered by Jigme Sigye Wangchuck, the King of Bhutan, which is situated in the northeastern part of India. The king emphasized that a nation’s happiness depends not only on a good living standard but also on good government, environment, and sustainable economic development, so that a nation’s natural resources are properly used for current and future generations. GNH has more recently attracted the attention of UN economists and environmentalists.
Thus, a good government, a pollution-free environment and a decent living standard are the three ingredients of people’s happiness.
4.2 The Circular Flow
One idea introduced by Keynes is called the circular flow that prevails in a macro economy. The circular flow is that the revenue of firms comes mainly from consumer spending and the incomes of people come from that revenue. The model is presented in Figure 4.1. The firms expect or estimate a certain level of demand for goods and services produced by them and offer that much output to consumers, who buy this output at a certain price from money that they earn from working for the firms. Thus, money flows from consumers to firms, which then return it to the same consumers in the form of wages, rent, interest, and dividends. Firms offer goods and families offer them factors of production in the form of labor and capital.
Figure 4.1 The standard circular flow model in Keynesian economics
Source: Harris, Jonathan M., Codur, Anne-Marre. Macroeconomics and the Environment, p. 1.
This interdependence of markets underlies the income multiplier that we studied in Chapter 2. In the context of environmental economics, the circular flow also includes the biosphere and the use of natural resources, because production occurs not only from the use of labor and capital but also from the use of land, water, air, minerals, which are the natural resources, if these resources are depleted or polluted, then their costs should be included in the estimates of GDP or national income. This is the main idea that the environment should be a part of any circular flow model.
There is natural capital and there is produced capital, and while the depletion of produced capital is part of NDP, we should also include the depletion of natural capital to estimate the true level of output available to society. Otherwise, NDP is an overestimate of an economy’s output. The circular flow diagram that includes the biosphere is presented in the Figure 4.2.
Figure 4.2 The circular flow linked to the biosphere
Source: Harris Jonathan and Codur Anne-Marre, Macroeconomics and the Environment, p. 3.
The true concept of NDP is then
NDP = GDP – Capital Depreciation – Resource Depreciation.
Resource depreciation is hard to estimate but the World Resources Institute (WRI) has provided estimates for a few countries. WRI estimated depletions for 3 years of resources such as forestry, petroleum, and soil. In the case of Indonesia, for example, resource depreciation amounted to 9 percent of GDP per year. This is a very substantial amount and shows how important are the costs of pollution.
The World Bank has provided estimates of resource depletion in the form of reduction in savings. For instance, for Saudi Arabia, which depends primarily on the production of oil, the nation used so much of its resource that its savings rate has been substantially negative. Such costs are real.
4.3 Macroeconomic Policy
Many environmentalists emphasize that there are limits to economic growth, but their warnings have been mostly ignored especially since the start of the Great Recession. But nations can devise such economic policies that raise employment, create growth, and provide good jobs. Fossil fuels can be replaced over time by forms of energy that are friendly to the environment. Solar energy, wind power, and hydroelectric power are a vast unlimited resource and are mostly free from pollution. Two economists Roar Bjonnes and Caroline Hargreaves have written a book Growing a New Economy, which offers a variety of ways in which an economy can grow fast while reducing pollution at the same time.
They write:
Science has concluded that pollution causes individual as well as collective problems—various cancers, as well as polluted rivers and oceans full of plastic waste. Sometimes the price is very costly . . . On a cold day in January 2000 a dam burst in Romania. The dam contained toxic waste—one hundred thousand cubic meters of cyanide-laden water . . . Cyanide is extremely toxic. Even a small doze can be deadly to humans and animals alike . . . The mining disaster killed at least 80 percent of the fish in the region, the water became unsafe to drink, and environmental disease was no longer just an abstract medical term—it became a personal health problem for many people. (p. 220)
Bjonnes and Hargreaves note that there are limits to growth because of the limits to environmental degradation. Yet they offer ways in which growth may continue while the environment shows improvement. Some of the ways that have been already implemented are as follows:
- Fossil fuel subsidies fell 44 percent in 2009. . .
- Continuing its rapid ascent, installed global wind power capacity increased 24 percent . . . in 2010.
- Solar photovoltaic generating capacity grew even faster.
- Global biofuel production increased 17 percent in 2010 . . .
- Organic farming methods were used on 37.2 million hectares worldwide in 2009 . . . a 150 percent increase since 2000. (pp. 233–4).
In short, Bjonnes and Hargreaves have produced a virtual encyclopedia of how to generate environmental-friendly economic growth.
4.4 Keynesian Policy
One way to fight a recession is Keynesian policy of increasing budget deficit through a tax cut and a rise in government spending. Normally, the spending rise is directed to keep consumer demand from a continued fall that results from falling production. This was clear during the recent recession as unemployment benefits were repeatedly extended for the unemployed. The tax cut was also designed to keep disposable income from falling too much and thus prevent a big decline in consumer spending. But the Obama administration also directed some spending toward investments that are friendly to the environment. They included spending to make federal building energy efficient, grants to states to do the same, research on renewable energy production, and public transit to reduce dependence on cars.
Similarly, tax incentives were granted to solar industries, while the public received big tax credit for installing solar roofs and buying energy-efficient appliances. In other words, fiscal policy showed an understanding that environment matters a lot to the economy.
Even monetary policy was somewhat friendly to the environment. Electric cars and hybrid cars that give great mileage for gasoline use are more expensive than other cars. As interest rates fell sharply, the more expensive cars become affordable.
4.5 Carbon Taxes
Another way in which fiscal policy can become friendly to the environment is to change the mix of taxes. Taxes imposed on fossil fuels that increase air pollution, through the rise of carbon dioxide, are known as carbon taxes. Such taxes are those imposed on coal, oil, gasoline, natural gas, and so on. If these taxes go up in a big way, they will cut the demand for fossil fuels and improve the environment. But then they may lower consumer spending because a part of these taxes will be passed on to the consumers. But if suppose some other tax is lowered at the same time to keep the tax revenue constant, then consumption demand in the economy may remain constant or even go up. For instance, if a strong rise in a carbon tax is matched by a slight fall in the sales tax so that the revenue is constant, consumer spending could even rise because the sales-tax revenue is rather large and sales tax cut would mean a lot to consumers. This way tax policy can stimulate consumer demand and cut pollution at the same time.
4.6 Sin Taxes
A sin tax is one that cuts the consumption of things considered harmful to public health. Excise taxes on cigarettes, alcohol, and so on, are examples of such taxes. A rise in such taxes along with a sales-tax cut has the same effect as a rise in carbon taxes along with a fall in the sales tax. A cigarette tax increase will reduce smoking, improve people’s health, and also reduce air pollution. The point is that fiscal policy can be used to raise consumer spending and cut pollution at the same time.
Summary
This chapter deals with the increasing awareness that economists have shown for environmental-friendly macroeconomics since the start of the Great Recession. While the phenomenon of global warming due to climate change still does not command full consensus, there is no doubt that global pollution continues to increase and so do its costs, especially in terms of mounting health problems all over the world. It is not hard to imagine that if the environmental degradation keeps up its breath-taking pace, a time may come when people may choose a stable environment over continued growth. However, fiscal policy can be devised that may be consistent with continued growth along with pollution reduction.
References
Bjonnes, Roar, Hargreaves, Caroline. Growing a New Economy: Beyond Crisis Capitalism and Environmental Destruction. InnerWorld Publications, Puerto Rico, 2017.
Harris, Jonathan M., Codur, Anne-Marie. Macroeconomics and the Environment Global Development And Environment Institute, Tufts University Medford. http://ase.tufts.edu/gdae
Kelly, Annie. Gross National Happiness in Bhutan: The Big Idea from a Tiny State That Could Change the World. December 1, 2012. https://www.theguardian.com/world/2012/dec/01/bhutan-wealth-happiness-counts
Neuhauser, Alan. Obama Budget a Gas for Environmental Advocates. The president’s proposed spending plan would put plenty of green behind his green initiatives. U.S. News. February 2, 2015. https://www.usnews.com/news/articles/2015/02/02/obama-budget-spends-big-on-climate-clean-energy
World Resources Institute. World Resources 1996-97: A Guide to the Global Environment. Oxford University Press, New York, 1996.