A Theoretical Approach to the EKC Model
It was not until the early 1990s that environmental pollution problems began to be more frequently described in exiting economics literature (Groosman and Krueger 1991; Shafik and Bandyopadhyay 1992; Panayotou 1993; Selden and Song 1994). Since Grossman and Krueger (1991), many studies have analyzed the connection between economic growth and environmental damage. The underlying argument behind the EKC theoretical model is that environmental pollution is an increasing function of the level of economic activity, until a critical income level is reached. When an economic system reaches a certain income level, a better level of environmental quality appears, at which point environmental destruction diminishes; this pattern usually takes an inverted U-shape (Fig. 5) (Grossman and Krueger 1991; Panayotou 1993; Selden and Song 1995).
Originally, Grossman and Krueger (1991) proposed an inverted U-shaped relationship between environmental degradation and income level (Fig. 5).
Figure 5 shows an inverted U-shaped relationship between income level and environmental pollution. This behavior implies that in the early stages of economic growth, environmental pollution levels rise until a certain turning point is reached,
Fig. 5 Inverted U-shaped Environmental Kuznets Curve (Source Prepared by the author)
Fig. 6 EKC: Inverted U-shaped relationship between environmental pollution and income level ( Source Prepared by the author)
beyond which economies experience a reduction in pollution levels. This behavior also implies that economic growth affects environmental quality via three channels (Grossman and Krueger 1991): scale, composition, and technical effects (Fig. 6). This progression also supposes a dynamic structural change connected with economic growth (Dinda 2004).
Figure 6 illustrates how the economic cycle influences environmental quality through three channels: scale, composition and technical effects (Grossman and
Krueger 1995). When the economic system is in a developing stage, the scale effect overcomes the net effect. The scale effect asserts that even if the structure of the economy and the technology of the countries do not change, an increase in production will result in decreased environmental quality; therefore, economic growth initially has a negative impact on the environment. This effect suggests that even if the structure of the economy and the technology of the countries do not change, an increase in production will result in decreased environmental quality. In other words, when shares of inputs, and by extension energy demands, are employed to obtain higher output levels, this process involves an increase in environmental pollution levels (Torras and Boyce 1998).
At high levels of economic growth, the composition effect positively affects environmental quality. This effect suggests a positive impact on environmental quality because the economic structure changes from agriculture and heavy manufacturing industries to cleaner industries and the service sector. During the earlier stages of economic development, pollution levels increase, but, during the second stage of development, when the economic structure changes from agriculture to more intensive heavy manufacturing industries, pollution levels decrease as a consequence of shifts in the economic structure towards services and light manufacturing industries. This effect represents the transition from a developing economy, with highly polluting production processes, to a developed system, with a production pattern involving less-polluting activities (Hettige et al. 1998). In other words, the composition effect refers to developing economies’ transitions from capital-intensive industrial sectors to service sectors (Fig. 6).
Finally, when economies are in a developed stage (high-income level), the technical effect captures their advances in productivity and their adaptation to cleaner technologies. This process will lead to an increase in environmental quality.
Since Grossman and Krueger (1991), other studies have also examined the EKC pattern (Shafik 1994; Holtz-Eakin and Selden 1995). To analyze the long-term relationship between economic growth and environmental pollution, it is necessary to explore an extension of the EKC’s theoretical framework; this allows us to identify different scenarios of the relationship between environmental quality and economic growth (Fig. 7).
Behind the EKC theoretical scheme outlined here, which links a relationship between environmental pollution and income levels to an N-shape, the EKC’s cubic scheme is expressed as follows (Eq. 1):
Where EPit is the environmental pollution in the country or region “i”, in time “t”. Yit is the per capita income level (we also incorporate the quadratic and cubic polynomial), and Zit is the other influential, or auxiliary, variable over environmental quality. The ait coefficient includes the environmental quality average when income has no special relevance to environmental pressure, while p coefficients represent the relative importance of exogenous variables; variable eit is the error term. Depending on the value allocated to coefficients p (Eq. 1), the EKC can adopt
Fig. 7 Potential behaviors between environmental pressure (GHGpc) and GDP per capita. Notes 1 If P1 > 0, P2 = P3 = 0, increasing monotone relationship, where high levels of income are associated with high levels of pollution. 2 If P1 < 0, P2 = P3 = 0, decreasing monotone relationship, where high levels of income are associated with decreasing levels of pollution. 3 If P1 > 0, P2 < 0, P3 = 0, quadratic relationship in inverted U pattern, representing the EKC and indicating that high levels of income are associated with decreasing levels of pollution once a certain level of income is reached. 4 If P1 < 0, P2 > 0, P3 = 0, quadratic relationship in U pattern, contrary to the EKC. 5 If P1 > 0, P2 <0, P3 > 0, cubic polynomial, representing the N shape, where the inverted U hypothesis occurs up to a certain point, from which pollution increases again. 6 If P1 < 0, P2 >0, P3 < 0, cubic polynomial, inverted N shape. 7 If P1 = P2 = P3 = 0, flat
behavior, indicating that emissions are not influenced by the level of income
different forms other than the typical one (Fig. 8). We must pay special attention to the N-shaped pattern (see Fig. 6: pattern 5), following the contributions of Grossman and Krueger (1995), among others. The N-shaped EKC suggests a behavior that amplifies the income-environmental pollution relationship in the long term (Shafik and Bandyopadhyay 1992; Selden and Song 1994; Grossman and Krueger 1995; Moomaw and Unruh 1997; Torras and Boyce 1998). The N-shaped pattern of the EKC makes it possible to discuss aspects related to the scale effect and the long-term effects of energy innovation. This, in turn, makes it possible to analyze the potential return to rising emission levels once economies have achieved negative pollution rates, and environmental technological obsolescence becomes possible (Balsalobre and Alvarez 2016).
Although most of the EKC’s theoretical contributions assume an inverted U-shaped pattern (Selden), it is necessary to consider the N-shaped behavior (Fig. 8) to analyze the long-term evolution of the relationship between income level and the environmental pollution process (Shafik and Bandyopadhyay 1992; Grossman and Krueger 1995; Torras and Boyce 1998, among others). The N-shape checks whether environmental degradation returns at very high levels of economic growth.
This N-shaped relationship occurs when the relationship between the environmental degradation of the economy and income level is initially positive,
Fig. 8 EKC N-shaped (Source Prepared by the authors)
but it becomes negative once a given income threshold is reached, until environmental degradation becomes positive again. In other words, this EKC’s behavior means that environmental degradation increases during a developing stage, but once it reaches an initial turning point, environmental degradation decreases (Fig. 8). This process continues until a second turning point, where environmental pollution once again begins to experiment with an increase. This third stage is characterized by high income levels with low economic growth rates and inefficient and insufficient environmental innovation measures. Torras and Boyce (1998) consider that the return to an upward pollution path appears when the margin for successive improvements in the distribution is exhausted; in other words, when there are diminishing returns in terms of technological change reducing pollution because of “obsolescence”. At the end of this section, we will more exhaustively develop the technical obsolescence-within-EKC model.
Next, we discuss the theoretical relationship between economic growth and the innovation process.