The Environment and Structural Change

This paper builds and estimates a general equilibrium model with production (pollution) externalities to jointly explain income and price effects for the United States experience of structural change. First, I document the rise of energy-savings technologies and increased tastes for air quality since 1970. Second, I solve a multi-sector model featuring preferences over air quality and estimate it using simulated method of moments. The presence of non-separable preferences between pollution and consumption plays a key role in reconciling joint income and price effects. Since the inclusion of pollution creates non-homothetic preferences, the decline in manufacturing produces a rise in air quality, which occurs at precisely the same time that the price on services is growing. I decompose the contributions of income and price effects by simulating counterfactual models that omit income and price effects separately. Comparing each equilibrium allocation to the benchmark allows me to characterize the relative effects. On average, price effects dominate with the ability to explain 60% of structural transformation, while income effects explain the remainining 40%. Third, I simulate the effects of introducing permanent and temporary pollution taxes. I show that the magnitude of the counterfactual simulations depends crucially on assumptions about income and price effects.

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