Pollution abatement and long-term growth

Abstract This paper examines, first, the conditions under which sustained economic growth and the preservation of environmental quality are compatible and optimal, and, second, in what way economic growth is affected by environmental policy. A general equilibrium one-sector model is developed in which the environment is essential for production and welfare. The growth rate is endogenously determined. Pollution occurs as an inevitable by-product of economic activity but can be reduced by spending a fraction of total output on abatement activities. Feasibility of long-term growth requires a critical level of substitution in production and productivity in abatement technology. Low-development traps may arise due to environmental constraints. Whether the optimal growth path implies sustainability depends on the rate of discount, and the rates of intratemporal and intertemporal substitution. Because producers fail to take into account the positive effect of private abatement activities on aggregate environmental quality and productivity, growth in the market economy may be either too low or too high. In the former case, environmental taxation boosts growth.