EKC A BRIEF LITERATURE REVIEW The relationship between economic growth and environmental conditions is a debated issue since

e 1990. Several studies, on the subject, have argued that the level of environmental degradation and economic growth follows an inverted U-shaped relationship. The advent of the Environmental Kuznets Curve (EKC) hypothesis is closely related to the concept of sustainable development. 2.1 THE THEORY OF EKC The environmental Kuznets curve hypothesis is a well-known hypothesis providing support for a policy that emphasizes economic growth at the expense of environmental protection. It posits that the levels of environmental degradation will increase in countries which are in the development process until some income threshold is met and then afterwards decrease. This implies that the environmental impact indicator is an inverted U-shaped function of income per capita. The genesis of the Environmental Kuznets Curve can be traced back to Kuznets (1955), who originally hypothesized that the relationship between inequality in income distribution and income growth follows an inverted-U curve. Panayotou (1993) first coined it the Environmental Kuznets Curve (EKC) given its resemblance to Kuznets hypothesis. The EKC assumes that the growth of the income per capita goes along with a decline in environmental quality up to a turning point, beyond which this relationship is reversed in the sense that the income growth coincides with the reduced environmental damage. EKC hypothesis has also been tested for other indicators of environmental degradation ,such as deforestation, carbon emissions and municipal waste. The EKC theme was popularized by the World Banks World Development Report 1992 (IBRD, 1992), which argued that: The view that greater economic activity inevitably hurts the environment is based on static assumptions about technology, tastes and environmental investments and that As incomes rise, the demand for improvements in environmental quality will increase, as will the resources available for investment Beckerman (1992,) observed that that there is clear evidence that, although economic growth usually leads to environmental degradation in the early stages of the process, in the end the best and probably the only way to attain a decent environment in most countries is to become rich.

Figure 2.1 Environmental Kuznets Curve Thus the EKC hypothesis is intended to represent a long term relationship between environmental impact and economic growth. As economic development accelerates with the intensification of agriculture and other resource extraction, the rate of resource depletion begins to exceed the rate of resource regeneration, and waste generation increases in quantity and toxicity. As income moves beyond the EKC turning point, it is assumed that transition to improving environmental quality starts. The EKC hypothesis highlights a well-defined relationship between level of economic activity and environmental degradation. In the first stage of industrialization, pollution grows rapidly because high priority is given to increase material output, which inevitably results in greater use of natural resources and emission of pollutants, which in turn put more pressure on environment. Environmental consequences of growth are ignored. As income rises due to industrialization, people value the environment more, regulatory institutions become more effective and pollution level declines. (Dinda, 2004) Proponents of the EKC hypothesis argue that at higher levels of development, structural change towards information-intensive industries and services, coupled with increased environmental awareness, enforcement of environmental regulations, better technology and

higher environmental expenditures, result in leveling off and gradual decline of environmental degradation. (Panayotou, 1993, 1997). Thus, it could be a depiction of the natural process of economic development from a clean agrarian economy to a polluting industrial economy, and, finally, to a clean service economy. . Most of the EKC models have emphasized the role of income elasticity of environmental quality demand (Beckerman, 1992;; McConnell,1997) and this elasticity is often invoked in the literature as the main reason to explain the reduction of emission level. The most common explanation for the shape of an EKC is the notion that after a particular level of income, people attach increasing value to environmental amenities ( Selden and Song, 1994) and the willingness to pay for a clean environment rises by a greater proportion than income (Roca,2003). This will be reflected through defensive expenditures, donations to environmental organizations or choice of less environmentally damaging products. Thus, rich people value the clean environment and preserve it. Generally, it is recognized that income elasticity of environmental quality demand and resource goods is in excess of unity, i.e., clean environment and preservation are luxury goods. As observed by Dinda Poor people have little demand for environmental quality, however, as a society becomes richer, its members may intensify their demands for a more healthy and cleaner environment. The consumers with higher incomes are not only willing to spend more for green products but also create pressure for environmental protection and regulations. In most cases where emissions have declined with rising income, the reductions have been due to local and national institutional reforms, such as environmental legislation and market-based incentives to reduce environmental degradation.(Dinda, 2004) Stern (2003) observes that the EKC is explained by the following proximate factors: Scale of production implies expanding production at given factor-input ratios, output mix, and state of technology. Different industries have different pollution intensities and typically, over the course of economic development the output mix changes. Changes in input mix involve the substitution of less environmentally damaging inputs for more damaging inputs and vice versa. Improvements in the state of technology involve changes in both:

a. Production efficiency in terms of using less, ceteris paribus, of the polluting inputs per unit of output.

b. Emissions specific changes in process result in less pollutant being emitted per unit of input. The proximate variables may in turn be driven by changes in underlying variables such as environmental regulation, awareness, and education in the course of economic development. For the appraisal of the feasibility of sustainable development and for possible policy implications, the validity of the EKC hypothesis is of utmost importance. Panayotou gives the following three reasons for the downward sloping portion of the EKC curve. (i) First, not until the basic human needs have been met will additional resources be spent in favour of the environment. But only rising income makes these resources available. In addition, with rising income, non material goods usually become more important. The amenity value of the environment constitutes such a non-material good. Second, education and with it, environmental awareness, the fear of environmental health hazards and the concern for reduced life expectancy all increase with income. Finally, due to rising wages the opportunity costs of lost work-days caused by health problems rise with income. As a result, individuals are likely to express their changed priorities in the political progress, e.g. by voting for stricter environmental regulations. (ii) During the growth process the structure of an economy changes. In the early phase of industrialization, pollution increases due to the setting up of many inefficient, dirty polluting industries. When industrialization is sufficiently advanced, the service sectors takes on the leading role and pollution may fall. Thus, structural change can be in favour or to the disadvantage of, environmental quality depending on the development status of an economy. (3) When a country begins to industrialise the scale effect will take place and pollution increases. Further along the trajectory firms switch to less polluting industries. This gives rise to composition effect which levels the rate of pollution. Finally due to the technological effect mature industries invest in pollution abatement equipment and technology which reduces pollution. Technological progress can lead to more environmentally friendly production technologies so that the same amount of output can be produced with both less (natural) resource inputs and less waste or pollution as a by-product. The three effects and their impact on EKC are shown in Figure 2.2a, 2.2b and 2.2c.

Figure 2.2 Impact of Scale Effect, Composition Effect and Technological Effect on EKC. To these three points, two more have been added: (4) It is often argued that developed countries relocate dirty industries to poorer countries with laxer environmental regulation thereby reducing domestic pollution but not overall pollution. The reallocation of pollution comes inescapably to an end as soon as the poorest countries would like to source out their dirty industries. The migration of polluting production from rich to poor countries is often referred to as the pollution haven hypothesis. The counteracting factor endowment hypothesis, however, suggests that dirty production, which is usually capital intensive, is located where capital is more abundant, i.e. in developed countries (Antweiler et al., 2001). Which of these two counteracting eects dominates, is mainly an empirical question. (5) Finally, the downturn of an EKC for a specic pollutant may be the result of a substitution process between pollutants. By reducing the emissions of a targeted pollutant, the emissions of another not yet considered or known may rise. As a result, the eect of the substitution on overall environmental damage can be ambiguous. Ongoing substitution between pollutants would result in overlapping EKCs. In recent years numerous theoretical papers on the EKC have been published. These studies contribute to the EKC debate by identifying diverse mechanisms leading to a nonlinear relationship between economic development and environmental degradation. Within the theoretical EKC literature two major strands of papers can be distinguished. Both of them concentrate on technological aspects as the main reason for the EKC pattern. The rst class of models stresses shifts in the use of production technologies as the main cause of the hump-

shaped pollution income relation. In Stokey (1998), the dirtiest but most productive technology is used at low levels of income. The economic reason is simply that the marginal utility of consumption is higher than the marginal disutility of pollution. Economic growth is accompanied by increasing environmental degradation. After a critical threshold is passed, (due to decreasing marginal utility of consumption and increasing marginal disutility of pollution), cleaner but less productive technologies are implemented and a decoupling of economic growth and environmental degradation occurs. In Jones and Manuelli (2001) there is again a range of technologies which dier according to their production costs and their pollution intensity. The technology options and, in the end, also the pollution path depend on the type of pollution regulation. With euent charges as the instrument of pollution control, a non-monotonic pollution path results, in particular, the pollution path is N-shaped. However, if regulation restricts the choice of technology, i.e. if a minimum standard is set, pollution monotonically increases over time. Panayatou (1997) observes a significant cubic income SO2 relationship that takes the form of an N curve as shown in figure 3.

Figure 3 N shaped EKC The second class of theoretical EKC models focuses on the abatement technology, which captures the fact that pollution can be alleviated by devoting resources to improving

environmental quality. In Selden and Song (1995), abatement is zero initially and starts to increase once economic development has created enough consumption and environmental damage (through capital accumulation) to merit expenditures on abatement. Similar results are presented by Chimeli and Braden (2002). Formulating a simple growth model with environmental quality (as a stock variable) the authors show that capital accumulation dominates at early stages of economic development and environmental eort is of secondary importance. Subsequently abatement becomes more relevant and attracts more resources, and economic growth declines. In a widely cited paper, Andreoni and Levinson (2001) focus on the characteristics of the abatement technology. Assuming that the abatement technology exhibits increasing returns to scale, the authors show that an inverted U-shaped pollution-income relation results. The EKC results solely from the interaction of the polluting economic activity and the technological properties of the abatement function. The discussion is incomplete without the mention of a third class of models which emphasises structural changes within an economy. However, the underlying mechanism is restricted to developing countries and does not apply to mature economies, since their inter sectoral shifts have been relatively small in recent decades. Most approaches stress the importance of a suciently high income elasticity of demand for environmental quality. It can be shown, however, that a high income elasticity for environmental quality is indeed helpful for an EKC conformable pattern, but it is neither sucient nor necessary (McConnell, 1997).As a matter of fact, the decisive point is that environmental quality has a positive income elasticity which exceeds unity (luxury good) (Lieb, 2002). 2.2 EVIDENCE FROM LITERATURE: The EKC literature was initiated in the early 1990s by a paper of Grossman and Krueger (1993, rst published in 1991) investigating the environmental impacts of North American Free Trade Agreement ( NAFTA). These authors found empirical evidence that emissions of a number of air pollutants rose with income at low levels of income, but reached a turning point around USD 5.000 (1985 PPP$) and further economic progress then led to decreasing environmental degradation. Almost at the same time but independently, Shak and Bandyopadhyay (1992) and Panayotou (1995, rst published in 1993) reported similar results. Shak and Bandyopadhyay (1992) estimated EKCs for ten different indicators using three different functional forms. Lack

of clean water and urban sanitation were found to decline uniformly with increasing income and over time. River quality, municipal waste and carbon emissions tended to worsen with increasing income whereas deforestation showed no such relationship. However, local pollutants turned down between $3000-4000. De Bruyn et al. (1998) believe that the inverted U shape does not hold in the long run as it would be only an initial stage of the relationship between economic growth and environmental degradation. Above a certain income level, there would be a new turning point that would lead to N shaped curve, meaning that the environmental degradation would come back in high growth levels. Harbaugh et al. (2000) reexamined the empirical evidence for EKC using the air pollution data studied by the World Bank (1992) and by Grossman and Krueger (1991), with the benefit of a retrospective data cleaning and ten additional years of data for SO2, smoke and total suspended particulates (TSP). He observed that SO2 and smoke exhibit the most dramatic inverse U shaped pattern in the reference studies. Harbough et al. conclude that the evidence for inverted-U is much less robust than previously thought, and the locations of the turning points as well their existence is sensitive to slight variation in the data as well as reasonable permutations of the econometric specification. Martinez-Zarzoso and Bengochea-Morancho (2003) used panel data for 19 Latin American and Caribbean countries over the period 1975-1998 and observed that there is no commonality due to great heterogeneity observed in the scatter diagrams showing the relationship between emission and pollution. Nevertheless emission has been growing continuously since 1975 to the present time. They observed increasing still sufficiently lower level of pollution in these countries as compared to OECD countries. Annexure 1 gives details of studies on EKC. In the literature on EKCs a point of comparison could be the turning point of the relationship between income and pollution that is the point at which countries will begin to demand better environment. Table 2.1 gives details on turning points calculated for select pollutants.

Table 2.1 EKC Turning Points- Evidence form Literature Year Pollutant CO2 1996 Author(s) of study Sengupta 16 developed and developing countries CO2 1997 Moomaw and Unruh CO2 1999 Agras and Chapman CO2 1999 Galeotti and Lanza SO2 1994 Year Pollutant SO2 1998 Shafik Author(s) of study Torras and Boyce SO2 SO2 1997 1995 Cole et al Selden and Song SO2 1998 Kaufmann et al 11 OECD countries for 22 OECD and 8 developing countries 13 developed and 10 developing countries. $ 14730 $8232 $ 10391-10620 cities in 42 countries $4641 47 cities in 31 countries Study Area $4379 Turning point 110 countries. $15,073-21,757 34 countries $13,630 16 developed countries $12,813 $8,740 Study Area Turning point

The peak points for SO2 were estimated as $4379 by Shafik (1994) for 47 cities in 31 countries, $4641 by Torras and Boyce (1998) for the cities in 42 countries, $8232 by Cole et al. (1997) for 11 OECD countries, $ 10391-10620 by Selden and Song (1995) for 22 OECD and 8 developing countries and $ 14730 by Kaufmann et al. (1998) for 13 developed and 10

developing countries. Listing of peak points associated with individual countries may prove much more useful in analyzing the economic and environmental history at the local level which may facilitate the prediction of turning points for others. There have been subsequently a number of studies addressing the hypothesized link and these are also summarized in Table 2.2. 2.3 Studies on EKC with respect to CO2 emissions Kaika and Zervas classify research studies on EKC with respect to CO2 emissions under 4 categories: 1. Studies which use panel data or time series cross sectional (TSCS) data 2. Studies dealing with energy issues 3. Studies which include structural changes and technology 4. Other studies. Table 2.2 gives details of such studies covered by Kaika and Zervas. Table 2.3 Studies on EKC for CO2 Emissions
S.No 1. Author Shafik & Bandyopadhyay Year 1992 Data Details 10 indicators of Environmental Quality for 149 countries Specification Panel Data Results Income has a significant effect on all indicators of environmental quality. CO2 emission seems to be rise monotonically as income rises. 2. Agras & Chapman 1999 Constructed CO2 model that included energy prices No EKC pattern found with the inclusion of energy prices.EKC pattern for CO2 may arise due to the effects of 1970 Oil shocks. 3. Moomaw & Unruch 1997 16 OECD Countries Energy use for CO2 emission Declining CO2 emission is driven by oil price shocks. If it shifts the fuel mix of energy, then fuel mix is an important determinant of EKC

relationship. 4. Richmond & Kauffmann 19731997 International data for the year 19731997 Relationship among income, energy-mix and energy-use &/or carbon emission 5. De Bruyn 19601993 Netherland, Western Germany, UK, USA,for various time intervals during 1960-1993 6. Lantz & Feng 19702000 Canada Structural changes in technology, CO2, NOx & SO2 emission. 7. Kander 1970 Sweden Structural changes in technology, CO2, NOx & SO2 emission. 8. Galeotli & Lanza 19701996 110 countries EKC tested Technological (or) structural changes have resulted in increase of CO2 emission intensity for 1970-2000. CO2 emission declined after 1970 due to a stabilized of energy emission which occurred due to Industrial sector. EKC existed for CO2 emission predicted that for future global emission will due to increase in per capita income in developing countries. 9. Azomahou & Van phu 19601996 100 countries Non-parametric model & a sample model of EKC. Monotonic relationship Structural changes in technology, CO2,NOx & SO2 emission Improvement in the environmental quality is due to income accumulation. Data did not support in this studies A limited EKC pattern for OECD countries but this due to high oil prices emissions for &/or CO2 OECD countries.

10.

Lee

19602000

Middle income American & European countries

Inverted Ushaped relationship No evidence of an EKC

Inverted U-shaped curve between income & CO2 emission Emission increase with economic Growth & decrease in environmental degradation.

11.

Aslanidis & Iranzo

19711997

Non-OECD countries

12.

Narayan & Narayan

Middle, eastern & South Asia 19701998 29 OECD Countries

EKC hypothesis EKC hypothesis

CO2 emission decreases with increases in income. 12 countries have strong evidence of EKC, an increasing or decreasing relationship for 9 countries & 8 countries has no clear trend are concluded.

13.

Pauli

14.

Jaunky

19802005

36 high income countries 17 OECD countries & 11 non-OECD countries

Panel data

CO2 are stabilizing & EKC pattern is rejected. When CO2 emission is at increasing rate, decreasing in OECD countries & increasing in non-OECD countries.

15.

Iwata

16.

Acarauci & Ozturk

19602005

19 countries

EKC pattern

Support the validity of an EKC pattern only for Denmark & Italy. Energy consumption plays a key role in CO2 emission.

17.

Dijkgraaf & Vollebergh

EKC with panel data

Results are different with examining each countries with time-series data

18.

Egli

1966-

Germany

EKC pattern

No clear trends

1998 19. Friedl & Gesner 19601999 20. Jhalil & Mahmud China Austria Time-series data EKC pattern N-shaped relationship between CO2 & income. Indicates possible EKC pattern despite of impressive growth of industrial sector.

According to Maryam Lashkarizadeh and Parvaneh Salatin (2011), most of the studies on relationship between CO2 emissions and percapita income share few common points such as: The relationship is a reduced-form equation relating per capita CO2 emissions to per capita income. In general, and with the possible exception of a time trend, no extra explanatory variables are included. The analysis is usually conducted on a panel data set of individual countries around the world. Moreover, the data for CO2 emissions invariably have come from a single source, namely the Oak Ridge National Laboratory. The functional relationship considered is generally either linear or log-linear in GDP. Due to the almost complete coverage of countries, the estimation technique is typically the least squares dummy variable method, allowing for both fixed country and time effects. The work on carbon dioxide emissions has been largely inconclusive, with some studies indicating that per capita emissions increase monotonically with income growth and others identifying a range of turning points. Shafik (1994) finds evidence of a positive relationship between income and emission per capita with no evidence of a turning point. By contrast, HoltzEakin and Selden (1995) infer a turning point of $35,418 whilst Neumayer (2004) cites a range of between $55,000 and $90,000 as the turning point, depending on assumptions. The range of results and the sensitivity of these results to changes in model specification imply that that the conclusions drawn cannot be considered robust (Stern, 1998; Engli, 2002). The peak points for CO2 were estimated as $8,740 by Sengupta (1996) for 16 developed and developing countries, $12,813 by Moomaw and Unruh (1997) for 16 developed countries, $13,630 by Agras and

Chapman (1999) for 34 countries, and $15,073-21,757 by Galeotti and Lanza (1999) for 110 countries. The EKC results have shown that economic growth could be compatible with environmental improvement if appropriate policies are taken. The nature and causal relationship between economic growth and environmental quality must be understood before making a policy decision on development . The empirical studies on EKC is a search for an answer to the question: Is economic growth a solution or cause of environmental problem? What is the policy implication of the turning point income level? The empirical studies on existence of an EKC attempts to answer these questions.