The Relevance and Implications of the Environmental Kuznets Curve Under Stock Effects and Non-Linearities: A Hysteresis Based Approach

A number of studies in the past have come up in order to explain and verify the observation made by Grossman and Kruger that that there may exist an inverted U-shaped relationship between environmental pollution and income. While some studies have found this relationship to hold true for certain pollutants, other studies have rejected this hypothesis based upon empirical observations of certain other pollutants. Further, most of these results have been derived from cross-sectional observation of such patterns across countries and therefore have given rise to further sckepticism. Though a number of empirical estimates of this relationship exist in the literature, there have been very few attempts to explain a theoretical basis for such a pattern. Primarily, there have been two arguments to justify such a relationship. The first one hinges upon the assumption that people have preference for environmental quality that rises disporportionatley as income increases. The other explanation is based upon a pollution-reducing technological progress that causes pollution levels to fall as income rises. This argument makes the assumption that a threshold level of income exists beyond which less polluting technologies could be used efficiently. However, in absence of conclusive empirical estimates these theories have been subjected to severe criticisms and counter-theories. One such argument that has been made against the existence of any such inverted relationship between environmental pollution and income is by Suri and Chapman. They contend that the observed relationship holds true mostly in developed countries and primarily so because they shift production of pollution-intensive goods to developing countries thus reducing their own emissions. Therefore, if international trade is factored in these theroies, the EKC may not exist. Further, the concern against any pollution-reducing technological progress has been that though such technologies may reduce the emissions of one type of pollutant, they lead to other kinds of toxic accumulations in the long run. It seems that the major emphasis of the prior literature is on establishing either the existence of such a relationship or rejecting it altogether. Obviously, the intention of most of such studies is to derive a threshold level of income beyond which pollution starts falling and then suggest the fastest growth paths to achieve that target income level. The hope has been that with the discovery of Environmental Kuznets Curve (EKC) the focus could be again shifted back to economic growth. However, this focus seems to ignore the possibility that even if EKC exists it may still be desirable not to wait until the threshold level of income is achieved in order for pollution levels to go down. It is possible to explain the observed discrepancies in the literature on EKC through an alternative approach. One reason EKC may not be observed in some cases is that even though there may exist a relationship between pollution levels and income, the observable indicators of environmental quality may still keep degrading due to stock effects. A simple example is the case of diminishing biodiversity all over the world. The existence of EKC, in such cases, then depends upon the type of environmental indicators chosen. This explains the conflicting nature of observations made by studies in the past. A consequential implication of this explanation is that perhaps one must not put too much emphasis on proving the existence of EKC, because it may give misleading policy implications. Pollution may reduce over time with technological advances or increasing preferences for environmental qualities, but there may be stock effects from such emissions which may be irreversible and subject to hysteresis. A suitable example would be the global warming problem. In this paper we build upon the existing theoretical models in the literature to incorporate such irreversibilities and hysteresis effects that may exist between flow of pollution and environmental quality. In our model the incorporation of hysteresis between environmental quality and the flow of pollution implies that it may not be optimal to increase the pollution all the way up to the threshold level implied by a conventional EKC relationship. This is primarily due to the fact that once the pollution level crosses a threshold beyond which hysteresis sets in, the cost of reducing pollution in terms of income may become excessively high beyond that point. Consequently, even though a conventional EKC may exist between pollution flow and income, there may not exist a similar relationship between certain indicators of environmental quality and income. We further perform numerical simulations to derive parameter values for which existence of conventional EKC also implies existence of EKC for all other quality indicators and values for which it does not. We then incorporate the hysteresis and irreversibility effects into the theoretical model to derive the adjusted threshold levels of incomes beyond which pollution starts falling. Further, we derive lessons for the currently industrializing economies from these thresholds. Most of these economies are characterized by a heavy emphasis on capital accumulation with little or no regard for environmental degradation. Environmental concerns in such economies arise only after sufficient capital accumulation and a serious degradation of the environment. However, hysteresis and irreversibility may make such concerns futile as it may be extremely costly, if not impossible, to revert back to pristine states. For given initial endowments of capital and environmetal quality, we derive 'points of no return' for such economies. An untested hypothesis that exists in the EKC literature is that it may be possible to 'tunnel' through the EKC, i.e., accumulate high levels of capital and yet preserve the environment. Our analysis demonstrates that, when stock effects associated with pollution are taken into consideration, this tunnel may not exist. However, 'tunneling' may be feasible if there are significant pollution-reducing technological advances. Incorporation of both the technological progress argument and environmental preferences argument in the model makes the threshold income levels highly sensitive to parameter values, though many interesting implications arise from this case