Economy-wide policies and the environment
Consider larger scale issues that show how economy-wide policies (both macroeconomic and sectoral) may cause significant environmental and social harm.
Fiscal and monetary policies, structural adjustment programs, and stabilization measures all effect the natural resource base. Unfortunately, interactions among the economy, society and environment are complex, and our understanding of them is limited. Ideally, one would wish to trace the effects of economy-wide policy reforms (both macroeconomic and sectoral) through the socio-economic and ecological systems. Time and data limitations generally preclude such comprehensive approaches in developing countries. Practical policy analysis is usually limited to a more partial approach which traces the key impacts of specific economy-wide policies, at least qualitatively, and wherever possible, quantitatively.
No simple generalizations are possible as to the likely environmental and social effects of broad policy measures. Nevertheless, opportunities have been missed for combining poverty reduction or efficiency-oriented reforms with the complementary goal of environmental protection – i.e., “win win” outcomes[1]. For example, addressing problems of land tenure as well as access to financial and social services not only yield economic gains but are also essential for promoting environmental stewardship. Similarly, improving the efficiency of industrial or energy related activities would reduce both economic waste and environmental pollution[2].
Many instances of excessive pollution or resource over-exploitation are due to market distortions. Broad policy reforms, which usually promote efficiency or reduce poverty, could be made more beneficial for the environment. The challenge is to identify the complicated paths by which such policy changes ultimately influence conservation at the firm or household level. Some changes can have either beneficial or harmful environmental and social effects, depending on the nature of intervening conditions. The objective is not necessarily to directly modify the original broader policies (which have other conventional, non environmental goals), but rather to design more specific complementary policy measures that would help mitigate negative effects or enhance the positive impacts of the original policies on the environment.
Contents
- 1 Macroeconomic policies
- 2 Structural adjustment
- 3 Public investment/expenditure reviews
- 4 Sectoral policies
- 5 National income accounts and macroeconomic performance
- 6 Notes This is a chapter from Making Development More Sustainable: Sustainomics Framework and Applications (e-book). Previous: Discount rate, risk, and uncertainty in environmental decision-making|Table of Contents (Economy-wide policies and the environment) |Next: Conceptual framework linking ecological and socio-economic systems
Macroeconomic policies
During the economic crisis of the early 1980s, many developing countries that had been running substantial budget and trade deficits (and financing these by increasing external debt) were forced to adopt emergency stabilization programs. These programs often had unforeseen social and environmental consequences.
One important environmental impact of the crisis was related to poverty and unemployment. The stabilization efforts often necessitated currency devaluations, controls on capital, and interest rate increases. When income levels dropped, tax revenues decreased accordingly. As unemployment increased, governments fell back upon expansionary financing policies, which led to increases in consumer prices. The effect of such policies on the poorest population groups often drove them onto marginal lands, resulting in soil erosion or desertification. Fuel price increases and lowered incomes also contributed to deforestation and reductions in soil fertility, as the poor were forced to use fuelwood and animal dung for heating, lighting, and cooking.
Aside from the contractionary aspects of short term stabilization measures, many macroeconomic policies also have potentially important effects on resource use and the environment. Unfortunately, no easy generalizations as to the directions of these effects are possible; they can be either beneficial or negative, depending on specific conditions. For example, real currency devaluations have the effect of increasing international competitiveness, and raising production of internationally tradable goods (for example, forestry and agricultural products). If the agricultural response occurs through crop substitution, environmental impact would depend on whether the crop being promoted tended to be environmentally benign (such as tea, cocoa, rubber) or environmentally damaging (such as tobacco, sugarcane, and corn). Environmental impacts would also depend on whether increased production led to farming on new land (which could result in increased deforestation) or to more efficient use of existing farmland. Another possibility is that overvaluation of the exchange rate (and resulting negative terms of trade, decreased competitiveness of products and lower farm gate prices), may well push small cultivators onto more environmentally fragile marginal lands, in an attempt to absorb the effects of the price changes.
The output from a natural resource stock such as a forest or fishery will be affected by other factors like property rights (Property rights and ecological-social interactions). Thus, if trade policy increased the value of output (for example, timber or fish exports), then the degree of ownership would influence how production and resource stocks were managed. Reactions might range from more investment in and maintenance of assets (if environmental costs were internalized by owner users) to rapid depletion (when the users had no stake in the resource stock). Thus, Capistrano and Kiker propose that increasing the competitiveness of world exports would also increase the opportunity cost of keeping timber unharvested[3]. This could lead to forest depletion that significantly exceeds natural regenerative capacity. Another study (Kahn and McDonald 1991) used empirical evidence to suggest that a correlative link exists between debt and deforestation. They propose that debt burdens cause myopic behavior that often results in overdepletion of forest resources—through deforestation rates that may not be optimal in the long run, but are necessary to meet short-term needs.
| Table 1: Typical Examples of Direct and Indirect Environmental and Social Impacts of Economy-wide Policies | |||
|---|---|---|---|
| Policy Issue | Policy Reform | Direct Economic Objectives/Effects | Indirect (Environmental and Social Effects) |
| 1. Trade deficits | Flexible exchange rates | Promote industrial competitiveness, exports; reduce imports. | Export promotion might promote more deforestation for export, and lead to substitution of tree crops for annual crops. Industrial job creation may reduce pressure on land resources. |
| 2. Food security and unemployment | Agricultural intensification in settled lands and resettlement programs for new areas. | Increase crop yields and acreage; absorb more rural labor. | May reduce spontaneous migration to ecologically fragile areas. However there is potential for overuse of fertilizers and chemicals. |
| 3. Industrial protection, associated with inefficient production. | Reduce tariffs and special investment incentives. | Promote competition and industrial efficiency. | More openness may lead to more energy-efficient or less polluting technologies. It may also attract hazardous industries. |
Munasinghe and Cruz explicitly traced how economy-wide policy reforms to promote economic development could have numerous unanticipated environmental and social effects[4]. Table 1 summarizes some typical results. The first column lists only a few of the many economy-wide policy issues addressed through macroeconomic reforms. The policies in the second column of the table are usually designed to address these issues, with the corresponding economic development objectives or direct impacts in the third column. The fourth column shows important second order environmental and social impacts that may not be anticipated. While policy reforms could improve natural resource management, some potential negative environmental impacts that concern us are given in the last column. Thus, to properly evaluate such reforms, it would be necessary to assess their direct and indirect effects as well as the trade offs between their conventional development contribution and their environmental effects. Relevant defensive measures or modifications may then be analyzed for each policy. This systematic process is captured in the Action Impact Matrix (AIM) methodology.
The key influence of macroeconomic policies on agriculture has already been shown by early studies[5]. Krueger, Schiff, and Valdes also show that economy-wide factors may be more important than sectoral policies in agriculture[6]. When a broad assessment perspective is adopted, direct output price interventions by government have less effect on agricultural incentives than indirect, economy-wide factors, such as foreign exchange rates and industrial protection policies.
The impact of economy-wide policies may also be important for the environment. For example, Hyde et al. cite studies in Brazil and in the Philippines that demonstrate how economic policy spillovers constitute an important source of deforestation[7]. Agricultural subsidies in Brazil probably contribute to half of forest destruction in Amazonia[8]. A general equilibrium simulation for the Philippines suggests that foreign exchange rate changes, although motivated by general balance of payments concerns, have major implications for the demand for wood products, therefore influencing logging rates. The case of fuelwood may be as interesting, since fuelwood shortages have been identified as the major forestry problem in many developing countries. National price policies on fuel and investment policies on alternative energy sources may be important for addressing the fuelwood problem.
Structural adjustment
Structural adjustment programs address a well defined set of reform areas. These will generally include establishing an appropriate macroeconomic framework for growth, introducing a set of supporting sectoral policies and investment efforts, and integrating the domestic economy into the world economy[9].
Adjustment lending in the early l980s addressed problems of maintaining growth caused by the worldwide economic crisis. The crisis was triggered by the second round of energy price hikes, the collapse of export markets, and increased international interest rates. These external conditions, combined with lack of competitiveness of local industries, lagging employment generation, and persistent budget deficits, led to unsustainable current account deficits.
Thus, trade-oriented reforms, including tariff reductions and devaluation, became key components of adjustment lending. Adjustment implications for managing external debt also received much attention. In turn, this led to concern for stimulating domestic savings, increasing the role of taxation in resource mobilization, decreasing the extent of government expenditures, and making investments more productive.
The benefits and costs of such programs are country specific. In a review of the Latin American experience, Birdsall and Wheeler conclude that there is no evidence to show that open developing country economies are more prone to pollution[10]. The inflow of foreign technology and capital would tend to bring in better pollution standards. At the same time, it is the pollution-intensive heavy industries sector that has benefited from protective industrial and trade policies. Nevertheless, some concern persists that encouraging foreign investment and privatization might lead to the growth of “pollution havens,” given the weakness of environmental regulations in most developing countries. Trade liberalization also could encourage the growth of energy intensive and/or highly polluting industry. However, pollution caused by industrialization could be offset by afforestation (although this does not necessarily compensate residents of polluted areas), and limited by appropriate taxation policies that encouraged the use of pollution abatement technologies.
The environmental relevance of structural adjustment reforms was reviewed[11]. The reforms included (l) relative price changes in agricultural outputs, inputs, energy, export taxes; (2) trade and industry policy reform; (3) changes in public expenditure programs; and (4) institutional reforms by sector. In the early to mid l980s, environmental aspects were relatively neglected in adjustment lending operations, with few environmental loan components or conditionalities. The review also found that programs from fiscal year 1988 - fiscal year 1992 (FY88 - FY92), included more on the environment. For example, about 60% of the 58 countries reviewed had adjustment programs whose loan components or conditionalities were environmentally related, compared to 37% during FY79 FY87. Sectoral adjustment programs have also included environmental policy reforms.
In the 1990s, international donor agencies, non-governmental organizations and academic institutions contributed to the debate on the environmental effects of structural adjustment and stabilization programs. Several good studies exist, of environmental and social impacts of countrywide policies[12].
Public investment/expenditure reviews
Reductions in public expenditure are an integral part of many SALs, and usually emerge from recommendations on spending priorities made in Public Investment/Expenditure Reviews (PI/ERs). The main purpose of PI/ERs is to provide recommendations to governments on the size and composition of their spending programs and on ways to strengthen local institutions in ways that enhance country capabilities to design and implement such programs. They have also been used to carry out basic sector work and to identify projects appropriate for World Bank support. PI/ERs facilitate expenditure decisions by the core planning and finance agencies, which are central to the key objectives of structural adjustment, poverty alleviation, and sound management of natural resources.
Public investment programs often do not give adequate weight to environmental objectives as compared to efficiency and poverty alleviation. The potential exists for investment reviews to appropriately elevate environmental concerns and thereby help to avoid making investments that have some of the serious long term environmental consequences. While the expenditure reviews are perhaps less crucial, these could be used to ensure, for example, that environmental agencies and their programs get a fair share of current government expenditures.
Sectoral policies
While adjustment is inherently a macroeconomic effort, involving macroeconomic policy reform, it also requires specific sectoral reforms[13]. The key macroeconomic variables in adjustment programs are the investment savings gap, the fiscal deficit, the trade deficit, the exchange rate, and the rate of inflation. The microeconomic or sectoral reforms relevant to adjustment include industrial promotion and investment incentives, tax incidence, import liberalization and trade, and energy pricing. These are undertaken to improve resource allocation, but they also have important implications for macroeconomic stability and growth[14]. The first is primarily a microeconomic goal while the second is an adjustment goal.
For example, taxation and government expenditures are the prime microeconomic mechanisms for resource allocation. However, they also comprise the basic elements of fiscal policy. In turn, fiscal policy has a critical macroeconomic impact because it directly determines the fiscal deficit and therefore affects the current account deficit and, after a lag, investment levels. Tax reform issues are particularly relevant from an environmental management perspective because they can have a wide range of potential impacts on resource use. The choice of the tax or tariff base, can lead to substantial changes in the level of pollution related activities. However, such environmental implications are not considered in conventional assessments that focus on fiscal effectiveness. Other sectoral reforms, such as those dealing with energy pricing and industrial exports, also affect macroeconomic stability and have thus played a regular role in adjustment programs[15].
Beyond their role in contributing to a stable macroeconomic environment, sectoral policies also have economy-wide relevance in terms of promoting growth from the supply side. These include sectoral investment and pricing policies as well as sectoral regulation and institutional development. As noted by Fischer and Thomas, the traditional approach to development was through investment in agriculture, industry, infrastructure, and human resources[16]. However, the contribution of these sectoral investments also depended largely on macroeconomic policies and the presence of enabling institutions. Some countries subsidize urban consumers by placing price ceilings on food. In such cases, the environmental consequences will be the same as for currency overvaluation, as both result in lowered incentives to increase production of internationally tradable crops.
In the case of Brazil, Binswanger showed that general tax policies, special tax incentives, the rules of land allocation, and the agricultural credit system all accelerate deforestation in the Amazon[17]. These policies also increase landholding size and reduce the land available to the poor. Mahar traced many problems in the Amazon in Brazil to the decision in the mid 1960s to provide overland access to Amazonia[18]. Further examples of sectoral work that address issues of environmental concern through economy-wide policy reform are given by Munasinghe and Cruz and Munasinghe[19].
National income accounts and macroeconomic performance
In order to accurately recognize and include environmental concerns in macroeconomic analyses, standard national income accounting techniques must be re examined. Performance is currently measured by the growth in gross domestic product (GDP), and policy reforms are justified routinely on the basis of their short-, medium-, or long-term contribution to such growth. While GDP measures market activity reasonably well, it has been criticized for its neglect of other key aspects such as non-market value added, income distribution, and so on. Further, GDP does not consider depreciation of man-made capital (although the less quoted net domestic product or NDP does), and also leaves out the degradation of “natural capital.” Thus, GDP is an inaccurate measure of true, sustainable income.
In terms of the environment, there are several shortcomings in the widely used traditional system of national accounts (SNA) framework:
- Natural and environmental resources are not fully included in balance sheets; therefore, national accounts represent limited indicators of national well being, since they are a poor, or even “perverse,” measure of changes in environmental and natural resource conditions;
- Conventional national accounts fail to record the true costs of using natural resources in economic activity. The depletion or degradation of natural capital stocks (water, soil, air, minerals, and wilderness areas), which occurs due to productive activity is not included in current costs or depreciation of natural wealth. Thus, resource-based goods are underpriced – the lower the value added, the larger is the extent of underpricing of the final product. Some countries promote primary product exports by subsidizing them, often with disproportionately large adverse impacts on the poor (who are less able to protect themselves) – the small cultivator, the forest dweller, landless peasant, and so on. If such hidden costs or “subsidies” were estimated, the GDP of many countries could well be significantly lower. In addition, natural resource depletion raises intergenerational equity issues, since productive assets available to future generations may be unfairly diminished (see "Discount rate, risk, and uncertainty in environmental decision-making").
- Cleanup or abatement activities (e.g., expenditures incurred to restore environmental assets) often serve to inflate national income, while the offsetting environmental damages are not considered. For private firms, defensive environmental expenditures are netted out of final value added. In contrast, such cleanup costs are considered as productive contributions to national output if they are incurred by the public sector or households. GDP calculations are distorted in two ways, because undesirable outputs (like pollution) are overlooked while beneficial environment-related activities are often implicitly valued at zero.
Such deficiencies in the accounting techniques employed up to the 1980s pointed to the need for a system of national accounts (SNA) which permits the computation of an environmentally adjusted net domestic product (EDP) and an environmentally adjusted net income (EDI). National level decision makers and macroeconomic planners (typically, in a Ministry of Finance or Planning) routinely rely on the conventional SNA to formulate economic policies. Thus, a supplementary environmentally adjusted SNA and corresponding performance indicators would encourage policymakers to reassess the macroeconomic situation in light of environmental concerns and to trace the links between economy-wide policies and natural resource management[20].
Based on work done during the 1980s (Bartelmus, Stahmer, and van Tongeren 1989), the System for Environmentally adjusted Economic Accounts (SEEA) was created as an interim measure. Its objective was to integrate environmental data sets with existing national accounts information, while maintaining SNA concepts and principles insofar as possible. Environmental costs, benefits, and natural resource assets, as well as expenditures for environmental protection, were presented as satellite accounts in a manner consistent with the accounting framework of the SNA. The method involved disaggregation of the conventional SNA to highlight environmental relationships, linked physical and monetary accounting, imputations of environmental costs, and extensions of the SNA production boundary – without modifying the core accounts.
The SEEA framework received further impetus through the United Nations interim handbook on environmental accounting[21], which outlined the possibilities for computing various national accounts aggregates such as ‘green GNP’ – that are adjusted downward to reflect the costs of net resource depletion and environmental pollution. Green NNP is a Hicks-Lindahl measure of potentially sustainable income[22]. However, it cannot indicate whether the saving rate can maintain this income indefinitely, and typically does not measure potential consumption if the economy were actually on a constant-utility path. ‘Genuine savings’ is a better measure of macro-sustainability[23].
Next, an operational handbook was published[24], and finally the Integrated Environmental and Economic Accounting Handbook was issued in 2003[25]. The revisions provide methods to estimate environmental and natural resource-related expenditures, which were not effectively captured in conventional SNA. Features include: (1) natural resource asset accounts which include natural resource stock depletion,, and improve the balance sheets of the conventional SNA; (2) pollutant and material flow accounts which report the use of energy and materials, and the generation of pollutants and wastes in the production process and the final demand. These accounts are linked to the supply and use tables of the Input-Output table described in SNA; (3) environmental protection and resource management expenditures are shown more explicitly and this data may be used for policy analysis and other research on sustainable development; and (4) better macroeconomic aggregates like environmentally adjusted Net Domestic Product have been developed.
Natural resource accounts have a balance sheet flavor, with their emphasis on opening and closing stocks in quantity and values of natural resources, including both commercial natural resources and non-commercial or environmental resources. Thus, resource accounts underlie the expanded national balance sheet accounts in the revised SNA. The principal policy and analytical uses of these accounts include: measuring physical scarcity, resource management, assessing the balance sheet of the resource sectors, productivity measurement, portfolio analysis and management, valuing depletion, and identifying effects of environmental degradation. Natural resource accounts, and their counterparts in the national balance sheet accounts, can therefore have wide use with regard to resource management policies and broader environmental policies.
Several countries have explored various environmental adjustments to the SNA[26]. Various measures of national product and wealth are under consideration, including natural resource (stock) accounts, resource and pollutant flow accounts, environmental expenditure accounts, and alternative national accounts aggregates[27]. However, no countries have formally altered their SNA to reflect the environmental concerns in the 2003 revision to the SNA[28], although pilot studies have been done.
The simple measure introduced in "Economic, social, and environmental elements of development" to indicate the sustainability of natural resource stocks may be extended to cover total wealth per capita. The latter would be a useful indicator of sustainability, if the SNA aimed to measure total national wealth (including the value of stocks of manufactured capital, as well as living and non-living resources). For total wealth W and population P, development is (weakly) sustainable, when:
This index has several desirable properties – e.g., separately accounting for changes in natural assets having low substitution possibilities.
Note: The author welcomes comments, which may be sent to mind@mindlanka.org MIND.
Notes This is a chapter from Making Development More Sustainable: Sustainomics Framework and Applications (e-book). Previous: Discount rate, risk, and uncertainty in environmental decision-making|Table of Contents (Economy-wide policies and the environment) |Next: Conceptual framework linking ecological and socio-economic systems
