The Environmental Kuznets Curve:

1. Introduction The environmental Kuznets curve is a hypothesized relationship between various indicators of environmental degradation and income per capita. In the early stages of economic growth degradation and pollution increase, but beyond some level of income per capita (which will vary for different indicators) the trend reverses, so that at high-income levels economic growth leads to environmental improvement. This implies that the environmental impact indicator is an inverted U-shaped function of income per capita. Typically the logarithm of the indicator is modeled as a quadratic function of the logarithm of income. An example of an estimated EKC is shown in Figure 1. The EKC is named for Kuznets (1955) who hypothesized income inequality first rises and then falls as economic development proceeds. The EKC is an essentially empirical phenomenon, but most of the EKC literature is econometrically weak. It is very easy to do bad econometrics and the history of the EKC exemplifies what can go wrong. The EKC idea rose to prominence because few paid sufficient attention to econometric diagnostic statistics. Little or no attention has been paid to the statistical properties of the data used such as serial dependence or stochastic trends in time series and few tests of model adequacy have been carried out or presented. However, one of the main purposes of doing econometrics is to test which apparent relationships, or "stylized facts", are valid and which are spurious correlations. When we do take such statistics into account and use appropriate techniques we find that the EKC does not exist (Perman and Stern 2003). Instead we get a more realistic view of the effect of economic growth and technological changes on environmental quality. It seems that most indicators of environmental degradation are monotonically rising in income though the "income elasticity" is less than one and is not a simple function of income alone. Time related effects reduce environmental impacts in countries at all levels of income. However, in rapidly growing middle income countries the scale effect, which increases pollution and other degradation, overwhelms the time effect. In wealthy countries, growth is slower, and pollution reduction efforts can overcome the scale effect. This is the origin of the apparent EKC effect.