Environment

Figure 5.2 Sulfur dioxide emissions vs GDP per capita : Grossman and Krueger, 1991

There are numerous forms of externalized costs of free market capitalism that eventually end up in the form as pollution or resource depletion to the environment. Advocates argue that free market policies are ultimately beneficial for the environment due to improved problem solving efficiency of markets and the higher demand for non-material quality of life factors from wealthier societies. While there is empirical evidence for both of these claims, it appears to be valid only under limited circumstances that are conducive to collective action problems - that there is a short time delay between the cause and the effects of the pollution, that the pollution is concentrated near the source of the activity, and that the costs of the pollution are noxious enough that they are detected and elicit a response. Climate change in particular is a poor fit for these conditions and the evidence suggest that the EKC hypothesis does not hold up for global greenhouse gas emissions for this reason.

Conditions ideal for collective action on environmental problems

1. Short time delay between cause and effect

2. Pollution concentrated near the source, minimal leakage beyond the border

3. Effects are sufficiently noxious to motivate action

In this section

1. The Environmental Kuznets Curve (EKC)

2. Climate change is a challenge for collective action

3. Complimentary roles of state and financial markets

4. Evidence for the EKC hypothesis

5. EKC for climate change

The Environmental Kuznets Curve (EKC)

The Economic Freedom report claims that “people in economically free societies [...] are better stewards of the environment” (Miller, 2020). The report supports this claim by presenting a statistical relationship between environmental performance vs the Economic Freedom Index. The argument is similar to one put forward in a 1991 report on the US North American Free Trade Agreement (NAFTA) proposal by economists from the US National Bureau of Economic Research (Grossman and Krueger, 1991) known as the “Environmental Kuznets Curve (EKC) hypothesis”.

The report was a response to environmental activist concerns that the trade deal would ultimately worsen environmental performance in both countries. The report presented a cross-examination of the possible mechanisms proposed by the activists and plus alternative theories proposed by the NAFTA supporters (Grossman and Krueger, 1991). The resulting statistical relationship presented in Figure 5.1 is an inverted U of air pollutants and GDP per capita was claimed as evidence that ultimately the trade deal would be good for the environment. The message sounded similar to the Kuznets argument for inequality - that things would get worse before they get better but once the economic gains had crossed a critical threshold, further economic improvement would be complementary to and not competing with environmental interests. Grossman and Krueger organized their analysis by considering four factors summarized in Table 5.3 ; two factors proposed by the environmentalists which could conceivably make environmental conditions worse - scale, and lowest common denominator, and two alternative hypotheses that could make the conditions better - efficiency and post-materialism.

Factor	Up/Down	Description
Scale	Up	The rate of environmental pollution per unit of economic activity is mostly constant relative to the increase in overall scale and intensity of economic activity and net result is an increase in pollution and depletion. Example : increased sulfur emissions from increased cross-border road traffic
Lowest common denominator (LCD)	Up	The comparative advantage of lower labor cost and lax environmental regulation in developing countries will create competitive pressure for companies on both sides in a race to the bottom.
Efficiency	Down	Higher factors of production and other efficiency comparative advantages in the more advanced economies will result in lower pollution intensity per unit of economic activity
Post materialism	Down	The shift in political values in the more advanced societies away from material concerns to ideas of equity and sustainability will create pressure to tighten environmental standards from consumers, employees and citizens

Similar to Kuznets, the Grossman study did not further elaborate the post materialism theory. Instead the report focused on the first three factors and concluded that the third factor - efficiency and productivity would outweigh the effects of increased economic activity. The report dismissed the LCD argument but instead proposed that other factors relating to capitalization levels and efficiency would drive comparative advantage (Grossman and Krueger, 1991).

Climate change is a challenge for collective action

The problem of border leakage is particularly a difficult challenge for Greenhouse gas emissions (in particular CO2) causing climate change. The problem is “the biggest market failure the world has ever seen” since the consequences in the distant future and the emissions are a colorless, odorless gas immediately disperse into the global atmosphere (Stern, 2008).

Climate change is a particularly challenging environmental problem because it does not fit well with either of the three conditions for collective action. Climate change is a problem which affects the entire world simultaneously over very long periods of time - decades and centuries. It's effects are not immediately lethal or even directly detectable as CO2 is an inert gas, but rather the effects are periodic, intermittent extreme weather events and the link is obscured by statistics and not easily accessible to a non-scientific general public. A further complicating factor for climate change is its intrinsic relationship to energy consumption. While it is technically possible to decouple greenhouse gas emissions from energy production, the costs of are substantial. Consequentially pollution intensity per unit of energy reductions observed that are correlated with higher income societies are offset by a general increase in energy consumption that is also driven by increased economic activity.

The global economic case to reduce carbon emissions was presented by Stern in 2008 and by the IMF in 2019 (IMF, 2019 ; Stern, 2008). Given the speed of the required changes multiple policy measures may be needed. One of the most common instruments consistently recommended is some form of market penalty for emissions such as a carbon tax. The IMF recommends $75 per ton of carbon dioxide by 2030 (IMF, 2019 ; IMF ; 2013). The Economic Freedom report criticises such policies recommended by the IMF - specifically the carbon tax - to address climate change as “distortionary”, “imposing huge cost on society” and “retard economic growth” and instead draws attention back to the statistical relationship of the Freedom Index and Environmental Performance (Miller, 2020). The statistical relationship between economic freedom policies and environmental performance is analyzed in Appendix B. The results support the findings from other authors that generally the free-market conditions and economic growth improve local environmental measures, but have competing relationships for reducing carbon dioxide emissions through the relationship with the energy demands for general economic activity.

Complimentary roles of state and financial markets

Figure B.8 relationships in Legatum Prosperity Index to environmental performance

The general statistical relationships between environmental performance and free-market policies in the Economic Freedom Index is easy to find in the Legatum Prosperity Index database. The relationship is not uniform across all environmental performance measures and Appendix B unpacks this relationship into its detailed components. The analysis identified a general positive correlation among many of the parameters and in particular the “living conditions” group. This metric includes basics such as access to clean water and shelter and was used as a proxy for general poverty reduction and increase in economic activity. The scaled regression coefficients are presented in Figure B.8. The results are consistent with the analysis of the EKC hypothesis (Dinda, 2004 ; Miranda, 2020).

1. Public-private partnerships positive relationship with both governance and markets

2. Confirm "scale" argument against EKC due to coupling of energy and pollution

3. Mixed results post-materialism hypothesis - neutral effect education, positive result from freedom of expression

Public-private partnerships

The positive relationship with market liberalization seems to confirm the theory of improved efficiency and reduction in efficiency per unit of exergy. Strong government institutions did not appear to be positively related to better environment outcomes, but instead it is active citizen participation (such as protests) which seems to be a stronger determinant factor.

Scale - energy component of living conditions

The negative relationship with the general living conditions and education however appear to confirm the second finding that emissions is still positively related to economic activity via increased energy consumption. This negative relationship with basic living conditions appears stronger for emissions than other environmental performance measures and greater magnitude than the effect of free-market policies. Delivery of water, electricity, and mobility for basic living all have some energy demand.

Mixed evidence of positive effects of post-materialism shift in advanced economies

The negative relationship with education is suspected to be a proxy for lifestyle based carbon emissions since education is positively correlated with personal income. Freedom of speech however has a strong positive associated with better environment outcomes. This appears to provide some evidence for the post-materialism theory that increased average incomes improve environmental performance due to a shift in political demands and democratic mechanisms for leveraging those demands on markets through the state.

Evidence for the EKC hypothesis

Several studies around the world have found some evidence supporting the EKC hypothesis under limited conditions (Dinda, 2004 ; Miranda, 2020 ; Kalayci, 2019). One such meta-analysis review of multiple papers published in Ecological Economics found that the inverted U is observed for particularly noxious hazards such as sulfur dioxide SO2 and particulate matter PM that do not readily diffuse outside the local administrative region as an externality (Dinda, 2004). These conditions are similar to the condition of closure identified by Ostrom as important for a successful common pool resource (Ostrom, 1990). Other less noxious hazards such as noise pollution or those which are easily diffused across the borders into the commons such as municipal waste and carbon dioxide CO2 do not show the inverted U but instead show either a plateau or monotonic increase (Dinda, 2004). Regarding the effects of free trade on the environment, while cross-border transfers may appear to improve environmental performance in the wealthy country, they do not improve the global situation. The overall trend globally is a net monotonic increase in environmental costs with rising incomes (Kubiszewski, 2013).

EKC for climate change

A review of the effect of NAFTA on CO2 (instead of SO2) found evidence of efficiency gain (argument #3) that the emissions intensity per unit of exergy (useful energy) had the inverted U shape. The study concluded however that overall the increase is monotonic because the effect was neutralized by the increase of scale (argument #1), that consumption of exergy generally increased with increasing GDP per capita (Miranda, 2020).

The observations from NAFTA are similar for Singapore, which has observed a decline in CO2 emissions intensity per $ of GDP but a general plateau in CO2 emissions per capita (Singapore NCCS, 2020). The GPI estimated by Delang for Singapore is likely under-estimated as the author did not account for social costs outside the border other than territorial carbon dioxide (CO2) emissions for climate change (Delang, 2016). The social cost of climate change due to CO2 generated from economic activity is known as “carbon footprint” in units of tons of CO2 equivalent per person per year. These social costs include imported emissions, which are carbon emissions from producing and transporting goods beyond Singapore’s borders into Singapore. Including these imported emissions, Singapore’s total carbon footprint is the highest in the world and estimated to be 2-3x its territorial emissions due to lifestyle affluence and the carbon and material intensity of imported consumption (Moran, 2018).