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Environmental Sciences » "Air Quality - Measurement and Modeling", book edited by Philip Sallis, ISBN 978-953-51-2765-9, Print ISBN 978-953-51-2764-2, Published: December 14, 2016 under CC BY 3.0 license. © The Author(s).

# Economics and Air Pollution

By Fernando Carriazo
DOI: 10.5772/65256

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# Economics and Air Pollution

Fernando Carriazo
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## Abstract

This chapter discusses the relationship between economics and air pollution: first, it presents the main characteristics of the economic growth-environmental pressure debate and introduces the concept of environmental Kuznets curve hypothesis (EKC). As an example of the EKC, the estimated relationship between CO2 emissions and economic growth, using a cross-sectional sample of 152 countries, is reported. Second, the chapter discusses air pollution as a result of a market failure and introduces the main theoretical causes of ambient degradation, acknowledging air pollution externalities as a common problem that leads to overexploitation in the absence of well-defined property rights for the atmosphere. Third, the main instruments for pollution control, including traditional regulation based on standards and the more flexible incentive-based regulation, are presented. Finally, the chapter reviews the main features of cost and benefits related to air pollution emissions.

Keywords: air pollution, air quality, incentive-based regulations, transferable permits, air quality standards, cost-benefit analysis

## 1. Introduction

Most marketable goods are produced by the manufacturing sector. Industry is, with no doubt, one of the main contributors of economic growth, and its products are the bases of today’s lifestyles. The extraction of raw materials from natural resources is part of a transformation process where industries introduce both final products and pollution to society. In 2013, the proportion of value added from manufacturing (VAM) to the gross domestic product varied from 8.6% in low-income countries to 20.8% in middle high-income countries (see Table A1 in Appendix). Nonetheless, in the information era, traditional manufacturing is no longer the most important sector of the economy. The world average VAM has decreased from 19.2 to 16.3% during the period 2000–2013. This trend of the VAM is observed in both low-income and high-income countries, possibly explained by a more integrated industry to the services’ sector and the emergence of the so-called information economy.

Notwithstanding the trend described above, the negative effects of industrial activity on the environment, which once were perceived exclusively as a local pollution problem, today are widely debated in public policy, aiming not only to preserve the environment, but also to mitigate and adapt to climate change produced by greenhouse gases. Overall, emissions from CO2 coming from the industrial manufacturing and construction sectors are higher in low-income countries than in high-income countries. Even though VAM decreased worldwide, emissions of CO2 from the industrial sector do not seem to follow the same path. While CO2 emissions represented 18% of the total consumption of fossil fuels in 2000, they reached 20% in 2013 (see Table A2 in Appendix).

Traditionally, analysts of pollution classify this physical phenomenon into three categories: (1) greenhouse gases such as CO2 or methane, (2) pollution from chemical imbalances, and (3) aerosols.

Regarding the first category, in Ref. [1], NASA estimates that the global levels of carbon dioxide have increased since 1960 from 316 ppm to near 407 ppm in 2016. As documented in Ref. [2], these high levels of CO2 have caused the world to increase its temperature, and if the current trend persists, by 2035, we would observe a level of 535 ppm, which makes a global average rise of at least 2°C more likely. Today, strong scientific evidence suggests links between concentrations of greenhouse gases and changes in global temperature: a rising of 2°C relative to preindustrial levels could bring as a result risks in food security, significant changes in water availability, collapse of ecosystems, extreme weather events, and irreversible impacts such as the melting of Greenland ice sheet [2].

Chemical imbalances, on the other hand, create pollution mainly in the form of nitrogen oxides and sulfur oxides, which in turn produce acid rain and smog. Chemical imbalances such as the incomplete combustion of fossil fuels produce carbon monoxide which is known for its toxicity and the concomitant risks for the respiratory and circulatory systems.

Aerosols are essentially suspended particles of different sizes that are produced mainly due to the burning of fossil fuels and industrial processes. Particulate matter affects water systems, agriculture, and also the respiratory system of humans. Most local ambient pollution is attributed to chemical imbalances or to aerosols whose main sources are vehicles or combustion processes in industrial facilities. The World Health Organization (WHO) recognizes that air pollution is a major environmental risk to health. In fact, the WHO estimated that ambient air pollution caused 3.7 million premature deaths in both urban and rural areas worldwide in 2012 [3].

The deterioration of air quality from industrial smokestacks’ emissions and other sources that are well beyond the control of individuals has triggered public concerns and has inspired heated debates on the trade-off between environmental quality and economic growth. In this chapter, we discuss first the nature of the debate between growth and environmental quality; second, the theoretical causes of environmental degradation from the perspective of economics; and, third, the type of economic instruments that economists have proposed to regulate ambient pollution as an alternative to traditional policies based on the so-called command and control approach. Then, we briefly discuss the framework to think about costs and benefits of pollution. In the last section, we discuss some lessons learned.

## 2. Economic growth and emissions

The relationship between environmental degradation and economic growth has been object of constant debate among environmental economists. During the last two decades, the debate between economic growth and the environment introduced into the discussion the environmental Kuznets curve hypothesis (EKC). Within the framework of the EKC hypothesis, it is expected to observe an inverse U curve relationship between a variable that measures environmental pressure (i.e., air pollution) and economic growth (usually measured as income per capita). The name of environmental Kuznets is related to the bell-shaped relationship between income distribution (inequality) and economic growth that the economist Simon Kuznets suggested in the 1950s. Identifying the patterns of environmental pressure and economic growth allows researchers to understand whether economic growth is part of the solution to environmental problems, or whether, on the contrary, policies aimed to encourage economic growth have detrimental consequences on the environment. As pointed out by De Bruyn and Heintz [4], if we accept the hypothesis of the environmental Kuznets curve, we are recognizing that (1) pollution and environmental degradation is only a temporary phenomenon, and (2) economic growth can be part of the solution to global environmental problems.

Literature on the environmental Kuznets curve is extensive. An overview of some of the most influential empirical studies that have examined the relationship between indicators of environmental pressure and per capita income levels can be found in Ref. [4]. Most studies have used as indicators water and air pollution.

Indirect benefits from air pollution control also include those that are nonmarketable. Acid rain and exposure to particulate matter can affect human health and are usually linked to increased risks of lung disorders such as asthma and bronquitis. They also have been linked to premature mortality in adults and children. Acid rain or particulate matter may cause damages in ecosystems, including water bodies and forests, and may also damage human-made infrastructure [26]. Bazhaf et al. estimated 1980s benefits from reducing sulfur dioxide in a 50% in the Adirondacks region in the US. The authors found annual benefits of US$24 million from improvements in recreational fishing, US$700 million to grain crop producers, and US$800 annual value for the commercial timber sector [27]. Other efforts to measure benefits of air quality improvements include the monetary estimation of the impacts of air pollution in human health. The World Bank estimated that mortality and morbidity from urban air pollution in India and China meant annual losses that varied between 2 and 3% of GDP [28]. More recently, Cropper and Khanna evaluate the methods used by the World Bank to calculate economic costs related to the exposure of outdoor air pollution [29]. They recommend the usage of estimates of disability-adjusted life years (DALYs) lost due to outdoor air pollution produced by the Global Burden of Disease model (GBD) to calculate the monetary value of a statistical life. Other economic literature on nonmarket valuation has estimated the impacts of air pollution on property values. These studies use direct methods of environmental valuation, using as a framework Rosen’s hedonic pricing model [30]. The basic idea of this analytical framework is to learn about the price of air quality (a nonmarketable good) by observing the housing market. The main assumption is that housing is a marketable good composed by a bundle of heterogeneous characteristics that do not have a market, including air quality of the neighborhood where the house is located. By observing the housing market, we can indirectly observe trade-offs that individuals are willing to make with respect to a characteristic. A consumer of housing will be willing to pay more for a house located in a clean air environment than for an identical house in a polluted area, ceteris paribus. This differential in price is an approximation of the willingness to pay or implicit price of air quality. A long tradition of hedonic models examining the impact of air pollution on property values has been in the nonmarket valuation literature. These estimations are important efforts that economists have done to find a monetary value for air quality. Applications of the hedonic model relating property values with air pollution include [3136]. More recent applications include but are not limited to Refs. [3742]. All of these studies estimated the so-called hedonic price function that relates property values to air pollution levels and other characteristics of the structure of dwellings (e.g., area, bathrooms, number of rooms) and other local environmental amenities such as proximity to parks, proximity to main roads, proximity to noxious facilities, among others. Results from the valuation exercises are very contextual and differ from one city/country to another. For example, in Ref. [36] researchers found that in the US a unit (μg/m3) reduction in total suspended particles increases mean housing values between 0.2 and 0.4%. In other application of the hedonic model, the authors found that marginal implicit prices for PM10 air pollution in Santiago de Chile ranged from US$3 to US$6 depending on the estimation method [40]. In Bogotá, Colombia, the marginal implicit price for pollution measured as the annual average PM10 levels varied from US$ 0.31 in lower income neighborhoods to US$4.58 in higher income neighborhoods, also depending on the estimation method [42]. All hedonic valuations estimating the impact of pollution on property values suggest that air pollution improvements capitalize into housing values. These results from hedonic model estimations are important for policy makers related to air pollution control because benefits from housing capitalizations could be considered in cost-benefit analysis of pollution abatement. ## 6. Discussion The debate on economic growth and the environment is not a closed one among economists [43]. The relationship between economic growth and pollution is suggestive if we accept the environmental Kuznets curve. In this chapter, we illustrated the nature of the EKC and the possible explanations for the inverse U relationship between economic growth and pollution. One of the most echoed explanations for the inverse U relationship is the impact of regulation on pollution abatement [5]. Usually, pollution is perceived as an economic problem associated with production and consumption; however, it is important to recognize the public good properties of the environment that may cause pollution. Pollution could be explained, from an economic point of view, as a by-product of a market failure. The environment is perceived by polluters as a public good that is a nonrival and a nonexclusive good for which property rights are not well defined. This kind of market failure makes firms perceive polluting activities as costless; however, this chapter has shown that there are external costs of air pollution. If the objective of an environmental authority is to reduce pollution, we have discussed the basic nature of instruments that the regulator may use for pollution control, emphasizing on standards and economic-incentive-based regulation: namely the Pigouvian tax and Emissions Trading. This chapter highlighted the advantages of incentive-based regulation compared to the command and control approach for pollution abatement, as it is frequently discussed within the economics discipline. However, environmental regulation is not limited to standards or to the incentive-based regulation pointed out in this chapter. Other approaches to environmental regulation include decentralized policies where coordination among polluters is facilitated because of small numbers involved. Within these approaches, there are liability laws, well-defined property rights, and moral suasion (Field, 1994). Other environmental policies initiatives that have been used recently in developing countries rely on information and public disclosure as an initiative for industrial pollution abatement. An emblematic program using this approach is the Program for Pollution Control, Evaluation, and Rating (PROPER), launched in Indonesia [44]. As economists recognize the potential trade-offs between clean air and economic growth, and the impossibility of a zero pollution environment, economics as a discipline has proposed incentive-based regulation as a cost-effective way to control air pollution. The application of incentive-based regulation is compatible with the Intended National Determined Contributions (INDCs) agreed upon in the United Nations’ Framework Convention on Climate Change (UNFCCC) Conference of the Parties (COP21) in Paris in December 2015, to tackle global climate change. As this chapter suggests, economics as a discipline complements the efforts of governments and engineers to reduce industrial pollution. ## Appendix Group of countries 20002001200220032004200520062007200820092010201120122013 High income17.917.016.616.416.316.116.115.915.414.415.014.914.814.9 Upper middle income 24.724.523.324.124.123.923.923.923.723.023.221.621.220.8 Middle income22.822.621.922.622.622.522.522.422.221.521.620.520.219.8 Lower middle income 17.117.217.317.317.517.417.517.417.216.615.916.816.616.3 Low income10.211.211.511.311.010.510.410.410.29.99.09.18.88.6 World19.218.518.118.218.218.018.017.817.316.416.816.516.316.3 #### Table A1. Manufacturing, value added (% of GDP). [i] - Source: World Development Indicators. Group of countries 20002001200220032004200520062007200820092010201120122013 High income1414131313121312121212131212 Upper middle income 2322222224252424252525262525 Middle income2322222223242424242424262525 Lower middle income 2121212221222323232223232222 Low income4848474847474845464544393837 World1818171718181818191919202020 #### Table A2. CO2 emissions from manufacturing industries and construction (% of total fuel consumption). [i] - Source: World Development Indicators. Variable name DefinitionMeanSDMinMax Y2000 year GDP at market prices, constant 1995 US$ (WB estimates)
6468.6710518.0745.60546485.31
CO2Carbon dioxide emissions (CO2),
metric tons of CO2 per capita (Year 2000)
4.3035215.33227021.3

#### Table A3.

Descriptive statistics.

[i] - CO2 per capita emissions used for Eq. (2) comes from United Nations data base. GDP from 2003 World Development Indicators by the World Bank (WB).

[ii] - One hundred and fifty-two countries are included in the sample. The 2000 per capita GDP variable is measured at market prices in constant 1995 US\$ (WB estimates). According to the United Nations Definition, the variable CO2 measures emissions in metric tons of CO2 per capita. Emissions of CO2 refer to the release of greenhouse gases and/or precursors into the atmosphere over a specified area and a period of time. In our case, the time period for emissions is year 2000 and each area corresponds to each country in the 152 observations sample.

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## Notes

1 Turning point refers to the level of income at which environmental pressures start to decline.

2

3 S, the supply curve, is the marginal cost for the firm that maximizes profits. At the optimum, price = marginal cost for a competitive firm. S’ is the marginal social cost of production, which in turn equals the marginal cost of production plus the marginal external cost of emissions.

4 A table summarizing NAQS is reported by the US Environmental Protection Agency at https://www.epa.gov/criteria-air-pollutants/naaqs-table#4.

5 Details found in the Clean Air Act Mobile Source Fuels Civil Penalty Policy Title II of the Clean Air Act 40 C.F.R. Part 80 Fuels Standards Requirements.

6 The main difference between graph 3 and 4 is that graph 3 is in terms of pollution reductions and graph 4 is in terms of emissions.