2.4. Quantitative Results
2.4.2. Parameters with policy implications
∗
−
= − − − − , (2.38)
where
C
0= [ A ( N
∗) P
∗(1−α)εh
∗1−αL
∗yβ− g
∗− mh
∗P
∗ε] K
0,C and
0K are the initial
0 consumption and capital stock, respectively.13 The numerical values of social welfare under the three regimes are reported in the last column of Table 2.2. It is clear that the ranking of the level of welfare among the three regimes is the PAR regime, the GA regime and the PA regime in that order. The policy implication is that, given the baseline parameter values, the growth rate and welfare are the lowest if abatement activities are conducted privately without government intervention.Nevertheless, they could be both enhanced once the government engages in public abatement or provides incentives for private abatement R&D. If the latter is the case, the growth rate and welfare could achieve the highest levels.
2.4.2. Parameters with policy implications
It should be noted that the numerical simulations regarding the growth rate and welfare are examined only under the baseline parameter values. An interesting concern is how our simulation results are related to the values of the parameters. To this end, in what follows we propose three relevant parameters that need to be considered by the policy-makers.
13 Without loss of generality, we set K0 = 1 in our numerical model.
2.4.2.1. Market imperfection
An early but insightful point of view by Schumpeter (1942) is that more competition would erode the monopolistic rents, and thus reduce the incentive to undertake R&D activities. We stand in line with this perspective and extend it to an economy in which R&D investment is used to control the pollution. To be more specific, in our model the decentralized economy suffers from two market failures.
The first concerns the environmental externality. Pollution harms human health and productivity, but is not accounted for by the polluting firms. The second has to do with the market imperfections regarding the supply of intermediate goods. However, these imperfections can become the motivation for people to engage in R&D in the case where the polluting firms need to pay a license fee to use abatement technologies, but not in the case where there is public provision of free abatement knowledge. In other words, only in the regime of private abatement (PA and PAR) can the second market failure (imperfect competition) remedy the first market failure (the environmental externality). Based on this observation, market imperfections play a critical role when integrating abatement investment with private incentives.
Figure 2.1 exhibits the effects of varying the monopoly power parameter (θ ).
A rise in θ is associated with an increase in both the balanced growth rate and the level of welfare under both the PA and PAR regimes. To explain this result, by substituting (2.29) into (2.30) we obtain
π = ( 1 − s ω ) L
H, where a higher profit implies more employment of research workers. As noted previously, the R&D firms can price their ideas exactly to extract all the profit of the intermediate firms. For this reason, a higher θ (as well as the profit of the intermediate firms) means that more resources are contributed to hire labor in the R&D sector, thereby stimulating the balanced growth rate.In the GA regime, on the contrary, the effects of θ on long-term growth rate
and welfare are negative but almost negligible. The reason for this result stems from the fact that in the GA regime abatement investment is undertaken only by the government, and thus has no direct relationship with the firms’ profit. More specifically, the numerical simulations depicted in Figure 2.1 indicate that, under both the PA and PAR regimes, the greater the degree of imperfect competition, the larger the benefit of private abatement will become. When θ is large enough, both the balanced growth rate and social welfare for the PA regime may possibly exceed those for the GA regime. Moreover, if the government can recycle its tax revenues to provide incentives for private abatement R&D, both economic growth and welfare will be further enhanced.
2.4.2.2. The type of government spending
We now discuss the parameter related to the public sector. In their recent study, Fullerton and Kim (2008) show that government spending on transfer payments (φ ) is a non-environmental parameter with important implications for environmental policy.
The effect of changing φ is depicted in Figure 2.2. It is quite clear that, in response to an increase in φ , the growth rate and social welfare decline in both the PAR and GA regimes but remain intact in the PA regime. The intuition for this result is straightforward. In the PA regime all tax revenues are returned to the households.
The abatement investment which stirs up economic growth comes only from the monopolistic rents so that φ has no role in economic activities.
However, under both the PAR and GA regimes, economic growth becomes closely related to φ since the government uses its tax revenues to stimulate (or directly conduct) abatement R&D. A positive value of φ indicates that part of the revenues from the environmental tax must be spent on transfer payments. The greater need for transfer payments implies that less tax revenue will be used in
abatement R&D, and hence will lead to deterioration in the balanced growth rate.
As is evident, our results indicate that the Fullerton and Kim (2008) conclusion is valid under both the PAR and GA regimes and invalid under the PA regime.
2.4.2.3. The effect of an environmental tax
We now turn to investigate the effect of environmental tax policy. It is shown in Figure 2.3 that raising an environmental tax can stimulate economic growth as well as reduce the level of pollution. Bovenberg and Smulders (1995) have clearly pointed out the two opposing forces whereby the environmental policy affects the long-term growth rate. First, a lower level of polluting inputs decreases the productivity of reproducible inputs, thereby lowering economic growth. Second, a reduction in pollution improves the environmental quality, which benefits productivity and economic growth. As a result, Bovenberg and Smulders (1995) suggest that there is the environmental tax has an ambiguous effect on economic growth.
In our model, however, by referring to (2.6), the pollution inputs are purchased from abroad at a given price so that a higher environmental tax can simultaneously reduce the pollution
p
(=p
i) but keep the polluting inputse
(=e
i) unchanged.Under such a situation, a tighter environmental policy no longer decreases the productivity of capital and labor, because a lower level of pollution in production is offset by more abatement knowledge. Hence, our model only presents the second environmental quality effect.
To highlight the importance of this environmental quality effect, we consider the alternative value γ =0 to show that production gains no extra benefit from a better environmental quality. The simulation results are depicted in Figure 2.4. It can be seen that, in the absence of an environmental externality, raising an environmental tax has no effect on the long-term growth rate while it reduces pollution. Comparing
Figure 2.3 with Figure 2.4 enables us to realize that whether or not environmental policies affect economic growth crucially depends on the presence of a positive environmental externality.
In our model, as mentioned above, a fixed import price of polluting inputs (
m
) is the key to screening out the traditional negative policy effect on long-term growth in the literature. Therefore, it is worthwhile discussing why we need to introduce this parameter into our model. Theoretically, although numerous studies model pollution based on the concept of a “dirty input”, there are several reasons for treating them differently.14 First, pollution (i.e., dirty air, messy water or noise) is not directly used in the production process, while the dirty inputs (i.e., petroleum or chemicals) are.Second, abatement knowledge can hardly play any role in the pollution transformation process if we mix the two. Third and most importantly, pollution harms human health but is not internalized by the private agents and thus needs to be priced by the government, while dirty inputs should be priced by the market, because they are production factors just like other clean inputs. Hence, we allow for
τ
P andm
to denote, respectively, the price of pollution and dirty inputs.To be more specific, suppose that there is no polluting input price, from (2.5)-(2.7) and
q
=1 (the zero-profit condition in the final good sector) we have:i P yi i yi i
i
i
A N k p H l rk
ωl
τp
π = ( ) α ε(1−α) 1−α β − − − . (2.39)
One implication stemming from (2.39) is that, in the absence of any policy interference (
τ
P= 0
), the cost of pollution becomes zero so that the intermediate firms will select an infinitely large level of pollution. As a result, the environmental quality declines to the bottom and the economy cannot survive even temporarily. To14 Some studies (e.g., Ligthart and van der Ploeg, 1994; Smulders and Gradus, 1996; and Bréchet and Michel, 2007), on the other hand, treat pollution as a by-product of capital or final output. However, under such a situation, since an environmental tax levied on pollution is equivalent to that levied on physical capital or output, it might be difficult to tell whether economic growth is affected by an environmental tax or by a similar capital (output) tax.
this end, we introduce such a “non-policy” cost of polluting inputs to restrict the pollution to within a finite level even in the absence of an environmental tax. To be concerned with practicality, since firms usually import petroleum from abroad at a price that they can not bargain for, we believe that the assumption of a given price of polluting inputs is not very far from the real world.
Now we turn to welfare considerations. Figure 2.3 and Figure 2.4 show that the welfare level is increasing with the environmental tax, regardless of whether a positive environmental externality is present or not. As discussed earlier, in the case of γ =0 a tighter environmental policy has no effect on long-term growth.
However, it can still influence the level of welfare. More specifically, with the growth rate unchanged, a higher environmental tax reduces pollution to improve the environmental quality, and thus unambiguously enhances the welfare level. If the representative household does not care about the environmental quality (η=0), it is our conjecture that environmental policy cannot play any role in governing the balanced growth rate and the welfare level.