The Unassuming Economist

Economic growth has traditionally moved in tandem with pollution. But can countries break this link and manage to grow while lowering pollution?

Our research, based on joint work with Gail Cohen and Ricardo Marto, shows that yes, progress is being made. Our evidence is clear: advanced economies are starting to show signs of decoupling—increasing growth while reducing pollution—but emerging market economies not yet.

The chart summarizes our evidence on the link between the trend (long-run relationship) in greenhouse gas (GHG) emissions and the trend in incomes. Our analysis covers the world’s top twenty largest GHG emitters from 1990 to the present. Over this time, incomes have grown—the trend is positive—despite dips due to occasional recessions and financial crises. But what has happened to trend emissions?

The bars in the chart show the percent increase in trend emissions for every 1 percent increase in trend incomes—economists refer to such estimates as elasticities. Look first at the three cases on the far right of the chart—Germany, the United Kingdom, and France. For this group the elasticity estimates are negative: emissions have fallen despite the increase in incomes. These countries have achieved decoupling of emissions and output. Our results show that this is due both to active policies by these countries aimed at decarbonizing their economies as well as the structural transformation of their economies towards a greater role for services.

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From VoxEU:

After years of high commodity prices, a new era of lower ones, especially for oil, seems likely to persist. This will be challenging for resource-rich countries, which must cope with the decline in income that accompanies the lower prices and the potential widening of internal and external imbalances. This column presents a new VOXEU eBook in which leading economists from academia and the public and private sector examine the shifting landscape in commodity markets and look at the exchange rate, monetary, and fiscal options policymakers have, as well as the role of finance, including sovereign wealth funds, and diversification.

The sudden slide in prices in 2014 forced resource-rich developing countries into a rapid adjustment – less painful for those that had built buffers, more for those that had not. Whether the adjustment was more or less painful, resource-rich countries now face a second phase of adjustment: making structural changes to reduce resource dependence. The challenges over the medium run are enormous, especially considering how difficult it has been historically for these countries to diversify their economies (Venables 2016).  What is more, new risks have emerged such as stranded assets—fossil fuel assets that will no longer earn an economic return because of declining demand caused mainly by global environmental concerns (McGlade and Ekins 2015).

A new VoxEU eBook based on the proceedings of a conference held in Algiers, Algeria, in May 2016 aims to synthesise some key insights that have emerged from the latest economic research on resource-rich countries, making them user-friendly for both policymakers and scholars (Arezki et al. 2018). The common denominator of the research is that the countries must build and maintain a robust macroeconomic framework in the wake of the collapse in commodity prices. The scholars also cite the need to think differently about the role of finance and diversification in the transformation of these economies.

Shifting landscape

Most studies have emphasised excess supply as the dominant factor in the 2014 oil price collapse. Although historically supply changes have been exogenous to the economy, in this case the increase in supply was caused by powerful shifts in technology triggered by high prices.

These price-spawned technological innovations, led to the adoption of new recovery techniques, which in turn spawned the development of ‘unconventional oil’, such as that produced from shale. Provided they are effective and widely adopted, improvements in recovery techniques increase the size of recoverable oil reserves, which, in turn, changes expectations about future oil production – with potentially large and immediate implications for oil prices. But innovations in recovery techniques are not exogenous. Instead they are of the market, typically following periods of prolonged high prices or changes in regulations that render them more economical. Innovative drilling techniques such as 3D imaging and hydraulic fracturing – or fracking, in which water is injected to free up petroleum trapped in layers of rock – gave rise to the substantial increase in production of shale oil in the 2000s.

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From a new IMF report on Iran:

“The comparatively low share of oil exports to GDP reflects Iran’s relatively large and diversified economy. Natural resources dominate Iran’s exports representing almost 53 percent of total exports but account only for 12.3 percent of Iran’s GDP. Iran exports more products than the average of MENA countries but many of its products are closely related to the oil sector (such as plastic and rubber products).

Iran needs to expand and intensify its trade with more partners if it is to increase non-oil exports and achieve the Sixth Development Plan target of growing non-oil exports to 15 percent of GDP by 2020. Examining Iran’s main exports in three broad goods categories highlights the opportunities for Iranian non-oil exports:

• Polyethylene (top export of plastic and rubber category, representing 11.6 percent of Iran’s non-oil exports). Iran mainly exports this good to China (84 percent) and Turkey (10 percent). However, the large European market—which imported US$ 9.5 billion of polyethylene in 2015 and accounted for 35 percent of the global market — is largely underexploited.
• Car parts (top export of the transportation category, representing 0.1 percent of Iran non-oil exports). Iran mainly exports car parts to a small set of countries in Europe, namely Turkey (72 percent), France (24 percent), and Russia (3 percent).
• Pistachios (top export of the vegetable category, representing 5.9 percent of Iran non-oil exports). Iran exports pistachios to a large share of world buyers.

“Improving Iran’s export competitiveness, attracting more foreign direct investments, removing barriers to trade and developing bilateral and multilateral trade agreements would aid Iran in reaching its targets for the development of the non-oil export sector.”

Continue reading here.

From my latest IMF working paper with Gail Cohen, Joao Jalles, and Ricardo Marto:

“For the world’s 20 largest emitters, we use a simple trend/cycle decomposition to provide evidence of decoupling between greenhouse gas emissions and output in richer nations, particularly in European countries, but not yet in emerging markets. If consumption-based emissions—measures that account for countries’ net emissions embodied in cross-border trade—are used, the evidence for decoupling in the richer economies gets weaker. Countries with underlying policy frameworks more supportive of renewable energy and climate change mitigation efforts tend to show greater decoupling between trend emissions and trend GDP, and for both production- and consumption-based emissions. The relationship between trend emissions and trend GDP has also become much weaker in the last two decades than in preceding decades.”

From a new IMF working paper:

“Over the past two decades, Mexico has hedged oil price risk through the purchase of put options. We examine the resulting welfare gains using a standard sovereign default model calibrated to Mexican data. We show that hedging increases welfare by reducing income volatility and reducing risk spreads on sovereign debt. We find welfare gains equivalent to a permanent increase in consumption of 0.44 percent with 90 percent of these gains stemming from lower risk spreads.”