Dynamic Ecological Constraints to Economic Growth

An important characteristic defining the threat of environmental crises is the uncertainty about their consequences for future welfare. Random processes governing ecosystem dynamics and adaptation to anthropogenic change are the source of prevailing ecological uncertainty and contribute to the problem of how to balance economic development against natural resource conservation. The aim of this study is to describe the implications for steady-state economic growth subject to non-linear dynamic environmental constraints. In a two-sector exogenous growth framework we model a stochastic environmental good, exhibiting uncertain ecological responses to environmental change and describe the economic and environmental trade-offs that ensue for a risk-averse social planner. Allowing for ecological risk tends to slow long run economic growth if environmental impacts are assumed to increase exponentially as the level of disturbance increases. A combination of low risk aversion and linear or concave ecological response functions leads to accelerated economic growth and environmental impact. This result is reversed for social planners characterised by high levels of risk aversion as conservation with zero environmental impact becomes the economically optimal policy choice. The environmental option value of preserving a natural resource in the face of uncertainty is treated in this paper as a Cicchetti-Freeman type risk premium.