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Weaknesses Of The Eurozone Economics Essay

Robert Mundell described the Bretton Woods System as Hamlet without the Prince due to the lack of a unified currency in the form of a monetary union expressed as Bancor or Unitas. Given the experience of EMU, does this analysis still hold theoretically and/or empirically? Discuss.
Introduction of EMU In 1999, the European Central Bank (ECB) launched the single currency (euro) together with the foundation of the Economic and Monetary Union (EMU). The EMU is based on the existence of the euro as a common currency. The ECB supervises the implementation of a common monetary policy. At the beginning of 2002, euro replaced the national currencies of 12 member countries for all transactions. Sweden, Denmark, and the United Kingdom joined European Union (EU) but did not join the euro. In 2004, there were ten new member countries joined the EU, five of them joined the euro.
The prior monetary unions are unsuccessful as they rested on the value of metals (i.e. gold or silver). The money printed should be determined by the silver of gold stored, therefore the Metallism monetary system is a stable system since silver and gold are scarce resources.
The EMU rests on the euro or chartalism, as fiat money which is issued by a central national bank. The credit level of the issuing body is important to determine the value and stability of the fiat money. The stability of the country in terms of economic and political will in turn determine the credit level. However, when the treasury is unable to finance the deficit, fiat monies can become unstable due to the temptation of the inflationary tax or seigniorage. In order to achieve and sustain the stability, the EMU needs an economic union and a monetary union. Economic union is achieved by complying with the Stability and Growth Pact (SGP). The goal of SGP is to maintain fiscal stability through implementation of specific fiscal requirements among member states of EMU.
The strength of the Eurozone rests completely on the credibility of the requirements set when the EMU was being implemented and the ECB was established. However, if member states are not respect or follow the set requirements, the credibility level of Eurozone will be affected and as a result negatively affect the euro.
Mundell’s Theories The original idea of a common currency in Europe was derived from the theory of Robert Mundell on the areas of optimal currency. In his paper “A plan for a European Currency” in 1973, Mundell clarified the gains of European countries if they adopt a common currency. The works of Mundell have been classified into two categories by Ronald McKinnon (2004).
Mundell I In 1961, Mundell published his paper entitled “A Theory of Optimal Currency Areas” which is rooted in Keynesian ideas. The theory of Optimum Currency Areas (OCAs) studies how countries with a monetary union and common currency adjust, if these countries are affected by asymmetric economic shocks. Mundell point out that adjustments are based on whether wages are rigid, labour mobility is limited, income transfers are difficult, and differences exist in the labour market and growth rates. Mundell claimed that when countries are in a monetary union and use a common currency, they cannot absorb asymmetric shocks properly unless, among other circumstances, labour mobility is unlimited.
Mundell II In Mundell’s article “Uncommon arguments for common currencies” which published in 1973, an alternative theory is illustrated. Mundell emphasised “the common currency assures an automatic and equal sharing of the risk of the fluctuation”, a common currency has advantages in overcoming economic shocks. Mundell II argues that it is easier for member countries to stay inside a monetary union than outside it since the private insurance would assist against asymmetric shocks. More specifically, it will be easier for member countries to borrow in the capital markets of the monetary union when hitting by a negative shock, as a result it will be easier for member countries to smooth consumption. In addition, the exchange rate would be a source in arising asymmetric disturbances; especially capital mobility of financial market is very high.
The criticism of Mundell II becomes more obvious in terms of political context. If financial markets in a monetary union provide insurance to reduce asymmetric shocks, the need to integrate national budgets for political means becomes weaker. Hence the motive to form a political union is even weaker. However, the Mundell II point out that if there is no budgetary union, it would be optimistic to say that private financial markets would provide insurance against asymmetric shocks. The financial markets will only provide insurance to those who possess high assets stock in the financial markets. Since wealth is not equally distributed, the private provision of insurance will overwhelmingly support the wealthy and keep the poor relatively uninsured. In addition, the Mundell II theory ignored the possibility that countries may involve in a position of a ‘bad equilibrium’. If there are not adequate instruments to lead the economy out of the bad equilibrium, countries would get caught in the bad equilibrium after a negative shock. It is a major problem for the future of EMU if there is no adequate instrument in a monetary union. This is reinforced by the fact that different member countries of EMU continue to work in different directions due to the absence of a political union.
Weaknesses of the Eurozone In the last ten years, the euro has demonstrated that there are many efficiency gains by adopting a common currency (i.e. reduced transaction costs of exchanging currencies, eliminated exchange rate uncertainty, and increased transparency in prices), particularly if the currency becomes not only an international currency but also a global currency. However, maintaining various standards requires difficult adjustments and constant surveillance of every single member state in Eurozone.
As the economic crisis has hit the world, certain Eurozone Member States – Greece, Portugal and Spain are being seriously affected. The Greek tragedy is making the EU realize that highly indebted countries can put the EMU at risk and that measures must be taken without delay.
Institutional Weakness Article 102.a of the Maastricht Treaty establishes that member states and the community should “conduct their economic policies with a view to contributing to the achievement of the objectives of the Community”. In order to guide Article 102.a, Article 103 highlights that the correct implementation of economic policies is a matter of common, stating that “Member States [are to] coordinate them within the Council, in accordance with the provisions of Article 102a”. Article 103 also highlights that it is important to avoid excessive deficits of each government. There is an obvious institutional weakness in terms of monetary policies. The Maastricht Treaty had defined the objectives of the ECB which is price stability. ECB has defined an inflation rate below 2% as the objective of price stability. In addition, in terms of unemployment, the rest of society is not convinced and will not easily accept the attempt of the ECB to release itself from any responsibility for unemployment. However, the delegation of the responsibility of unemployment to the governments of each member country creates a political problem.
The purposes of SGP contain that member countries should avoid excessive debt and deficits and each member country should maintain fiscal stability. There are two important two Council Regulations in SGP (i.e. Regulations 1466/97 and 1467/97). These two regulations require member countries of the EU must comply with to help “contribute to the overall climate of stability and financial prudence underpinning the success of the EMU”. The Council Regulation 1466/97 set out the details of stability programs (i.e. submission and monitoring regulations) and convergence programs. The ultimate purpose of the multilateral surveillance by the Council is to prevent, at an early stage, the occurrence of excessive general government deficits and to promote the surveillance and coordination of economic policies. The purpose of regulation 1467/97 is to clarify the excessive deficit procedure to deter excessive government deficits (European Navigator 1997, 2). However, the SGP is not sustainable due to the lack of accountability of the EU commission. Hence, the national governments are bound to win when conflict arises. The problem will exist as long as national governments continue to possess the sovereignty over spending and taxation.
Political integration De Grauwe (2006) acknowledged that the EMU is a remarkable accomplishment, but the absence of a political union is a major weakness in the Eurozone governance. Grauwe’s view is consistent with the findings of Nitsch on the political integration. He conclude that “political integration is not rapidly followed by economic integration” (Nitsch and Wolf 1). Grauwe point out in his article that national governments holding most economic policies decision creates asymmetric shocks. The asymmetric shocks truly affect the sustainability of the monetary union. For example, member countries of the Eurozone have different competitive positions due to the uncoordinated policies of each member country in relation to national wage.
Italy, Ireland, Portugal, Greece and Spain were in constant financial and economic turmoil before the adoption of the euro. The turmoil situation disappeared due to the economic booming of the past years. These five countries have barely met the requirements of monetary and economic stability and are becoming increasingly difficult to maintain the stability. For the past years, these countries are not only suffering from excessive deficits and debts, but also economic unbalances (i.e. excessive current account deficits). The current account positions are becoming worse due to, among other reasons, their extremely uncompetitive trade position. As a consequence, they are beginning to blame the euro.
The problem that these countries are facing originates from the fact that monetary union amplifies fiscal imbalances. Opting for devaluation of a competitive currency is not an option and the only other alternative stems from forcing differentials of bond yield reduced. In 2005 there were almost no yield differentials between the German Bund and the yields of those countries with excessive current-account deficits. In 2009, however, yield spreads has increased government default risks measured by a sudden increase in the demand for credit default swaps. Hence, the current economic crisis has demonstrated that currency risk is replaced by default risk in a monetary union. There are two reasons for this situation: 1) the sovereign debt of each member country is issued under the control of each Ministry of Finance, 2) there is no European Ministry of Finance.
The Germans has proposed the creation of a European Monetary Fund, the French league has proposed the creation of a European Debt Agency which required that the Lisbon Treaty were amended or that a new treaty were negotiated. Many people blamed this situation due to the lack of a common bond market which would help to put all members together. Some people reject the suggestion based on the fact that a common bond market would lower borrowing costs for weaker countries and increase costs for stronger countries such as Germany. In addition, the common bond market would obtain the budget rights from each governments which would not be able to make national budgets by themselves.
Exit clause For years some countries have not respect or followed the requirements listed in the Maastricht Treaty and are now facing extremely difficult economic situations. It is obvious in the current crisis that there is no political homogeneity among member countries from a political point of view. As a result, each member country has implemented its own particular economic model and how to conduct its own economic model. In addition, Greece, Spain, and Portugal do not truly realise that their economic models are embedded in a globalised economy and these countries need to implement a set of painful structural reforms to keep them competitive. From the economic point of view, the countries in trouble have two major common reasons. The reasons are the lack of respect for the requirements and the lack of appropriate implementation of the structural reforms required under an economic recession.
Currently there are debates on what should or should not be done with these countries. However, there are not room to manoeuvre this situation under the current legal framework.
Expulsion of these countries from the Eurozone is not a good choice as it would definitely hurt the image of the EU and its member countries. Many scholars, economists propose that voluntary withdrawal from only the Eurozone while staying in the EU to would be the most beneficial option.
The legal framework – the Treaty of Lisbon, does not provide the necessary methods to deal with problems of withdrawal, expulsion from Eurozone nor any other similar problem that might arrive soon. First, the Treaty of Lisbon has the “no-bailout” clause to prevent a budgetary problem in one country spilling over the EU as a whole. The no-bailout clause prohibits member countries from rescuing other countries or from accepting the debts of other countries. However, the Article 122 of Lisbon Treaty states that any member country “seriously threatened with severe difficulties caused by natural disasters or exceptional occurrences beyond its control” can receive financial assistance from other members. The question is whether a member country’s current debt crisis could qualify as an “exceptional occurrence” and not a “man-made” issue. This clause was inserted to strengthen unity and commitment of Eurozone. But the reality is that some countries are possessing extremely high level debts and deficits far exceeding the requirements. Therefore, there are not many methods for to assist these financial troubled countries under the current circumstances. The Articles 4(2), 118, and 123(4) explicitly indicates that the process for adoption of the Euro is irreversible. Participation of the EMU becomes a legal obligation due to the irrevocability of the agreement and the monetary union process. Thus, the exit option of leaving EMU while staying in the EU is impossible. The exit option is only allowed to exit the EU and EMU altogether.
In addition, there is no clear mechanism by which members could expel a fellow country. The expulsion could only be possible if the treaty were amended and provided that all member countries respond favourably to this amendment.
Conclusion The EU and the Eurozone are suffering not only a financial crisis, but also a totally lack of appropriate structural reforms. The proper functioning of the EMU depends on the compliance with requirement provided in monetary and fiscal policies. Some member countries need to adopt urgently a number of structural reforms to promote economic growth of its own country and to stable euro as part of the EMU. Most importantly, the EMU should take this crisis as an opportunity to create a restructuring mechanism to strengthen and reform the economic, political foundations of the euro project.

Explain Formally The Environmental Kuznets Curve Hypothesis Economics Essay

Clearly as countries strive for increased growth they attempt to produce greater output and logic dictates that with greater output, ceteris paribus, there must be greater input and thus a depletion of resources from our environment. Simultaneously greater output leads to greater levels of emissions and waste, thus the carrying capacity of the biosphere will be exceeded sooner. Simon Kuznets’s Environmental Kuznets Curve hypothesis states that ‘economic inequality initially increases, reaches a critical threshold, and then decreases as the country “develops”‘ (Economic Growth and Income Inequality, 1955). The hypothesis is shown by Figure 1 below.
http://upload.wikimedia.org/wikipedia/commons/6/6b/Kuznets_curve.png
Figure
It is important to realise the relationship of the EKC shows a correlation between environmental equality and income, not causation. This simply means that a trend has been realised between income and economic inequality which states that initially as income rises so does inequality, however at a certain threshold inequality begins to diminish, and the reason for this change is not immediately apparent.
The concept that environmental equality is influenced by economic growth originated from earlier economic theory, as in many 1970s theoretical literature on pollution and growth, optimal pollution control models have ‘inverted U curves’ of pollution implicitly embedded in them (Selden, 1994).
There are two main economic explanations for the Kuznets Curve hypothesis. Firstly the environment can be viewed as a luxury good. This means that although initially individuals are not willing to trade consumption for environmental investment, at a certain level of income individuals begin to increase their expenditure on the environment to enjoy its benefits. It can therefore be argued that economic development is a means to environmental improvement and thus whilst initially the environment will suffer from growth, it will benefit from the economic prosperity in the long run.
Secondly as countries experience growth and income increases there are recognised historical structural development stages to the country’s economy much like, as Roslow noted, the moving from traditional to industrial economies and then to a mature mass consumption economy (The Stages of Economic Growth, 1960). For example, in a Less Developed Country (LDC), a structural transformation from primitive agriculture, through manufacturing and into services would initially utilise the environment efficiently through agricultural trade, with greater income this might transform into manufacturing which is highly dependent on environmental resources and also carries large negative externalities such as pollution. However once again, with further growth industry and trade will move towards services which have the least impact on the environment. The study by Syrquin in 1989 econometrically ties structural changes to economic growth and is often used to discuss the EKC hypothesis (Grossman, et al., 1995). It is obvious to conclude that if these developmental stages occur and the transitions between the stages correlate with specific per capita income levels, then a relationship where pollution levels initially rise before subsequently falling, as average incomes increase. Unrah and Moomaw argue that we cannot be sure whether the ‘stages of economic growth’ are a deterministic process that all countries must pass through, or simply a description of the development history of a specific group of countries during the 19th and 20th centuries that may never again take place (An alternative analysis of apparent EKC-type transitions, 1998).
We can look at the turning point in the EKC from increasing environmental inequality to diminishing environmental inequality as a change of individual interest from self-interest to social interest. However Arrow (2000) points out that the EKC provides very little information about the mechanisms by which economic growth affects the environment. For example, as income increases industry developments and innovations may have reduced negative externalities on the environment. Also with greater national income and wealth there is greater demand on the authorities for environmental regulations.
There have been several empirical and analytical studies of the EKC hypothesis and whilst some support the conclusions of Kuznets others counter his findings. There is however, little debate that many pollution emissions in the developed countries of the Organisation for Economic Co-operation and Development (OECD) have stabilised or indeed declined over recent years whilst these same countries per capital incomes have simultaneously increased (An alternative analysis of apparent EKC-type transitions, 1998).
Unrah and Moomaw demonstrate in their 1998 empirical study of France GDP growth against CO2 levels an ‘inverted U-shaped curve’ is produced which supports Kuznets hypothesis (An alternative analysis of apparent EKC-type transitions, 1998).
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Figure – France CO2 vs GDP 1950-1992
Grossman and Krueger in 1994 produced a study with an “N-shaped” curve where after a high enough threshold there were increases in environmental degradation. Grossman also in 1994 found that the turning point is sooner for an obvious short term environmental hazard for the local population (Grossman, et al., 1995). Arrow in 1995 stated that responsiveness is not immediate so income growth does not spontaneously bring a reduction to environmental degradation. As such Arrow concludes that while short term indicators would support Kuznets’s hypothesis, long term indicators would not.
The huge potential for economic growth through effective utilisation of the environment has made efficient and socially desirable management of environment resources is a key issue within economics. The environment surrounding each individual economy has always been fundamental to the performance of economic growth. Along with creating economic prosperity the environment also performs the essential function of supporting life and thus managed with care and responsibility. As has been seen through history, exploitation of the environment which has provided crucial economic inputs may also be the instrument which impairs the earth’s ability to support life. For example, in last decade we have seen the emergence of concern about how economic expansion of the world economy is leading to irreparable global damage (Silbert, 2009). As such decisions regarding the environmental trade-off between economic growth and preservation require careful consideration from political authorities.
Kuznets EKC Hypothesis EKC Analysis Conclusions
One policy proposed by economists is to allow countries to economically grow out of environmentally damaging activity. Looking at countries with already large economies, we see signs of environmental regulation such as emissions standards, extensive recycling programs, and limited timber harvesting. The economists supporting a policy that initially allows for environmental degradation assert that if a country can achieve sufficient economic growth in a short period of time then perhaps environmental damage should be tolerated.
A well-known hypothesis providing support for a policy that emphasizes economic growth at the expense of environmental protection is the environmental Kuznets curve (EKC) hypothesis. It posits that countries in the development process will see their levels of environmental degradation increase until some income threshold is met and then afterwards decrease. If true, economic policies should allow extensive, although not necessarily absolute, use of the environment for growth purposes. But carrying out such policies involves inherent dangers.
If developing countries decide to overlook environmental protection by counting on rising incomes to abate environmental damage the consequences could be devastating. The most pressing danger is that additional environmental degradation could cause some irreversible and significant harm. This could occur before the predicted income threshold is met. The other concern with counting on incomes to reduce environmental damage is that the EKC hypothesis could easily be incorrect and relying on its predictions would lead to consistently insufficient protection.
This paper evaluates the validity of the EKC hypothesis and argues that it is not a sound basis for policy formation and justification with so much at stake. The plan of the paper is as follows. Section II examines the basis for the EKC hypothesis and conditions under which it may accurately predict a country’s future environmental status. Section III briefly summarizes empirical studies investigating EKCs and looks at the findings of these studies. Section IV identifies the inherent dangers in determining environmental policy based upon the EKC hypothesis. Some concerns are relevant if the hypothesis does not hold and others are present even if it proves a correct forecaster of environmental quality. Section V concludes with my assessment of how well the hypothesis works as a justification for dubious environmental policies.
Section II: The Concept of the Environmental Kuznets Curve
The EKC hypothesis asserts that countries will naturally move from relatively low environmentally degrading activity to highly degrading activity and then, once a certain income threshold is achieved, will proceed to less degrading activity once again. This assertion allows one to predict the relative level of environmental damage being caused by a country by looking at GDP per capita. However, this prediction is relative to individual countries. In other words, each country has its own EKC, based upon resource endowment, social customs, etc., from which it progresses along relative to its GDP. A graphical model of the hypothesis helps illustrate the inverted “U” shape of the relationship:
Environmental Damage
Y*
Income per capita
The y-axis represents the amount of environmental damage due to economic activity and the x-axis represents income per capita. Y* represents the threshold income, sometimes referred to as the “turning point”. That point signifies the income level at which environmental damage per capita begins to recede.
It is important to note that the theoretical EKC graph does not explicitly express time as a dimension and for this reason the use of the EKC hypothesis to justify policy decision – an action that by definition incorporates time – would appear inadequate. Only by comparing two different countries can the inverted “U” shaped curve be derived as seen above. However each country possesses its own unique EKC and therefore each country’s policies should be organized accordingly. In order for the graph to show an EKC, and thereby be valid as policy justification, we must incorporate a time dimension. We find a time dimension along the x-axis. The EKC hypothesis assumes that changes in income per capita only occur over time. By including this supposition of changes in income inherently signifying time, the graph can now show an EKC for a specific country. The identification of a country’s particular EKC provides a basis for using it to influence policy. Possessing the theoretical model by which the EKC hypothesis is used for economic policy we turn our focus to explaining why the inverted “U” shape exists.
There are two primary explanations for the proposed shape of the EKC. The first examines the history of developed countries and the paths they took to achieve development. The second reflects the changing preference for environmental quality as incomes rise.
Historically, all developed countries’ economies were originally based upon agriculture, a state that produced little environmental damage. Their economies later switched to a much more environmentally damaging state that focused on industry and manufacturing. Finally, upon switching from heavy industry to the now-prevalent service-based economies the levels of environmentally damage fell in most developed countries. Two main factors lead to environmental damage that occurrs during industrialization. First, the harmful by-products of production damage the environment. High levels of pollution and water contamination accompany the expansion of industry. The second factor is the increased consumption of natural resources. The extensive over-use of land, deforestation and mining of mountains is a form of environmental damage in and of itself. A common conclusion of this development pattern is that LDCs must pass through the same phases in order to achieve economic growth. Furthermore, if forced to adhere to strict environmental regulations, LDCs will be at an economic disadvantage compared to the already developed countries. Many LDCs point to this competitive disadvantage when rejecting global environmental standards. The next stage of development saw industrial nations switching to service-based economies, a trend that all global GDP leaders tend towards. During this phase the income threshold of for the EKCs for certain substances appear to have been reached. Service-based economies are able to avoid many of the most environmentally damaging economic activities. Also, highly resource-dependant production is cut significantly which reduces the impacts of resource input and harmful emissions.
The graph reflects the switch from an industrial to service-based economy somewhere around point Y*. The decreasing industrial production decreases the environmental damage despite the rising GDP associated with the service sector economy.
Environmental impacts also fall as a result of improved technology discovered in developed countries. In some cases technology leads to a more efficient use of inputs. Other technological advancements make it possible to restrict the harmful effects that economic activity have on the environment.
The second reason that a high-income level can reduce environmental damage is by altering the demand for environmental quality. Known as the “income effect”, sufficiently high GDP per capita often leads individuals to place environmental quality above additional economic growth. The aggregation of these individual preferences plays an integral role in determining the income threshold.
The EKC income threshold aggregates all environmentally damaging agents into a single numerical value. However, taken individually economists can place dollar values on the turning points of damaging agents. For example, in a 1997 paper by Cole, Rayner and Bates, the authors found the turning point of CO and NO2 emissions to be around $9,900 and $14,700, respectively. Using environmental quality preference as an explanation, the income threshold represents the income level per capita at which the preference for environmental quality outweighs the preference for additional income. This change in preference occurs on a public level, rather than a private one. Microeconomic decisions to support more environmentally friendly goods and services cannot account for the income effect. The issue is instead a matter of public policy. The changes in environmental standards reflect political pressure on the federal government and state governments. Effective lobbyists have altered the political and social landscape to favour one of increased environmental quality.
Despite the ‘clean’ nature of high-income countries it remains difficult for EKC supporters to explain certain things – such as the fact that the United States is, by far, the world’s largest greenhouse gas emitter. Defenders of the EKC hypothesis say this is due to the incredibly large economy of the U.S. and that the seemingly large figures are, proportionate to GDP, not as astonishing as they appear. The only other defense to the greenhouse gas emission statistic is that the income threshold may not have been reached.
According to the EKC hypothesis, changes to evolving economies and the individual preference for environmental quality combine to determine the income threshold. However, whether or not an inverted “U” shaped curve exists at all is still up for debate.
Section III: Evidence For and Against the EKC Hypothesis
Evidence regarding the EKC hypothesis is circumstantial and inconclusive. Most early studies that supported the hypothesis focused on a single damaging agent, such as a pollutant. Identifying key characteristics associated with agents that have been studied we find that only certain types of agents exhibit an EKC.
Evidence supporting the EKC first began in 1994 when Selden and Song found an EKC for SO2 (Environmental quality and development: Is there a Kuznets curve for air pollution emissions?, 1994). A later test in 1995 by economists Grossman also found SO2 emissions to follow an EKC (Grossman, et al., 1995). They found a turning point between $4,000 and $6,000. Another early documentation of EKC support came from Theodore Panayotou who found the turning point of deforestation to be $823.
After the initial studies, other economists began to investigate the validity of the EKC hypothesis and found refuting evidence. In the 1997 paper by Cole, Rayner and Bates, they found no EKC for traffic, nitrates or methane. A different study in 1997 by Horvath examined energy use and found no EKC; rather, energy use per capita rose steadily with increased income.
Evidence appears to support the EKC hypothesis only for a limited type of damaging agents. The emission SO2 is found in urban waste areas and is thereby characterized by its locality. Deforestation also reflects a situation involving a specific location. Damaging agents that affect only a particular site tend to show EKCs. However, a damaging agent such as traffic is plain to see and also affects certain areas heavily. In this case the agent is dominated by a scale effect – increased activity leads to increased environmental impact. While traffic-related pollution is generally iterated by population size, damaging agents such as energy production by-products increase with GDP per capita.
Section IV: Dangers of the EKC Hypothesis as Policy Justification
There exist many dangers in allowing an economy to simply grow out of environmentally damaging activity. Some of these dangers arise because the EKC hypothesis does not hold true in all cases. Others exist even if we assume the hypothesis as an accurate predictor of environmental conditions.
The following is a list of concerns regarding the EKC hypothesis:
(I) It remains inconclusive if most damaging agents follow the EKC.
(II) The threshold income may be irrelevantly high or the temporary period of increasing environmental damage too long.
(III) The decrease in environmental damage seen in developed countries may reflect the production of “dirty” products abroad and subsequent importation.
(IV) The “absorptive capacity” of our earth is unknown.
(V) EKCs may only exist in certain political atmospheres.
A detailed examination of the above concerns illustrates the inherent dangers in accepting the EKC hypothesis and afterwards using it to justify policy.
As discussed above, only local and regional damaging agents show signs of EKCs. Other “difficult to detect” agents may simply increase with GDP per capita. This discovery leaves open to question whether more agents than not respond to income increases. If there exist more agents that do not respond then attempting to grow past these impacts would be impossible.
Many damaging agents may respond to income levels, but not until GDP per capita approaches out-of-reach levels. If in a developed country, the turning point for a damaging agent is above, say, $50,000 then neglecting to react will create damage for a considerable amount of time. Over the time it takes to achieve the turning point, the environmental damage may prove more costly than it’s worth. Obviously, in an LDC the turning point value needs only to be considerably lower and still have the same adverse effects. It is important to note that it is unclear if forgoing the opportunity for economic growth may is the right or wrong decision. Nonetheless, using solely the EKC hypothesis to justify this action remains unwise, as the outcome is not known.
Another consideration that challenges the EKC evidence is that wealthy countries may be importing “dirty” products, thereby contributing to environmental degradation; the only difference is that the degradation is not domestic. The first hypothesis to bring up this possibility was the Pollution Haven hypothesis. It states that developed countries export their dirty industries to LDCs whose governments have more lax environmental standards. Many economists discounted this hypothesis with strong evidence showing that capital flows do not follow environmental regulations. However, this does not exclude the possibility of dirty industries existing in LDCs and coincidently exporting their products to wealthy countries. In this case, wealthy countries only started along the downward slope on the EKC by domestically reducing environmental damage. When taken globally their increased consumption due to income may still be increasingly damaging.
Another danger is that leaving the quality of our environment subject to economic activity, even for only a short period, may be disastrous. The ability of the earth to absorb the damaging agents produced by economic activity, called “absorptive capacity,” is not yet known. A good example is global warming. More and more studies confirm that rising global temperatures are due at least in part to human activity. Predictions regarding the consequences of this change are still being debated. But further activity could push the environment’s limits to a point that causes serious repercussions for humanity.
A final concern is that even if developing countries can achieve high levels of income per capita they may not possess a political atmosphere conducive to environmental protection. Assuming that the aggregate turning point is in a country reached, that country it is not necessarily going enact protection. Countries that possess sufficient demand for environmental quality still only achieve it with policy revisions. The most successful avenues for obtaining environmental quality are lobbyists. Without a government that responds to political pressure by these public groups there is no reason to believe that its policies will reflect the demand for a cleaner environment. In addition to this point, it also remains to be seen if all cultures place similar values on environmental quality. While constituents of currently developed countries may desire protection, countries in the process of developing may reach a point of equivalent income and still not demand environmental quality. Conversely, they may actually demand protection earlier.
Section V: Conclusion
The questions and concerns about the EKC hypothesis that I have examined in this paper raise significant doubt as to the wisdom of adopting environmental policy based upon the EKC hypothesis. Even assuming its validity, the EKC hypothesis generates considerable doubt as to its effectiveness at balancing economic growth with environmental protection. Given these doubts policies must be, at most, based only partially on predictions by the EKC hypothesis.
The correct balance between environmental protection and economic growth continues to be debated. Both of the opposing views present important arguments. Obviously, having either extreme – either unhindered economic activity or overly protective environmental measures – is an inadequate solution. The largest problem facing the debate is the lack of knowledge regarding the degree of robustness present in our earth’s environment. Still unclear of its ability to offer its resources and to soak up our by-products, our only course of action is to, with both needs in mind, tread carefully.

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