Environmental damages and the prospects for economic development

We analyze the extent to which the prospects for economic development may relate to the environmental damages associated with economic activities. We consider an economic growth framework in which production activities generate polluting emissions which in turn negatively affect production capabilities, and publicly-funded abatement is pursued to mitigate such effects. Since the time preference is endogenously related to capital, abatement affects the size of the discount factor through its implications on capital accumulation. We show that the elasticity of environmental damages affects the optimal tax rate and thus the abatement level, which in turn determines whether the economy will end up in a stagnation or growth regime. This suggests that the cross-country heterogeneity in environmental damages may explain the different development patterns experienced by industrialized and developing economies. Our results are robust to the presence of productive public spending and two alternative forms of capital (clean and dirty capital).