On the impossibility of sustainable economic growth: Theory and policy implications

This paper investigates a possibility of sustainable growth in a multi-output endogenous growth framework where the capital accumulation takes place mainly through the production of the dirty manufactured goods. The paper is motivated by the empirical observation that, despite growing effort on abatement activities in major industrialized countries, the world CO₂ emissions have constantly been growing. This paper reexamines the basic premise of the existing theoretical literature that posits pollution first increases with income but reaches a turning point beyond which it continuously declines, and emphasizes the important role of clean capital in sustainable growth.The paper finds that in a closed economy, economic growth is not environmentally sustainable, even under an optimal pollution tax unless the consumption elasticity of substitution between clean and dirty goods approaches infinity as in a small open economy which exports dirty goods. If the capital accumulation takes place mainly in the dirty industry, the return to the capital declines fast enough to remove incentives for accumulating capital in a closed economy as the environmental stringency increases over time. As long as the investment consists of dirty goods, positive, sustainable growth becomes unattainable under a Pigovian pollution tax, even if the clean good industry is characterized by model with positive spill-over effects. The paper also shows that there exists a minimal threshold level of the ratio of clean to dirty capital that ensures sustainable growth in a closed economy. Further, this paper shows that in order to obtain a socially optimal positive growth rate, the economy needs to redirect some of its accumulated capital towards abatement activities. This redirection will impose a substantial social burden if the growth is driven primarily by the accumulation of dirty goods.