From growth to green growth

China grew at about 10% a year over the last 30 years, from a poor country to the world’s second-largest economy. Yet, the Chinese government is now reconsidering the strategy that permitted this economic miracle, in an effort to green its development process (World Bank and DRC 2012). Brazil, Indonesia, Mexico, Morocco, and Tunisia are also acting to green their growth or using green industries as sources of growth. Ethiopia is developing a green-growth strategy. Kenya is investing heavily in geothermal power. And many other countries are hoping to leapfrog and better balance the environment and the economic imperative of rapid growth.

Why such efforts, when many have argued that environmental issues will “solve themselves” with economic development, and that early action in developing countries would be detrimental (Grossman and Krueger 1995)? There are serious flaws in this argument. First, a distinction needs to be made between environmental impacts that affect welfare through income and those that affect welfare through amenities. Poor households that struggle to feed and house themselves will indeed place a lower priority on the amenities provided by a park than wealthier households might. However, they care deeply about soil degradation that reduces agricultural yields and about the absence of solid-waste management that lead to dengue epidemics and to clogged urban drains and floods.

Making the ‘grow dirty now and clean up later’ argument even less palatable is the fact that it may simply be too costly to do so. Acting early is critical when the choice of technology and infrastructure can ‘lock in’ high-carbon or polluting lifestyles or economic structures. This is particularly the case of urban forms, which are almost impossible to modify when cities are built. This issue is particularly relevant in developing countries, where most of the infrastructure and cities will be built in the next few decades. Even worse, some damages cannot be reversed. In Kenya, for example, traditional forests are being destroyed; replanting can restore their water tower and other functions, but most biodiversity losses are probably irreversible (Chapin et al 2000).

What can be done to combine the need for growth with environmental constraints? In Hallegatte et al (2011), we argue that what is needed is to reconcile developing countries’ urgent need for rapid growth and poverty alleviation with the need to avoid irreversible and costly environmental damage. As such, efforts to foster green growth must focus on what is required in the next five to ten years to sustain robust growth, while avoiding locking economies into unsustainable patterns, preventing irreversible environmental damage and reducing the potential for regret. This can be done with growth that is efficient in its use of natural resources, clean in that it minimises pollution and environmental impacts, and resilient in that it accounts for natural hazards – the definition of what we call ‘green growth’.

In 1956, Robert Solow put forward a formal model that suggested that GDP growth comes from increases in physical capital, labour (or human capital), and productivity. In this model, physical capital increases thanks to investment. Labour increases as a result of population growth, greater labour force participation, and better health and education. And productivity increases thanks to technological change – which can stem from investments in education and research and development (R&D), economies of scale, and learning by doing.

What is missing in this model, however, is the notion that economic production depends on the stock of natural resources and the quality of the environment – that is, that the environment is a factor in the production function. This notion has been around at least since Malthus (1798), but it was not until the early 1970s that classical growth theory was modified to embrace the environment – referred to as ‘natural capital’ – as a factor of production (Dasgupta and Heal 1974, Nordhaus 1974, Solow 1974, Bovenberg and Smulders 1996). If the environment is considered as productive capital, it makes sense to invest in it, and environmental policies can be considered as investment.

In this ‘greener’ framework, environmental policies increase economic output directly by improving environmental conditions. But green policies can also contribute to economic growth indirectly, because the world’s economies are highly inefficient. Indeed, many market failures hurt both the environment and the economy. Correcting these market failures can increase efficiency and yield benefits that go beyond the environment. Environmental policies can theoretically increase conventionally measured GDP through four channels:

• Input effect: The input channel works by increasing the quantity of natural capital, labour, and physical capital, which allows for more economic production. Individual transferable fishing quotas, for example, help maintain and even increase fish stocks and thus the economic activity that depends on them (Heal and Schlenker 2008). The ecological restoration of the Loess plateau in China led to a near doubling in farmer incomes, and a significant reduction in floods. Environmental policies can also increase labour by improving population health, and they increase physical capital by better managing natural risks. Protecting mangroves, for instance, not only protects biodiversity, it can also improve the resilience of coastal zones to hurricanes and floods.
• Efficiency effect:The efficiency channel works by increasing productivity by correcting market failures and enhancing the efficiency of resource use. One example is energy efficiency. Many firms and households fail to make cost-effective energy-efficiency investments – because of market failures and behavioural biases (Gillingham et al 2009). Environmental policies that aim to reduce energy consumption may correct these market failures or influence these behaviours, leading to less environmental damage and a more efficient economy, with a higher growth potential.
• Stimulus effect:The stimulus channel can occur during an economic recession, when capacity utilisation and employment are low. Green investments increase demand, potentially increasing employment (Zenghelis 2011). Underemployment is not always related to demand, however; it can be structural, especially in developing countries. In this case, a stimulus may prove costly and do little to increase employment.
• Innovation effect:There is clear evidence thatenvironmental policies (eg, European fuel taxes or SO2 tradable permits in the US) can shift the production frontier (increasing the potential output the economy can produce) by accelerating the development and dissemination of innovation and creating knowledge spillovers. Given that investments in knowledge tend to be lower than desirable in the absence of public intervention, policies that encourage green technologies can thus usefully increase them (Porter and van der Linde 1995, Fischer and Newell 2008). The innovation effect is illustrated by investments in R&D on photovoltaic power motivated by the desire to mitigate greenhouse gas emissions. Success could make photovoltaics competitive with fossil fuels, increase the supply of electric power, and reduce the cost of providing electric power, especially to remote off-grid communities.

Environmental policies may also improve welfare through distributional impacts. For instance, subsidies that incentivise the use of energy (eg fuel subsidies) are bad for the environment, and they mainly benefit the wealthiest. According to a study by Arze del Granado et al (2010) in 20 developing countries, the 20% richest households capture 43% of such subsidies. Replacing them by targeted cash transfers can thus free resources for public investment (in schools or infrastructure) and benefit the poor and the environment. Environmental policies can also reduce potential risks to growth by increasing resilienceto environmental shocks (such as natural disasters, see Hallegatte 2011) or economic shocks (such as oil shocks or spikes in commodity prices, see Rozenberg et al 2010).

Trade-offs and synergies between green policies and growth

Of course, environmental efforts may also reduce productivity and growth, by causing producers to use more expensive technologies, by crowding out R&D in non-environmental domains, or by forcing the replacement of productive capital based on polluting technologies. Policymakers need thus to weigh the trade-offs between the costs and benefits of environmental policies.

The balance between costs and benefits will be affected by how they are defined. In a narrow economic framework, a policy to protect a mangrove forest has an economic opportunity cost (because it prevents shrimp farming, for example) and no direct benefit. In contrast, in a framework that includes the valuation of ecosystem services (Heal and Kriström 2005), the policy also has economic benefits, including protection against coastal storms.

In sum, although many observers fear that green policies require incurring large costs now for benefits that will materialise only in the long term, the reality is that many of the benefits can occur in the short and medium term. And action needs to be taken now on issues that carry a risk of lock-in and irreversibility to minimise regret and avoid costly policy reversals.

A start is classifying the potential green-growth policies as a function of the co-benefits they create and of the urgency in implementing them, as done in Table 1. Developing countries (especially low-income countries) should focus on environmental policies that have a negative or zero economic cost thanks to synergies with development (such as implementing specific urban plans); have a positive economic cost but large direct welfare impacts (ie when they target local environment goods such as local air pollution or natural risks); and whose cost can be offset with external resources (such as carbon trading).

This framework – and its policy implications – will be developed in the World Bank report “Greening growth – a path to sustainable development”, which will be released in April 2012, and through the work of the Green Growth Knowledge Platform, a common initiative of the World Bank, the OECD, UNEP, and GGGI.

Table 1. Prioritising green-growth strategies

Note: The examples provided in this table are illustrative, and the extent of trade-offs, synergies and inertia is highly context dependent.

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