Limits to Growth Revisited: Are Economic Growth and Environmental Regulations Compatible?

Greenpeace, a prominent environmental protection group, has declared that economic growth must cease altogether to ensure environmental sustainability [1]. When amendments to the Clean Air Act aimed at reducing acid rain were proposed, “the electric utility industry warned that they would cost $7.5 billion and tens of thousands of jobs” [2]. And, in the midst of a prolonged jobless recovery to the Great Recession, certain politicians and pundits are highly critical of any additional environmental regulations on similar economic grounds.


The “Limits to Growth” report predicted a collapse in economic output and natural resources as pollution increases [10].


Claims like these are not uncommon in the public discourse surrounding environmental policy and regulation, and beg the following question:  Is sustained long-run growth compatible with regulation aimed at protecting against environmental degradation and the depletion of natural resources?


As an aspiring academic economist, I view the importance of growth as self-evident. Economic prosperity is a near-necessary condition for the advancement of human welfare, but so is environmental health. Hence, if the two are incompatible, important tradeoffs must be made.


This is not to say that GDP is a perfect metric for human welfare, as Greenpeace seems to suggest is the dominant view in the economics profession (it is not) [3]. But, as first put forth in Lipset’s (1959) modernization theory, which has received inconsistently but generally positive empirical support [4, 5, 6], sustained GDP growth often brings with it societal characteristics – such as democracy and political openness – that we hold in high moral regard [7]. Even in the short-to-medium run, prolonged unemployment is understood to have substantial economic costs (through, e.g., job-market hysteresis) and be dehumanizing along non-economic dimensions (see, e.g., Amartya Sen’s “capabilities” theory of welfare).


Nor is this to say that environmental health should be valued solely through its services to human production and welfare. Even if methods and criteria for carrying out such non-market valuation were widely agreed upon (to my knowledge, they are not), it seems clear on both intuitive and philosophical grounds that environmental health should be “valued” for its own sake, if it can be “valued” at all. But, thinking in purely economic terms at least provides a lower bound on the level of environmental protection that should be instituted, and is therefore, I believe, a useful starting point.


How, then, can we intelligently address the question at hand? Careful economic theorizing provides an internally consistent way to attack the problem, so let’s see what this literature has to say.


Much theoretical work on joint economic and environmental dynamics is based on variants of the neoclassical growth model, in which agents’ key decision is how to invest in capital goods. Since capital growth drives output growth in this model, the key endogenous variable is the after-tax rate of return on capital (the real interest rate), which determines incentives to accumulate. The somewhat pessimistic conclusion of these models is that, since regulations such as carbon taxes drive down the real rate, there is a fundamental tradeoff between environmental quality and economic prosperity.


I favor a view of the world that both better captures the production dynamics in industrialized economies and largely eliminates the tension between environmental quality and continued economic growth. A recent paper by Acemoglu et al (2010) [8] determines the optimal environmental regulations in a model of directed technical change. Without delving into the taxonomy of endogenous growth theories (which posit that firm-level innovations drive aggregate output growth), models of directed technical change capture the intuitive and realistic idea that firms can be incentivized to undertake qualitatively different types of innovation.


This paper shows that, if we take the idea of directed technical change seriously, immediate interventions – in particular, an optimal combination of carbon taxes and research subsidies for “green” technologies – are optimal, and continue to be optimal even at “high” discount rates. Importantly, these interventions need only be temporary. The intuition is that the policy instruments direct innovation toward the “green” production sector, and that after a certain duration, this sector is sufficiently large that firms will choose to undertake green innovation and production even in the absence of taxes and subsidies. Robust growth survives in the long run.


Is this view too optimistic? Perhaps, but it provides yet another argument that carbon taxes are the way to go.


The bottom line? If we have faith in industry’s capabilities to innovate, immediate and decisive – but temporary – regulatory measures can reconcile continued growth with environmental health. Carbon taxes are a powerful instrument to this end, if only political incentives could align with their implementation – an event that may not be likely in the near term [9].





[4] Barro, R.J. (1999). “The Determinants of Democracy.” Journal of Political Economy.

[5] Benhabib, J., Corvalan, A., Spiegel, M. (2011). “Reestablishing the income-democracy nexus.” NBER Working Paper.

[6] Murtin, F., Wacziarg, R. (2013). “The Democratic Transition.” Journal of Economic Growth.

[7] Friedman, B. (2006). The Moral Consequences of Economic Growth. Vintage.

[8] Acemoglu, D., Aghion, P., Bursztyn, L., Hemous, D. (2010). “The Environment and Directed Technical Change.” Working paper.


[10] Meadows, Donella, et al (2004). The Limits to Growth: The 30-year Update.