Why Macroeconomists and Environmentalists Need Each Other

International Monetary Fund. External Relations Dept.
Published Date:
January 1995
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Imagine a developing country—let us call it “Ecotopia”—where macroeconomic policymakers care deeply about the environment and environmental policymakers care deeply about the macroeconomy. Of course, the primary job of each group is different: environmentalists must address the coun try’s environmental problems, and macro- economists are responsible for achieving price stability and balance of payments sustainabil- ity, to lay the foundation upon which Ecotopia’s economy can grow. But they recognize that they have a great deal to gain, in terms of sustaining and improving domestic living standards, by working together.

At the moment, Ecotopia is threatened with imminent macroeconomic instability and severe environmental degradation if it does not immediately undertake dramatic environmental and economic policy reforms. How will Ecotopia fare when its policymakers simultaneously tackle environmental and macroeconomic problems? Much will depend upon the willingness of both groups not only to talk but also to implement sound macroeconomic and environmental policies. Inaction by one group—or lack of coordination—is bound to have effects on the ability of each group to achieve its primary objectives. Exactly what these effects will be, however, still remains uncertain, largely because the links between macroeconomics and the environment are complex and, as yet, not fully understood. In an effort to explore those links, the IMF held a seminar on May 10-11, 1995, that was attended by about 80 individuals from the IMF, the World Bank, academic institutions, and nongovernmental organizations (NGOs). This article draws heavily on the studies presented and the discussions that ensued, in the hopes of sharing the insights gained with Ecotopia’s policymakers.

Economic effects of degradation

Ecotopia’s environmental policymakers know that if their country were a developed one, it would have more resources to spend on environmental problems. Moreover, developed countries generally have relatively well-functioning markets, adequate environmental infrastructure and institutions, well-defined and secure property rights regarding communal resources, and well-structured and enforced environmental standards and regulations. Some even have environmental taxes (though these are not always adequate) for internalizing environmental costs, and public utility prices normally reflect long-term private (if not social) costs.

By contrast, many developing countries, like Ecotopia, must grapple with nonexistent, thin, or uncompetitive markets, inadequate environmental infrastructure and institutions, poorly defined and insecure property rights, poorly designed or enforced environmental standards, few (if any) environmental taxes, and public utility prices that do not reflect even the long-term private costs. Thus, prices for environment-intensive goods and services tend to be too low to reflect environmental costs in Ecotopia. Moreover, high rates of population growth, acute rural and urban poverty, and the dependence of total output and exports on depletable natural resources typically exacerbate the root causes of environmental problems—market, policy, and institutional failures. The most serious consequences of these failures are likely to be output and human capital losses.

Ronald Mcmorrana Canadian national, is an Economist in the IMF’s Fiscal Affairs Department

Laura Wallacea US national, is a Senior Public Affairs Officer in the IMF’s External Relations Department.

Economists and environmentalists in one room: the Norwegian experiment

Getting macroeconomists and environmentalists to talk to each other about policy options—preferably in the same language—is no easy task. But Norway seems to have found a way to do so, as Stein Hansen, Director, Project for a Sustainable Economy, Norway, and Knut Alfsen, Director of Research, Statistics Norway, reported at the seminar.

Two years ago, the Ministry of Finance, the Ministry of Environment, and the National Research Council launched an innovative study based on initiatives taken by Friends of the Earth and Project Alternative Futures of Norway at the time of the 1992 Earth Summit in Rio de Janeiro. The idea was to simulate the long-term environmental and economic impacts of imposing environmental demands on a small, open economy, thereby providing a basis for a dialogue among today’s decision makers on policy options that would affect future generations. The results would be used to see how different Norway would look by 2030 if the environmentalists were calling the shots, rather than the macroeconomists.

The simulation was accomplished by feeding the environmentalists’ top 26 demands—such as restraints on carbon dioxide and sulfur dioxide emissions, as well as on oil and gas into the long- run computable general equilibrium model used by Norway’s Ministry of Finance for its own long- run macroeconomic policy analysis.

This rather unusual approach to a dialogue was made possible by several features perhaps unique to the political economy of Norway. First, Norway’s wealth is, to a larger extent than any other OECD country (except Iceland), based on how it manages its natural resources (fish, timber, petroleum, and sources of hydropower). Second, Norway has a long tradition of making use of operational models in policymaking—a collaborative effort that brings together academics, the Ministry of Finance, and Statistics Norway. Third, Norway’s political tradition involves including different constituencies, especially NGOs, in environmental discussions—part of a political process aimed at generating a consensus.

What did the Norwegians learn from this experiment about enhancing communication between macroeconomists and environmentalists?

  • A model that integrates the environment and the macroeconomy offers an excellent way of focusing the debate between macro- economists and environmentalists because it offers a common framework for analysis—forcing both sides to see the linkages and, when necessary, face the trade-offs. This occurs because the technical analysis gives rough estimates of the magnitude of the changes in the level and structure of output associated with alternative environmental control policies.

  • It is preferable to integrate resource and environmental issues directly into existing macroeconomic policymaking tools—rather than dealing with these issues in a separate exercise—as this approach gives environmental issues more prominence and forces policymakers to recognize the links between macroeconomic and environmental objectives.

Macroeconomy. Environmental problems may directly affect the macroeconomic balances—particularly external and fiscal ones—sometimes to the point of threatening their viability and sustainability. On the external side, exports that lead to exhaustion of nonrenewable natural resources (e.g., from mines) and of renewable natural resources (e.g., from forests and fisheries) without adequate replacement and renewal may seriously erode a country’s future export base, forcing it to import primary products. On the fiscal side, revenues may be greatly reduced if output of primary exports declines because of soil erosion or other environmental degradation.

Over time, environmental degradation and natural resource depletion can also affect the macroeconomy by leading to reduced output, which, in turn, can seriously reduce the rate of economic growth. Studies give abundant evidence of lost labor productivity resulting from ill health, forgone crop output from agricultural soil degradation and erosion, lost fisheries output and tourism receipts from coastal erosion, or lost soil productivity from deforestation.

Human capital. A growing body of epidemiological studies suggests that air and water pollution are taking a heavy toll, particularly on people in the developing world, through ill health and premature mortality. Studies cited at the seminar by David Pearce, Director of the Center for Social and Economic Research on the Global Environment, University College, London, indicate that “pollution control is not a ‘luxury good’ to be afforded after the development process has ‘taken off’, but a prior requirement for sustainable development.”

Tackling degradation

Faced with these potential costs, how will Ecotopia’s environmental policymakers tackle the nation’s environmental problems? It is imperative that they introduce policies that address the root causes of the problems. Environmental policy tools—designed with the assistance of microeconomists with environmental expertise—could include establishing property rights for open-access resources, eliminating subsidies for environmentally damaging goods or activities, introducing environmental user charges or pollution taxes, and establishing environmental regulations. In practice, a combination of policy instruments may be most effective, and, of course, it would fall to the finance ministry to implement the tax and subsidy policies.

Clearly, Ecotopia’s policymakers will want to take the macroeconomic implications of these policies into account, although this will not be easy, given the uncertainty still surrounding many of the links, particularly over the longer run. A recent major Norwegian study, which brought macroeconomists and environmentalists together in an unusual dialogue, looked at this issue by asking whether Norway’s economy would survive very strict environmental policies, such as a carbon-emissions tax (see box above). The answer: yes, given sufficient time to adjust—say 40 years—albeit with lower, but still significant, economic growth relative to a world without a carbon tax.

The Norwegian study, which was presented at the seminar, also highlighted the need for adequate environmental data compatible with existing national accounts. Another seminar paper, by IMF national accounts experts Adriaan Bloem and Ethan Weisman, has noted that the idea of placing statistical coverage of environmental concerns in a national accounts framework now commands widespread support. The United Nations recently completed a major revision of the System of National Accounts. Although countries will not be required to fully integrate environmental concerns into their core accounts, it is suggested that they prepare “satellite” accounts denominated in both physical and monetary units. Already, several attempts have been made at experimenting with satellite accounts—notably in Costa Rica, Mexico, the Netherlands, Norway, and Papua New Guinea, among others. Indicative estimates suggest that conventionally measured GDP may exceed GDP adjusted for natural resource depletion and environmental degradation by between 1.5 percent and 10 percent.

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