Does Environmental Policy Necessarily Discourage Growth?

What is it about?

This paper analyzes the long-run impact of an environmental policy on economic growth. A growth model with vertical innovation is modified by including intermediate goods as a source of pollution. Taxation on pollution reduces profits of intermediate firms as well as final outputs. However, it increases their markups and alleviates profit losses. In this setting, profit losses are offset by the general equilibrium effect; thus, the tax enhances R&Ds which drive economic growth while it reduces pollution. If the government provides an R&D subsidy, the growth rate will be accelerated.

Featured Image

Why is it important?

Traditionally, a conflict between economic growth and environmental conservation has often been postulated. However, we find whether the tax affects growth negatively or positively depends on two effects. The first one is called the ‘‘profitability effect’’, i.e., the loss or gain in the profits of the intermediate sector, which are the payoffs from innovative activities. The other one is the ‘‘general equilibrium effect’’which is associated with a resource constraint on R&D activities. Overall, the tax drives R&Ds, which drive economic growth, as well as reduce the level of pollution, because the profit loss is offset by the general equilibrium effect.

Perspectives