Economic Aspects

Rumen Gechev
 Sustainable
Development
Economic Aspects

Rumen Gechev

UN I V E R S I T Y O F I N D I A N A P O L I S P R E S S

2005
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 P R E FAC E

This book focuses on the economic aspects of sustainable development. The

various dimensions of sustainable development (environmental, social, economic,
and institutional), however, are strongly interrelated and mutually supportive, so
analysis from an economic perspective supposes a broader scope of research, which
goes beyond traditional analytic approaches. A subject as complex as an analysis of
sustainable development calls for methodology that integrates these dimensions in a
dynamic system.
On one hand, intensity and type of interaction between economic activities
and the environment refers the social dimension of sustainable development and
vice versa. On the other hand, the institutional dimension determines the rules and
conditions for materials production, which is based on extraction and processing of
natural resources. I have attempted to analyze these dimensions as mutually dependent
instead of viewing them as independent subsystems, which does not discount the
necessity for constructing such an analysis on an economic base.
With few exceptions, our socioeconomic development takes place within
competitive market conditions. Environmental and social problems cannot be
solved without conforming with economic rationality. I believe strongly that any
environmental or social program can be successful only if it applies appropriate
economic incentives. These incentives, jointly with noneconomic measures (standards,
norms, administrative barriers, laws, and so on), must play a decisive role in fulfilling
the policy for sustainable development. In some cases, nonstandard approaches have
to be applied when market principles contradict that policy. In fact, this is the greatest
challenge before scientists and policy makers, requiring reranking of priorities and
new balances of interests between stakeholder groups.
This book is divided into seven chapters. Chapter 1 is devoted to the essence of
sustainable development and the specifics of its dimensions. Although sustainable
development is a widely used concept by governments, international organizations, and
NGOs, an intensive discussion remains about its definition. I stress the understanding
of sustainable development as “socially justified and environmentally friendly
economic development.” This understanding of sustainable development expresses the
interdependency among the different dimensions and key relationships of social and
environmental fields, mediated by the production and distribution of wealth.
Chapter 2 discusses the most appropriate criteria and indicators for sustainable
development. I perform critical analyses of existing systems of indicators and their
advantages and disadvantages. I believe it is impossible to have a single, highly
aggregated indicator, as sustainable development has too many quantitative and
qualitative parameters for one to be sufficient. Despite this stance, I use the GDP
Matrix, which integrates some environmental indicators into the widely used
aggregation for economic output. Therefore, I share the belief that the GDP matrix
is incorrectly applied and that, if appropriately coupled with indicators from other
(noneconomic) dimensions, it could become a reliable yardstick for sustainability.
Various problems with the interaction between economic growth and the
environment are analyzed in Chapters 3 and 4. Based on the GDP Matrix, these
analyses define the sustainability of growth in correspondence with its energy and
resource intensity and the degree of dependence on renewable and nonrenewable
resources. Special attention is paid to growth’s structure and its effect on GDP
qualitative indicators. I conclude that many of the problems confronting sustainable
development can be solved at the stages of investment planning and investment project
assessment. Some aspects of globalization are considered. Global sustainability can
clearly not be achieved through only reallocation of factors of growth. The challenge
is how to improve social and environmental parameters of GDP, whether production
takes place in Germany or Brazil. In other words, the transfer of problems from one
country or region to another worsens these problems rather than solving them.
Finally, Chapters 5, 6, and 7 consist of thorough analyses of two main policy
instruments: fiscal policy and the newly developed markets for emissions tradable
permits. As in the previous chapters, the comparisons and the recommendations in
these chapters are based on extensive data from and experiences had in developed
and developing countries. Economic incentives clearly have proven potential for
formulating and modifying behavior, of both producers and consumers. Those
instruments are seen not as alternatives to one another but rather as mutually
supportive policies aimed at the same final results. At the end of the day, the selection
of the most appropriate policy depends on the situation, traditions, and balance of
interests in the country or group of countries (the European Union, for example)
wanting to use emissions tradable permits. I illustrate the advantages of these policy
instruments based on two criteria: economic cost and environmental results.
 TA B L E O F C O N T E N TS

Preface

Chapter 1. The Essence of Sustainable Development Page 1

Definitions and Criteria for Sustainable Development—Critical Analysis. Natural Capital
versus Produced Capital. The Concepts of Strong and Weak Sustainability. Concepts of Eco-
economy and Natural Preservation. Methodological Aspects of Sustainable Development.
Modified Definition of Sustainable Development. Socially Justified Development.

Chapter 2. Indicators for Sustainable Development Page 25

Methodological Aspects of Creating a List of Indicators. Human Development Index as One of
the Sustainable Development Indicators. Alternative Indicators for Sustainable Development.
GDP: Is it a reliable indicator for sustainable development? Ecological Footprint of GDP. A
GDP Matrix: An Attempt for Systematic Approach. Appendix 1.

Chapter 3. Natural Resources and Economic Growth Page 59

The Invisible Hand versus Regulated Market. Energy Intensity of Economic Growth. The
Depletion of Natural Resources as a Limiting Factor for Growth. Economic Growth Based on
Renewable Energy.

Chapter 4. Growth & Environment: Ecological & Economic Outcomes Page 99

Ecological Footprint of Economic Growth. Economic Effects of Dwindling Pollution.
Challenges before the Economic Growth in the Agrarian Sector.

Chapter 5. Fiscal Policy for Sustainable Development Page 131

Specifics of Environmental Fiscal Policy. Fiscal Mechanisms for the Protection and
Maintenance of Forests. Some Alternative Sources for Ecofinancing. Pros and Cons for the
Policy of Subsidization.

Chapter 6. Effectiveness of Environmental Fiscal Policy Page 167

Policy Instruments for Achieving Sustainable Development: Mechanisms and Results.
Environmental Fiscal Policy and Competitiveness.

Chapter 7. Mechanism of Emissions Tradable Permits Page 197

Nature of the Mechanism for Trading in Emissions Permits. National, Regional, and Global
ETP Markets. Particularities of the Tradable Permits Mechanism Stipulated by the Kyoto
Protocol. Elasticity and Structure of ETP Markets. Appendix 2.
 S U S TA I N A B L E D E V E L O P M E N T

C H A P T E R 1.
THE ESSENCE OF
S U S TA I N A B L E D EV E LO P M E N T

The problem of sustainable development is one of the most promising and

challenging directions of modern science. It became a major criterion for evaluation
of tendencies in social development after the UN Conference on Environment and
Development (UNCED) in Rio, 1992. Traditional economic theories and indicators
of economic development cannot sufficiently explain the casual connections in the
process of relations between man and nature, nor the possible alternatives for restoring
the disturbed ecological balance and overcoming the increasing social polarization.
During the past few decades, the world has seen phenomenal development of
technologies, industrial increase, and expansion of material wealth.
The problem, however, is that the achievement of these results has too high
and unacceptable a price for this and future generations. Despite some success in
development and use of ecology-consistent technologies, partial replacement of
nonrenewable with renewable resources, and improved quality of production of
goods, the disproportionality in the environment has reached critical levels. The
pollution of soils, water, and air continues to rise; the biological diversity of the
planet decreases; and the nonrenewable natural resources are too quickly exhausted.
Scientists warn of changes in climate, or global warming, which is caused by
environmental pollution, especially by carbon dioxide emissions. If no immediate
measures are taken, the results will be disastrous for the living environment and for
the world economy.
The intolerably fast rate of pollution and destruction of the natural environment
is accompanied by a deepening gap between rich and poor. Half of the earth’s
population lives on barely two dollars a day. Hundreds of millions of people have no
roofs, nor access to healthcare, education, or clean water. The developing countries in
Africa, Asia, and Latin America are in a disastrous situation. Disturbing tendencies
exist in even the most developed countries, where the rich become richer and the poor

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poorer. In the USA, one of the most developed market economies, health insurance is
an unaffordable luxury for almost 40 million people.
Obviously, the current socioeconomic system needs corrections regarding the
goals of development, mechanisms used for reaching those goals, and more just
distribution of public wealth. Also, natural resources are physically limited; some
are exhausted to the critical minimum, and others have reserves that will last for
only several more decades. Despite the obvious potential regarding competition,
motivation, economically efficient distribution, and use of financial resources, the
market mechanism is unable to solve the indicated problems. In some cases, the
market mechanism is the main cause for the generation, deepening, or both of these
problems. The potential of the market economy, then, should have purposes that are
not limited to only profit and economic efficiency. This supposes the use of a new
system of economic stimuli, changing the direction of development of production and
consumption, with new technical and ecological standards and improved mechanisms
of distribution of income. The “new economic order” of the 1970s did not work out;
international economic relations need serious modification, taking into consideration
the principles of sustainable development.
The research on this difficult matter and, most importantly, the suggestion
of alternative solutions to problems, supposes specifying the term “sustainable
development” and its scope, dimensions, and quality and quantity characteristics. For
many reasons, the scientific community did not reach a generally accepted definition of
sustainable development. This is quite understandable, considering that this problem
has been worked on for only about fifteen years, and considering that sustainable
development has several dimensions: social, economic, ecological, and institutional.
Adding to the problem of definition, as we will see in further discussion, some authors
suggest an even more detailed scope of dimensions than the four listed above.

Definitions and Criteria for Sustainable Development-Critical Analysis

In 1987, the World Commission on Environment and Development (WCED)
defined sustainable development as “development that meets the needs of the present
without compromising the ability of future generations to meet their own needs.” The
WCED definition of sustainable development focuses on the balance between present
and future generations. Undoubtedly, such balance suggests the need of economical and
adequate use of the existing natural resources, as well as the need for harmonization of
short-term and long-term purposes of development. This definition sounds like good
intentions but does not specifically state the scope and goals of sustainable development.

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 S U S TA I N A B L E D E V E L O P M E N T

The scope of defining a process or science includes determining the correct

definition of research targets and the mechanisms for achieving those targets. The
Commission for Sustainable Development at the UN, established in 1992, is one
of the most competent and influential international institutions, developing and
coordinating for solving these definition problems. The Commission accepts that
sustainable development has four major and relatively independent dimensions—that
is, social, economic, ecological, and institutional—mentioned earlier.
Other scientists prefer a more extended and detailed approach in determining
the scope of the term sustainable development. For example, Bossel (1999) includes
in this term nine dimensions: natural, material, ecological, social, economical, legal,
cultural, political, and [Link] purpose of these details is to show separate
aspects of the term, their relative independence and importance, and the interacting
mechanisms of sustainable development. The criteria for separating some of these
dimensions are not sufficiently grounded, however.
In such separation, how exactly to differentiate “material” dimensions is not clear,
considering that materials are always in some specific form, and this “general form of
movement of matter” is manifested in all other spheres, notwithstanding whether that
connection is direct or indirect. Like the material dimension, the cultural dimension
is difficult to differentiate clearly from other dimensions. Spiritual culture also has its
material expression and develops more or less together with material culture.
It is generally accepted that separate dimensions, despite their number,
details, scope, and so on, are studied or modeled considering the ways that they
interact. Results of the dimensional interactions are measured relative to previously
accepted indexes and considering possible mechanisms and instruments for directing
this interaction to the goals of sustainable development. I believe that the development
of one dimension at the expense of another dimension of sustainable development is
not acceptable. All dimensions must be in harmony with the main goals of sustainable
development.
It is not acceptable to define the development of a country as sustainable if the
country’s gross domestic product increases and modern production technologies are
introduced but the social polarization increases or simple democratic freedoms of the
majority or minority are violated. Many countries have good indicators for currency
income, but these indicators are good at the expense of increasing exploitation and
export of nonrenewable natural resources.
Numerous countries guarantee formal political freedoms through a constitution
and have a multi-party political system. But is the development of these countries

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sustainable if the average indicators of the living standard are worsening, unemployment
levels are high, and the processes of social polarization push a large number of these
voters to the social periphery? Obviously not. Will the development of these countries
truly be more sustainable if citizens’ democratic rights are violated but the parameters
of national economy improve?
These questions are not simply theoretical; many countries can be numbered
among one or the other group. This is one of the reasons why the adoption of a unified
system of indicators for sustainable development with consensus of all UN member
countries is and will remain possible but very problematic. My experience in the UN
Commission for Sustainable Development in discussing and adopting an advisable
system of indicators for sustainable development confirms this problem. The differences
in the political systems or in their specific forms of realization in various countries,
therefore, will continue to be a problem in the search for a definitional consensus,
as is the preference in not only the UN but also most international organizations.
Experiences so far indicate reaching such a consensus is possible if a balance is
achieved in the interests of the participating countries. The problem is whether this
compromise will remain within the main criteria for sustainable development and
what the proportion is between the created new opportunities and limitations for the
realization of this development.
The policy of sustainable development is carried out under certain conditions.
I do not call the conditions “limited” because the limitations concern mainly
nonrenewable natural resources. Limitations related to renewable resources are only
temporary and can be changed at any time. That is why these conditions should
be defined as “constant” or “changing.” Both types of conditions are subject to
management in their use, but only changing conditions can increase their qualitative
and quantitative parameters. This means that the criteria for efficient nonrenewable
resource management should be even higher because the loss or incorrect storage of
these nonrenewable resources has irreversible consequences.

Natural Capital versus Produced Capital

The discussion on mechanisms of use and management of industrial resources—
both natural and produced—continues in literature. Resources are defined as natural
and produced capital, respectively. I will not start a detailed discussion on terminology,
but in principle, capital can be a produced resource only. Natural resources become
capital only if included in the production of goods and services. Capital is an increasing
value, and such increase can happen only in the process of production.

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When the term natural capital is used, researchers mean not natural resources in
general, but only those resources that are used in the production process; therefore,
both natural and produced capital are produced capital, but one is created by nature
(given or inherited), while the other is a product of socioeconomic relations. That is
why, unlike natural capital, the term “capital” refers to economic relations.
The theoretical clarification of sustainable development’s definition has another
problematic aspect: What is the essential difference between the definition of natural
capital concerning the resources already being used (having become part of the
economic system) and those discovered but not used (their use is only potential)? The
analysis of those characteristics is important and related to the discussion of the nature
and possible substitution between natural and produced capital. I believe that natural
capital, if this terminology is accepted, should have a clearly defined scope; possibly,
the most suitable criterion is whether those resources are included in the process of
production—mining, processing, and so on. Those resources not yet included in this
process cannot be defined as capital but only as a reserve of resources. Using the same
judgment, strategic reserves of raw materials and other natural resources cannot be
capital because they are mined but not included in the system of production. That
expenses were made for the production of these resources does not automatically make
them capital.
The problem with resource reserves of companies is different; under certain
conditions, the resource reserves comply with the above criteria for capital. The
criterion for these reserves, rather, is whether they are required for maintaining
commodity production. Naturally, gas refineries and metallurgical and some chemical
companies work in continuous production, which automatically suggests maintaining
enough reserves, determined quantitatively pursuant to the optimum ratio between
the volume of productivity and the volume of reserves, for guaranteeing production’s
continuity. Such reserves are necessary also for productions that do not require
continuous work. If the volume of natural resources is more than their optimum
quantity, the natural resources are not capital but pure economic loss.
Should the term natural capital be differentiated if it is viewed as both renewable
and nonrenewable resources? I believe so because this difference is important from both
the point of view of economical analysis and the criteria for sustainable development.
Nonrenewable resources do not fulfill these characteristics.
Defining the term natural capital as renewable resources has certain nuances.
Air, water, and solar energy are resources that are renewed by nature without the
involvement of man, but timber, for example, can be delivered by virgin forests or

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through forestation. Only in the second case is it a product of capital. In this sense, the
possible replacement of one type of produced capital with another type of produced
capital is naturally different from the possible replacement of nonrenewable resources
(or renewable but taken ready from natural resources) with some form of produced
capital (financial, technological).
The problem with the nature of capital in its different forms needs further
clarification that would facilitate not only the definition of sustainable development but
also the adoption of a stable reference point for carrying out and evaluating the policy
for such development. The distinction of capital as “natural” or “produced” is the root
of the discussion about “weak” and “strong” sustainability. Supporters of the “weak
sustainability” model accept that the nature of capital—produced vs. natural—is not
important in their understanding of economic growth sustainability. The neoclassical
economic school argues that the criterion for sustainability is the amount of capital
transferred from generation to generation, or measured in the time horizon of one
generation. They believe that a development is sustainable if the amount of this capital
at least does not diminish, or preferably, increases. This understanding is based on the
axiom that the nature of development is determined by the level of consumption of
goods and services. The growth (or at least the preservation of the same level) of capital
generates increasing consumption or is viewed as “stable” consumption.
For the neoclassical economic school, the structure of the capital is not important
if the consumption it guarantees does not increase. This is included in the classical
production function Y = f(K,L,N), where Y is the GDP, K is the capital, L is labor,
and N is the natural resources used in production. Presented for the first time by
Wicksteed (1894), this function presumes that the same end result, expressed by the
GDP, can be achieved also by n-number of quantitative combinations among different
production factors. The function measures the ratio between factor input and product
output, represented in natural, non-monetary expression. On this basis, Atkinson
and Pearce (1995) try to qualify the sustainable development (Z), presenting it as a
resulting quantity of the ratio savings (S) and GDP (Y) minus the result of the ratio
between the natural capital (dn) and GDP and the produced capital (dm) and GDP.

Z = S/Y — dm/Y — dn/Y

Such differentiation of the criterion for sustainable development and the

optimization method for resource distribution among generations brings multiple
methodological and factual questions. The suggested paradigm does not take into
consideration any minimal levels (limiters) in the replacement of specific types of

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capital. As much as the productivity of labor is high and as much as the processing
of a natural resource is “deep,” this resource cannot be replaced with another in the
production of an end product. For example, certain quantities of steel can be produced
with different ratios between labor and capital. Whatever the level of technologies
and qualification of the labor force, an absolute minimum of each of the production
factors is necessary at any time. The iron ore cannot be replaced completely or partially
by technologies, regardless of how modern the technologies are or by an increased
number of workers, nor can the iron ore be increased in such a way as to produce
steel with one or no workers. Even full robotization requires someone to “robotize,” to
control, and so on. In the approach accepted above, no such minimal quantitative levels
are included. Also, how the ratios in these levels in different volumes of production
are changed is not shown. The law for decreasing return suggests such a distinction;
however, the utmost productivity from each resource has to be different.
Pierce and Atkinson’s model does not distinguish between renewable and
nonrenewable resources. It includes only random proportions of one production factor
replaced with another, not taking into consideration each resource’s renewability,
present quantity, time horizon of exhaustability, and so on. In other words, a nation
or a group of nations can freely “replace” nonrenewable natural resources until the
resources are completely exhausted. Whether this will happen in 5, 10, or 150 years is
not stated in the above model; therefore, it is not an expression of “weak” or any other
type of sustainability, simply because it is an anti-sustainability model.
Because of such an approach, large territories have been deforested with
irreversible damage of soils, landscape, and biological diversity. In some countries,
some nonrenewable natural resources are almost or completely used up because in the
“equation” of their use, the criteria “future generation” and “ecological damage” were
missing. Ayres et al. (1998) state an example, which is very suitable for this case, of
the Pacific country of Nauru, which in only a few decades used all of its accumulated
reserves of phosphates and now suffers the consequences of its unreasonable policy,
which can be referred to as “weak sustainability.” The export of these much-in-demand
goods brought good income to the country in convertible currency, but instead of
investing the income in the development of the local economy, the government
invested in a trust fund (almost a billion US dollars) that melted away during the
Asian financial crisis of 1997-1999. Similar will be the fate of most countries whose
economies continue to depend entirely on the export of oil, natural gas, minerals, raw
materials, and other nonrenewable natural resources.
In their critical analysis regarding this approach, Ayres et al. (1998) remark that

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this methodology is not reliable because it excludes important aspects of sustainability

on national and regional levels and does not take into consideration the role of
international trade with production factors and end product. The absence of any
analysis of the “replacement” of different forms of capital (natural, human, produced)
from territorial and national points of view is unacceptable. It is a public secret
that in many developed countries, the use of their own natural resources, especially
nonrenewable, is intentionally limited. In some cases, this is achieved through legal
and administrative limitations, in combination with economical incentives and
disincentives, or both. These countries prefer to provide the needed resources through
importation for various reasons: lower delivery prices, maintainance of their own
strategic reserve and environmental preservation, and no expenses for environmental
restoration. In this way, the negatives are transferred to suppliers abroad, which usually
are developing countries.

The Concepts of Strong and Weak Sustainability

In his concept of strong sustainability, Bretschger (1999) accepts that the volume
and intensity of this use must be at least equal to the volume and intensity of renewal
of the used resources. For example, the cutting down of forests in a certain sector to be
accompanied by planting of trees in another sector, the quantity of caught fish not to
exceed the limits guaranteeing its reproduction, or the volume and nature of the waste
from production and consumption (solid, liquid, aerosol, toxic, nontoxic, and so on)
not exceeding the potential of the environment to restore the equilibrium (including
the capacity for their recycling and turning into non-toxic, safe substances).
Bretschger’s approach deserves attention, although it is difficult to realize because of
lack of economic expedience. Solar energy, for example, could be an ecologically clean
substitute for coal in the production of electrical power. On one hand, then, the direct
pollution of air with sulfur and other solid particles will be evaded, and on the other,
the nonrenewable reserves of coal will be preserved. The problem, however, is that solar
power generator use is still too expensive and its opportunity cost is too high. Technical
solutions for the replacement exist, but they often contradict economic expedience.
Human-made capital is always more economically unprofitable than free natural
energy resources. That is why the countries given such resources by nature at this
stage still have no economic stimuli to replace the resources with ecologically clean
substitutes. The economic, social, and ecological effects of using different types
of resources depend on the delivery price of these resources. Some countries have
chosen coal as an energy source, and others, uranium ore or oil. Each resource has its

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advantages and flaws depending on its availability and accessibility in each country.
Daly and Cobb (1989) ground their understanding of “strong sustainability”
with the introduction of maximum levels of natural capital consumption. These
levels are determined in physical dimensions, and no opportunity is allowed for the
replacement of this natural capital with other forms of capital. The nonrenewable
resources are divided into ones that can be replaced by renewable resources and
those that do not have substitutes. In other words, the observation of the principle
for “strong sustainability” would mean halted mining of these resources and their
preservation for future generations.
Daly and Cobb’s principle is not realistic. It is not clear on what grounds this limit
of use is determined, nor what the time horizon will be for “future generations”—five,
one hundred, or more generations? Who will determine which future generation and
how much that generation will consume so that we would be able to determine how
many resources to leave as a reserve? Which resources will be the most necessary and
the most valuable for future generations? Obviously, the reserves in question, at least
by formal logic, should be in different quantities. It is not possible to estimate the
extent to which fields will advance science and technology in time and whether, for
example, in 500 years gas will be more valuable than coal or vice versa. The definition
of these odd exigible reserves for different deposits and countries would inevitably
reflect on international economic and political relations.
Another important question is whether the countries whose revenues depend
completely or mainly on the export of natural resources will be compensated for not
using resources. How will the amount of compensation be determined, considerating
that the ambiguity with the time horizon excludes any reliable determination of the
ratio between the present and future value (PV, FV) of the nonrenewable resources in
question? Logic suggests that without compensations, the freezing of resources is not
possible. Also to be considered is in what forms those compensations will be, to whom
they will be provided, what the conditions of the compensations will be, and so on.
The conservation of resources without the respective compensation of owners would
be a confiscation. Neither the countries under whose jurisdiction those deposits lie,
nor the private concession holders who have long-term contracts for the exploitation
of the resources, would accept the enormous economic loss.
Existing economical and legal systems exclude any such compulsory conservation;
therefore, the limitation in the use of natural resources must be carried out in other
directionssuch as price economic stimuli; development of energy- and material-
saving technologies; further perfection of ecological legislation, standards, and norms;

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optimization of ecological tax and fee distribution between consumers and producers,
exporters and importers, and so on.
The system of national economies and the world economy is inert enough that
it can endure some “switching” of production entirely to renewable resources. Such a
thesis has an unscientific, hypothetical nature and is not in compliance with the realities
of our time, but Meadows et al. (1974) included a similar thesis in compliance with
the understanding of “strong sustainability” in a report before the Club of Rome. This
report recommended zero economic growth as the only alternative in the condition of
fast depletion of natural resources.
Fortunately, the dark forecasts in the report for future profound quakes in the world
economy did not come through. The explanation is that not enough appraisal got the
potential possibilities for science and technology development that enabled major power
efficiency improvement, the wide spread of artificial materials in production, improvement
in the quality of capital and consumer goods and prolonged terms of their use, development
of “green legislation,” stronger pressure from international organizations and NGOs for
improving the quality of the environment and increased investments in this direction,
stronger sensitivity of the public toward these problems, and so on.
Indicative of this are the calculations of the oil reserves that have a key place among
nonrenewable resources as a main raw material for chemical industry and as widely-
used energy sources in transport and power production. Fortunately, the preliminary
evaluations of the actual oil reserves were very pessimistic. It is interesting that in 1920
Scientific American magazine warned that with the growing consumption, US oil
reserves would last for only twenty years. In 1932, the US Federal Oil Conservation
Board estimated that 10 billion barrels of oil remained, while in January 2003, Oil &
Gas Journal evaluated those reserves at 22.677 billion barrels; this after seventy years of
dynamic growth of consumption. The same competent magazine evaluates the world
reserves of conventional oil1 at 1,213.112 billion barrels, which is many times more
than the evaluation from 1950 of the American Petroleum Institute of a total reserve
of only 100 billion barrels.
Conventional oil is oil that is economically accessible under the current
conditions (with the current technological possibilities and current prices). It is
foreseeable that with the development of those technologies and the increase in oil
prices, unconventional oil will turn from a potential to a real source and will be
offered on the world market. Under other, equal conditions, this means possibilities
for wider supply. Similar is the situation with natural gas and minerals. Remembering
that nonrenewable resources (discovered + undiscovered and usable + unusable at

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this stage) are limited, we must not underestimate that in the process of development
and consumption of these resources, new mining technologies are created and new
sources discovered. For example, lately, large oil reserves on the west shore of Africa
were found in the region of the islands Sao Tome and Principe.
Stating these major differences between the suggested and actual reserves of
natural resources, I do not underestimate the need for taking adequate measures to
delay or even achieve a reversal in resource use tendencies. As a result, the depletion
of resources still has unacceptably high rates. Simultaneously, many environmental
characteristics are worsened, and, consequently, the quality of life of this and future
generations is also worsened.
In any case, the extreme theories of “weak sustainability” and “strong
sustainability” differ from reality one way or another. “Weak sustainability”
differs in many respects from the criterion for sustainable development in the way
sustainable development is understood by most scientists and prominent national
and international institutions. Undoubtedly, the present socioeconomic system of
the world economy, as well as the scope and quality of national and international
legislation on the relationship of man with nature, cannot adequately solve many
deepening contradictions. Turning wishes into reality is a possible but very difficult
process in which all stakeholders must play their parts.

Concepts of Eco-economy and Natural Preservation

Brown (2001) examines the environmentally sustainable economy, or his
“eco-economy,” as an economic policy created with absolute priority of ecological
principles. Such a position is understandable, especially considering the rates of
environmental degradation, including pollution, deforestation, soil erosion, desert
advancement, fertile land loss, underground water depletion, and so on. All of these
negative processes in the end reflect on human health, which is one of the major
indicators of the standard of life.
Economic development must be ecology-consistent, especially in the present
unfavorable and even alarming trends in the condition of the environment; however,
sustainable development means the seeking of optimum balance of purposes and
interests. In the same way that markets should not be the only basis for determining the
forms and degrees of interaction with the environment, ecological principles should
not be the only orientation for appropriate social development. Any absolutization of
one of the two sides of the man-nature equation is not consistent with reality and is,
therefore, not practical.

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In the same spirit is the position of Howe (1979), who believes that a responsible
natural resources policy is aimed at maintaining over time a constant effective natural
resource base. This thesis is developed lately by Daly (1992), who is convinced that a
development without growth is possible and that needs can be satisfied only through
higher efficiency with the use of natural resources without changing the resource
throughput. Such treatment of the resources—production-consumption-sustainability
relationship does not answer at least two questions. First, how, exactly, is it possible (if
at all) to define in quantity the effective resource base? Second, is it realistic to accept
the possibility of maintaining the physically steady state economy if consumption
grows? In the case of the now-applied technologies and organization of production,
maintaining a constant effective resource base would not only block growth but also
cause a dramatic drop in living standards in a short-term period.
It is logical to suggest that the consequences of such a plan for the least developed
countries will be very grave. The growth of consumer demand at this stage cannot
be met with only increasingly efficient use of material resources. For example, in the
next fifteen to twenty years, the demand for air transportation services is expected
to increase to three times the present level. Can the consumption of materials in
the production of airplanes, building of airports, or the use of plane fuel remain on
the same level? Obviously not, despite the possibility and necessity of decreasing the
material—and energy-consumption in the offering of a transportation service unit.
The increase in efficiency could not compensate for the increased physical volume
of the economic output. It is enough to follow the tendencies in demand for motor
vehicles in China and India as well as the demands for fuel, oils, parts, and so on to
see that, unfortunately, the increase in consumption leads to the demand for and use
of increasing volumes of material resources, notwithstanding the improvements in
production technologies.
Other authors distinguish more clearly between renewable and nonrenewable
resources. From there, they try to define sustainable development as development
that depends entirely on the use of renewable natural resources. According to Allaby
(1988) and Markandya and Pearce (1988), economic development is sustainable if
it can continue to infinity and if it depends entirely on renewable resources that,
according to them, should remain on a constant level. More realistic is the opinion
of Goodland and Ledoc (1987) for the use of nonrenewable resources, but only if the
use is in limited volumes and is only part of a transition phase to the use of renewable
energy. In other research, Pearce (1988) adds a new, very important element to the
limitations in the use of natural resources: The waste disposal rates should not exceed
the rates of assimilation by the counterpart ecosystem.

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Undoubtedly, restoration of ecological equilibrium can happen if major changes

are made in the manner and conditions of interaction between man and nature. The
accumulated disproportion, especially in separate components of the environment and
in specific regions, is such that urgent and decisive measures are necessary. One part
of the problem—what should be done to change the negative tendencies—was solved
quite successfully. The challenge is to find a solution to the second part of the problem,
namely how and under what conditions the suggested changes are to become reality.
Now and in the near future, the full conservation of nonrenewable resources is
not possible because of a number of technological and international legal limitations.
Many nonrenewable resources still do not have renewable substitutes, and many
of the renewable substitutes that are available are produced from nonrenewable
resources. Synthetic plastics and tissues, medicines, and so on are produced using oil,
and artificial fertilizers are produced using natural gas. The recycling of nonrenewable
and renewable resources definitely has much greater potential than the current
system, but it can hardly satisfy fast-growing consumption (industrial and personal).
Recycling itself is an energy-consuming process, and the price margin between the
recycled and newly-mined materials in some cases is not big enough. Currently, the
value of extracted natural resources includes only the expenses for extraction, but
does not include other important cost elements, like environmental pollution and/or
environmental damage, exhaustion of nonrenewable resources, etc. Also, the margin
in question will be changed in a favorable direction, but not at the rates we would like,
and that may bring a reversal in the current tendencies.
The sale of nonrenewable resources is a profitable business, both for developed
and developing countries. If for Norway, the export of oil has only an additional effect
on its high living standard, then for countries like Iraq, Libya, Venezuela, Saudi Arabia,
Russia, and so on, oil export is the only or main source of convertible currency. The
conservation of oil wells would cause economic catastrophe in these countries because
their economies could not restructure successfully even in a middle-term period. It
is not practical to expect the possibility of political support for such a decision. The
problem will hardly be solved with some international compensation funds because
it is not realistic to expect that the taxpayers of resource importing countries can or
would agree to finance such conservation by compensating the countries where those
renewable or nonrenewable resources are situated.
The producers of nonrenewable resources are also consumers of such resources.
It is not economically viable for the producers to replace their free resources with
imported renewable resources that cannot be cheaper, even if this renewal is done

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in the same country. Today, the electricity produced by wind and solar energy is
subsidized in the most technologically developed countries. For developing countries,
such subsidization is simply unaffordable at this stage. In this sense, a sustainable
development understood mainly as conservation of natural resources is not realistic.
That is why I fully agree with the critical notes of Dasgupta and Maler (1995) and
Beckerman (1992), which do not accept the understanding of sustainability as a
necessity for limitating economic growth.

Methodological Aspects of Sustainable Development

The problem of sustainable development has also a methodological side. I believe
that in the complex system of interactions and interdependencies between its four
dimensions, the natural environment cannot have absolute priority over humans
and their well-being. In these definitions, the prosperity of the society is taken into
consideration only indirectly; nothing is mentioned of how the resources are used,
what is produced with them, or how the product is distributed and used. It is as if
the protection of the environment, and mostly of the nonrenewable natural capital,
is a sufficient condition for sustainability. Such absolutization of priorities is not
acceptable for a number of historical, economic, and logical reasons. The history of
humankind is a history of interaction between it and nature for the production of
goods, first for survival, and, with the development of production, also for providing
a living standard.
Daly (2002) makes an interesting interpretation of the definitions of sustainability
and sustainable development. His definition is based on the second condition, stating
the impossibility of determining a given resource or product’s utility for future
generations. Daly prefers stating the impossibility of measuring both the product’s
utility and bequeathing the product to future generations. Moreover, the utility is not a
thing but just an experience, while the throughput is a thing. The author believes that,
in principle, sustainability means using the physical environment (nature) in such a
way as to bequeath it to the future generations as we have inherited it from the previous
generations. According to Daly, the organization and technology of production shall be
such as to guarantee an equality between the throughput and the output to nature so
that this output can be used as throughput in the next production cycles.
Throughput is an excellent indicator of sustainable development. Throughput,
however, cannot be sustained because no matter the technology level of production,
energy will always be lost through the use of nonrenewable sources. Currently, there
is no practical forecast about when energy production based entirely and only on

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renewable energy sources will be possible. This production will probably happen one
day, and the sooner the better, but it is unlikely to happen within 30-40 years.
More important than preserving the quantity of matter returned to nature is under
what form this matter will be returned, considering the degree of pollution (toxicity,
non-toxicity) and degrees of absorption, possibility for recycling, and reuse. That is
why I believe that the bequeathing of utility, including high technologies, knowledge,
and experience, to future generations is at least as important as bequeathing tons of oil,
coal, or iron ore. I speak of a thorough change in the production basis and scientific
knowledge that will be available for advanced use of non-waste technologies. These
new technologies would allow deep processing of raw materials, use of ecologically
clean energy and recycling of used materials.
Obviously, sustainable development does not exclude further exploitation of
natural resources. Complying with the understanding of “untouchable nature” that
is proclaimed by the supporters of the “strong sustainability” approach would mean
stopping human development somewhere in the Bronze Age, when the relatively intense
use of some nonrenewable natural resources (mainly ores) started. Development of
human society is impossible without the utilization of natural resources, however Of
course, the challenge facing us is how this utilization can be executed appropriately, in
correspondence with the criteria for sustainable development.
In general, development is not an excuse for inappropriate use of those resources.
In fact, the industrialization of the nineteenth century made the process of using ore
more dynamic and of much greater scope. The past few decades represent a serious
test for the planet’s ecology because the dynamics of production and consumption
of natural resources remains critically high. Especially worrying are the tendencies in
nonrenewable natural resource use. If the present rate of this consumption is preserved,
the life span of natural gas, coal, ores, and so on will be only a few decades, and of
specific types of resources will be one to two centuries at the most.
The scale of—and especially the technologies used for—mining and processing
of these nonrenewable resources is not yet at a level that is both waste-free and safe
to humans and environmental production. Ecological legislation and the resulting
norms and standards for production and consumption do not yet “cover” enough high
share in world production. As a result, the condition of many of the environment’s
dimensions continues to worsen. Some positive tendencies in the modern process of
production exist, however: introduction of synthetic materials, use of environmentally
friendly technologies and renewable energy, increased share of the recycled materials
for production, improved environmental legislation, and so on.

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In the next chapters, we will review some of these positive tendencies as well
as the instruments through which their scope and dynamics of application can be
expanded. I would like to state that the interaction of man with nature should not
be reviewed from only very pessimistic positions or in an apocalyptic aspect. I believe
that some principles and interests already existing in science offer enough potential
for staged solutions to the existing conflicts. In the case of having enough active
but balanced modification of existing economic relations, the desired effect can and
should be achieved. In any respect, restoration of the balance between man and nature
cannot happen in a short-term period unless a miracle change occurs in the today’s
technologies and energy sources. What are the grounds for such understanding?
The development of non-waste and highly effective technologies, involving a
sharp decrease of the power and material consumption of a unit of physical product, is
a long-term process that goes with different dynamics in different sectors and types of
production. These newly developed technologies would contribute to higher rates of
replacing nonrenewable resources with renewables. Unfortunately, such replacement
for specific types of production is impossible in the near future. For example, science
advances in finding alternative power sources (solar, geothermal, wind, biomass, and
other renewable sources), but coal, oil, and natural gas have no economically reasonable
substitutes at this stage. Overly sharp limitations in the production and personal
consumption of nonrenewable capital would also block the normal development of
scientifically applied research for finding suitable economically profitable substitutes.
The consumption of nonrenewable resources cannot be stopped without causing
deep disproportion and collapse in the whole system of public reproduction, especially
in the living standard. Even not full but sharp curbing of such consumption will have
a much larger effect on developing countries. On one hand, these countries cannot
afford to pay the higher prices of these resources, so what would be the immediate
effect on these countries from limiting the mining of nonrenewable resources? On
the other hand, for those countries in which the major part of revenue comes from
the export of such resources, the effect of limiting the consumption of nonrenewable
natural capital would be much stronger than the unavoidable increase of the prices of
those resources. The end result would be an economic catastrophe.
Preservation of natural wealth for future generations has an unlimited life span,
but satisfying the demands of the current generation has its very real challenges. The
present generation would hardly accept a drastic consumption reduction to create
possible beneficial effects for their successors of 200, 500, or even 1000 years from
now, nor would the current political system, in its most democratic forms, allow the

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making of such decisions. Most election mandates are for a period of four years, and
re-election depends mostly on economic indexes, internal and external safety, social
protection, and so on. The preservation of the environment, unfortunately, is an
auxiliary factor even in the countries where environmentalism has strong and deep
roots. This has been a problem in the past few years even in the Scandinavian countries
where environmental preservation has serious public support.
Some experts go to the other extreme, focusing only on the living standard
and not considering the environmental balance. For example, for Pezzey (1989) the
criterion for sustainability is the nondeclining per capita utility. This understanding
is another expression of the opinion of Allen (1980) that sustainable development is
what provides lasting satisfaction of human needs and improvement of the quality of
human life. By Pezzey and Allen’s perspectives, environmental degradation does not
need to be taken into account, although inappropriate consumption increases lead to
this environmental degradation. It is true that the purpose of man’s interaction with
nature is to improve his living conditions, and the quality of the environment has
always been among those conditions. Improving one parameter of the living standard,
however, is often at the expense of another.
Even if production is based on the most environmentally friendly technologies, the
use of some nonrenewable resources is unavoidable. Nevertheless, I share the belief that
an assessment of the living standard must consider the “environmental price” of this
standard. The higher living standard and better environment are not mutually exclusive
if the process of production is based on environmentally friendly technologies and if the
development is subordinated with the criteria for sustainable development.
Achieving a higher living standard with the lowest possible environmental
deterioration is the most challenging objective of the world’s sustainable development.
The problem is that the current economic system does not provide sufficient incentives
for optimizing environmental balances with the standard of living. It is obvious that
the market mechanism has no inherent incentives and disincentives for environmental
protection. The achievement of balance or the slowing of degradation processes is
due mostly to the introduction of specific standards and norms regarding production
and consumption. It is a matter of a separate analysis as to what instruments (legal,
economical, and social) are used for realizing this policy of sustainable development.
The reality, however, is such that the close binding of economical and political
principles with ecological principles could not happen in the very short term,
even though that binding is a necessary alternative to the present destructive trend
sirreversible processes

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The purpose of man’s interaction with nature is the improvement of his living
conditions. The quality of the environment has always been among those conditions,
but improvement of one parameter of the living standard is often at the expense of
another. Even if production is based on the most environmentally friendly technologies,
the use of some nonrenewable resources is unavoidable.

Modified Definition of Sustainable Development

The realities discussed thus far give us reason to believe that a development is
sustainable when a dynamic balance exists between social and ecological principles.
The social side of the equation includes an increase of public wealth and perfection
of mechanisms for its distribution. This gives us the basis to define sustainable
development as socially justified and environmentally sound economic development.
Let us try to decipher the following definition:
I believe that an economic development is environmentally sound when based on
the following principles.
Priority use of intensive growth factors
Decreased power- and material-consumption of production of a unit physical product
Substantially increased use of renewable natural resources and decrease the use of
nonrenewable ones
Progressive replacement of nonrenewable resources with renewable resources where
this is technologically possible
Introduction of economically viable technologies for mining unconventional
renewable and nonrenewable natural resources
Predominant use of non-waste technologies
Better utilization of recycled (used) materials
Improvement in the quality of goods for long-term use (higher utility per unit of
material throughput) and to decrease the power consumption for their use
Change patterns of consumption and, more specifically, limitation of the
consumerism and consumption of goods and services that are environmentally
harmful or for which production is based on valuable, nonrenewable resources
Appropriate stimuli to increase services related to restoring and preserving the
environment in countries and regions where the balance is disturbed
Optimized geographic location of production considering the accompanying
expenses of materials and energy and with the purpose of more balanced burdening
of local ecosystems

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Applied diversified and effective stimulus systems for businesses and households
that apply and aid the realization of the principles of environmentally friendly
production and consumption
The above characteristics explain mainly why I prefer the term “economic
development” before “economic growth.” Growth is determined only by the value of
the GDP, not considering the quality of the used technologies and the qualification
of the labor force, nor the method of the technologies’ production and use by society.
On the contrary, the qualitative characteristics of GDP and the mechanism of its
distribution and use by society are mirrored in the term development. Development
takes into account such important indicators as employment, quality and access to
healthcare and education, human rights, conditions for recreation and entertainment,
social protection, and so on.
Achieving sustainability of development is not possible when considering only the
quality of life and the level of consumption; equally important are the indicators for
how this result is achieved regarding the used natural resources and emitted pollutants
of the environment. Environmentally sound development is development in which
the interaction with nature is done in a manner and on a scale that does not threaten
and violate nature’s balance.

Socially Justified Development

Socially justified development requires
Full employment
Eradication of poverty and justified distribution of national wealth
A reliable social net for the low-income households
Improved purchasing power
Protected consumers’ rights
Access to appropriate healthcare
Access to education
Access to information exchange
Well-maintained national security
Political freedom and well protected human rights
Preservation of cultural heritage
The “socially justified” side of the definition of sustainable development emphasizes
the socioeconomic and institutional aspects of sustainability. It also reflects the effects
of the institutional dimension, as far as the regulatory mechanisms in the economic and
social sphere are directly related to achieving social justification. In fact, the interaction

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with nature expresses a system of economic relations regarding the production,

distribution, and consumption of material and spiritual goods. The characteristics
of sustainable development would be incomplete and incorrect if the problems of
distribution of produced goods were not considered. Many of the interpretations of
and attempts to define sustainable development absolutize the production-nature
relationship without considering the most important aspects—namely, principles and
results of distributing the created public wealth. The development of an ecologically
clean country with highlighted social polarization and a low living standard is as
unsustainable as the development of a country with a high economic level at the
expense of a degraded environment. Undoubtedly, socioeconomic and ecologic aspects
are mutually necessary for achieving sustainable development.
Development is sustainable if it improves the living standard of all citizens; leads
to limitation and later elimination of utmost poverty, homelessness, and illiteracy; and
provides access to work, education, healthcare, social security, and an ecologically-
clean environment for every member of society. Vylder (1996) underlines the need for
a multidisciplinary approach in analyzing sustainable development, which considers
not only the traditional factors of growth but also the real needs of people, their ideas,
and institutional structure. Harris (2003) defends the thesis that, together with the
new patterns of economic growth and sustainable management of natural resources,
sustainability also supposes new social and institutional structures. Goodwin (2003) also
shares the idea that a development is sustainable if it goes outside the frames of traditional
understanding of growth as increasing the GDP and if it has a higher purpose—that is,
development that is socially and environmentally just and sustainable (SAEJAS).
This is not the only piece of the puzzle. The other is that institutional structures
should guarantee political pluralism and democratic freedoms for every citizen but not
fall into the too-simplified understanding of democracy as only the right to elect and be
elected. Alperovitz (2003) stresses the major difference between the right to vote and the
possibility to influence political decisions. Unfortunately, even in developed countries
with stable democratic rules, this difference between the right to vote and real power is
widening. The traditional market instruments widely and seemingly irreversibly entered
the electoral system, creating profound deformations in the system of democratic
election. The respective candidate or political formation may win the election only if it
has enough political resources for printed materials and their distribution, campaigning,
and paying for radio and TV time, as well as for advertising in the printed media and on
the Internet, for support of personnel, and so on.

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Current political marketing has a rich set of instruments for influencing the vote
of the electorate, but this influence is very expensive; the tendency is to sharply increase
election expenses. In the USA, for example, election expenses are now hundreds of
millions of dollars. Election winning is inevitably influenced by the purses of the
strong people, i.e., representatives of corporate capital. That is why it is not difficult
to understand the serious problems in executive decisions that provide the conditions,
mechanisms, and stimuli for sustainable development. The US government refused
to sign the Kyoto protocol, not because it did not love the environment but because
such commitment would mean additional expenses of corporations for perfecting
technologies and the possible loss of jobs in a short-term period.
I defend the thesis that sustainable development should be regarded as a process
leading to the achievement of generally accepted indicators; it is a dynamic category.
The relatively high development level achieved in a certain country or region is not
enough for the development to be defined as sustainable if the ecological misbalance
becomes deeper or the social polarization grows, and vice versa. The development of
a “poorer” country that is going in a direction of improvement in those ecological
balance and social polarization can turn out to be more sustainable. It is understandable
that those tendencies should be reviewed at least in a middle-term period, and the
variations in the business cycle make short-term conclusions risky. Besides, this
process of movement to end purposes suggests high organization. Bartelmus (1994)
defined sustainable development as a set of development programs without which the
problems of conflict between generations regarding the use of natural resources and
those of social inequality would not be solved.
The sequence and complexity of development evaluation, from the point of view
of the degree of its sustainability, suggests moving the analysis from a specific company
or household to the municipal, regional, and national levels and finally to the global
community. Development cannot be sustainable in a single country or group of
countries if their development means the underdevelopment of other countries. The
prosperity of each country in one or another degree depends on the direction, dynamics,
and mechanism of development of the world economy. The level of interdependency
and mutual implementation of national economies inevitably suggests such dialectics in
the analysis of the ratio between the general (global) and single (country).
The essence of sustainable development defines the scope and purposes of
measuring its level with both quantitative and qualitative characteristics. For their
part, these characteristics and the tendencies they reflect aid in a full and detailed
analysis of sustainability.

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References
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Allen, R. (1980). How to save the world? London: Kogan Page.

Alperovitz, G. (2003). Sustainability and systematic issues in a New Era. In J. M. Harris (Ed.),
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The handbook of environmental economics. Oxford, MA: Blackwell.

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Bartelmus, P. (1994). Environment, growth and development. London: Rutledge.

Beckerman, W.(1992). Economic growth and the environment: Whose growth? Whose environment?
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Bossel, H. (1999). Indicators for sustainable development: Theory, method, applications. Canada:
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Bretschger, L. (1999). Growth theory and sustainable development. Cheltenham: Edward Elgar, pp. 190-
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the environment and a sustainable future. Boston, MA: Beacon Press.

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Dasgupta, P., & Maler, K. (1995). Poverty, institutions, and the environmental-resource base. In
J. Behrman and T. Srinivasan (Eds.), Handbook of Development Economics v. 3A. Amsterdam:
Elsevier Science.

Goodland, R., & Ledoc, G. (1987). Neoclassical economics and principles of sustainable development.
Ecological Modelling, 38, 36.

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Rethinking sustainability: Power, knowledge and institutions (p. 50). Ann Arbor: University of Michigan
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Harris, J. M. (2003). Rethinking sustainability: Power, knowledge and institutions. Ann Arbor:
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American Economic Review, 1, 972-974.

Howe, C. (1979). Natural resource economics. New York: Wiley.

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Meadows, D. et al. (1974). The limits to growth: A report for the Club of Rome’s Project on the Predicament
of Mankind. New York: Universe Books.

Pearce, D. (1988). Optimal prices for sustainable development. In D. Collard, D. Pearce, & D. Ulph
(Eds.), Economics, growth and sustainable environment (p. 74). London: Macmillan.

Pezzey, J. (1989). Economic analysis of sustainable growth and sustainable development. World Bank
Environment Department, (Working Paper, No.15). Washington D.C.: World Bank.

Solow, R. (1986). On the intergenerational allocation of natural resources. Scandinavian Journal of

Economics, 88, 141-149.

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Vylder, S. (1996). Sustainable human development and macroeconomics. Strategic links and implications.
Discussion Paper, p.9, New York: UNDP.

Notes
1
The “unconventional oil reserves” are of two main kinds: (a) heavy oils, which are thicker and contain
more sulphur and heavy metal contamination, necessitating further refining, and (b) tar sands, which can
be recovered via surface mining or in-situ collection techniques. These additional reserves are estimated
to total 3 trillion barrels. Accessed at [Link]

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C H A P T E R 2.
I N D I C ATO R S F O R
S U S TA I N A B L E D EV E LO P M E N T

The elaboration of a suitable system of indicators for sustainable development is

one of the major challenges facing contemporary science. The very interdisciplinary
nature of the issue, which is preconditioned by the intricate and highly dynamic
system of inter-relations and inter-dependencies between the socioeconomic system
and the natural environment, renders the solution to the problem of indicator
elaboration exceedingly difficult. Dozens of researchers, research teams, and national
and international institutions and organizations are relentlessly seeking solutions that
would permit an adequate and sufficiently comprehensive assessment of the qualitative
and quantitative parameters of sustainable development to be carried out.

Methodological Aspects of Creating a List of Indicators

It is obvious that without a reliable system of measurement, we have difficulties
not only assessing the current problem but also developing and implementing policies
and mechanisms that lead toward sustainable development.
Hardi and Zdan (1997) have offered a felicitous systematization of the criteria that
the indicators for sustainable development should meet. These criteria include policy
relevance, validity, reliability, availability of time-series data, simplicity, good quality,
affordability, ability to aggregate data and information, and sensitivity to small changes.
The individual indicators or systems of indicators that have been used thus far
are the product of two relatively autonomous approaches. The first approach is based
on the notion that sustainable development can be measured and assessed by using
several subsystems of indicators reflecting sustainable development’s various aspects—
environmental, social, economic, institutional, and so on. Such is the approach of
the United Nations Commission on Sustainable Development (UNCSD) and of the
much-respected International Institute for Sustainable Development (IISD) in Canada.
The second approach puts its stakes on some “magical” indicator of a maximally-high

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degree of aggregation designed to reflect the entire range of indicators, covering the
various aspects of sustainable development.
It is natural to assume that the implementation of the second approach is
considerably more difficult from a methodological point of view because it means
characterizing numerous and varied direct links and feedbacks between indicators
from various subsystems. Often, comparing these indicators along the lines of a certain
common trait (monetary, physical, extent of change, and so on) contains too many
conditionalities or is virtually impossible at this stage altogether. Researchers strive to
facilitate analysis by minimizing the number of indicators or to decrease the indicators
to a single integral indicator that is capable of sufficiently and reliably reflecting the
level of sustainability in relation to the set objectives and revealing development trends
at the same time.
I do not think that the two approaches are mutually exclusive. Arriving at an
integral and highly aggregated indicator is impossible without simulating an indicator
system and corresponding subsystems grouped according to their congruity with the
various characteristics of sustainable development. The issue we are focusing on is (1)
whether eliciting a sufficiently reliable integral indicator that could encompass and
reflect the entire specificity and variety underlying sustainable development is possible
in principle and (2) whether the sum of relatively independent indicators, grouped
in individual subsystems, could serve as a basis for the solving the methodological
problem outlined above. In this sense, the methodological aspect of a sustainable
development discussion is much more important than the question about how many
of indicators there should be.
The UN Commission for Sustainable Development (UNCSD) is the natural leader
in the effort to elaborate, summarize, and implement the system of indicators because
the UN member countries should adopt such a system of indicators by consensus and,
consequently, use their respective governments to implement the system. The elaboration
of a system of indicators or of a single aggregated indicator has its autonomous theoretical
significance, but inasmuch as sustainable development is possible only as a result of a
concrete policy, any model of indicator research would make sense only if its outcome
could be accepted as a universal basis of (1) assessing and forming a specific policy and
(2) elaborating on mechanisms for the policy’s implementation.
In 1997, at the 19th Special Session of the UN General Assembly, the UNCSD
tabled a proposal for the elaboration of a system of 134 indicators of sustainable
development grouped by the four relevant dimensions: social, economic, environmental,
and institutional. The UN General Assembly endorsed the proposal and gave its

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approval for the system of indicators to be tested in twenty UN member countries. The
experience from the tests and the results from the comparative analysis indicated the
need for further improvement of the systematization and formulation of some of the
indicators. This brought about a decrease from 134 to 58 indicators with the purposes of
avoiding double measurements and simplifying comparisons as much as possible.

Table 2.1. UNCSD: Indicators for Sustainable Development

Economic Environmental Social Institutional
A. Economic Structure: A. Atmosphere: greenhouse A. Equity: percentage of A. Institutional
GDP per capita, gas emissions, ozone- population living below Framework:
investment share in GDP, depleting substance poverty line, Gini Index national sustainable
balance of trade in goods consumption, ambient of Income Inequality, development
and services, debt-to- concentration of air unemployment rate, ratio strategy, ratified
GNP ratio, total Official pollutants in urban areas of average female wage to global agreement
Development Assistance average male wage implementation
(ODA) received or given B. Land: arable and
as a percentage of GDP permanent crop land area, B. Health: nutritional B. Institutional
fertilizer use, agricultural status of children, Capacity: number of
B. Consumption and pesticide use, forest area as a mortality rate of children Internet subscribers
Production Patterns: percent of land area, wood less than five years old, per 1000 inhabitants,
intensity of material harvesting intensity, land life expectancy at birth, main telephone
use, annual energy affected by desertification, percentage of population lines per 1000
consumption per capita, area of urban formal and with adequate sewage inhabitants, research
share of renewable energy informal settlements disposal facilities, and development
resource consuAmption, population with access to expenditure as a
intensity of energy use, C. Oceans, Seas, and safe drinking water, percent percentage of GDP,
industrial and municipal Coasts: algae concentration of population with access economic and human
solid waste generation, in coastal waters, percentage to primary healthcare loss from natural
hazardous waste of total population living in facilities, immunization disasters
generation, radioactive coastal areas, annual catch against infectious childhood
waste generation, waste by major species diseases, contraceptive
recycling and reuse, D. Fresh Water: annual prevalence rate
distance traveled per ground and surface water
capita by mode of C. Education: percentage
withdrawal as a percentage of children reaching grade
transport of total available water, five of primary education,
BOD in water bodies, adult secondary education
concentration of fecal achievement level, adult
coliform in freshwater literacy rate
D. Housing: floor area per
person
E. Security: number
of recorded crimes per
100,000 population
F. Population: population
growth rate, population of
urban formal and informal
settlements

Source: UNCSD. (2004) Retrieved 2 September 2004 from [Link]

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The system of indicators adopted by UNCSD is sufficiently broad and covers

the major dimensions of sustainable development. It includes indicators of various
degrees of aggregation, which are subject to exact quantitative or qualitative
measurement or both. A number of indicators such as energy intensity, GDP per
capita, distance travel per capita, crime rate per 10,000 inhabitants, and so on, are of
a relative nature and reflect more complex processes, which is undoubtedly their best
advantage. This system of indicators offers good opportunities for assessment of the
development in individual countries in accordance with the criteria that have been
adopted. The proposed system of indicators is sufficiently flexible, making it possible
for individual countries to include one or another set of indicators in their analyses,
depending on the specific peculiarities and priorities of each country. The flexibility in
the manner of assessment offers opportunities for modification of the indicator system
depending on the natural, climatic, geographic, social, or economic conditions of
the individual countries. What should be commendable in this sense is the approach
of combining general principles and criteria for sustainable development with the
specific approaches of formulating and assessing the indicators in compliance with the
specificity mentioned above.
The UNCSD approach does have downsides, however. Some of them are
connected with the very definition of certain indicators. Others stem from the
insufficient inter-relatedness of indicators from the various indicator groups or are
brought about by a combination of the two sets of problems. One example is that of
the “population growth rates” indicator. This indicator does not give qualitative ideas
about the living standard of the population, nor is it linked with any consequences for
the environment. For some countries, higher population growth rates are desirable (the
countries of Eastern Europe, for example, which have had a negative growth rate for
some time), whereas for other countries such as China and India, higher population
growth rates are creating or could create problems. Another indicator—“emissions of
greenhouse gases”—is expressed in absolute terms without any link to the volume or
type of industrial output.
Naturally, countries with larger volumes of industrial output, and that export
their products to the international market and thus meet certain demand, will record
higher levels of greenhouse gas emissions if all other conditions of the compared
countries remain equal. In the first years of the transition to a market economy, the
Eastern European countries—Russia included—marked a considerable decline in their
GDP and most notably in their industrial output. This had a “positive” impact on the
environment because the manufacturing facilities that used to pollute the environment

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had been closed down or only partially used. An important question to ask, however,
is, Are lower greenhouse gas emission indicators under such circumstances a suitable
sign for sustainable development?
The “debt-to-GNP ratio” and “trade balance” indicators, on their own, are also
incapable of giving any ideas about sustainability or lack of sustainability. Countries with
equal debt-to-GDP (or GNP) ratios are in different economic situations depending on
the capacity and viability of their economies. For the USA, for instance, a 35 percent
debt-to-GNP ratio may be a completely tolerable level, while for any less-developed
countries, this level could prove an exceedingly heavy burden, sizably affecting the living
standard, the capacity for protecting and restoring the environment, and so on. The
USA has had a chronic trade deficit since the Vietnam War, whereas Japan has been
maintaining a favorable trade balance for decades. Japan, however, pursues a specific
economic and, most notably, foreign trade policy. This is the reason why the discrepancy
in the indicators is not rooted in any radically different economic or social and political
factors, but rather in the different types of policies these countries pursue and the
different mechanisms of their interaction with the world economy. Many industrially-
developed countries, let alone developing countries, could not have possibly maintained
such a high level of economic standard had their trade balances suffered from a chronic
deficit. Also, because the trade balances of many less-developed countries suffer from
such deficits, they encounter problems in their social and economic development.
The “energy consumption” indicator (encompassing renewable and non-renewable
energy consumption) is far too general, as well. In its essence, this indicator expresses
an absolute value that is not related to the efficiency of the economy. In principle, it is
possible to see a scenario whereby the declining energy consumption per capita of the
population is a sign of lacking sustainability and a shrinking living standard, should
this result from rising energy prices rather than from growing energy efficiency.
Consequently, future development of the indicator system should aim at attaining
a more appropriate inter-relatedness, binding the social, economic, and environmental
factors in a way that permits a comparative evaluative analysis. The most difficult
problem to solve concerns the relative weight of the individual indicators employed in
the comparative country analyses or in the analysis of a single country’s development.
The issue here is not simply accurate quantification of individual indicators in their
capacity as components of some overall index; the difficulty in determining weights of
indicators lies in the fact that for individual countries, the weight of these indicators
differs depending on a country’s geographic location, specific natural and climatic
conditions, cultural and religious differences, political system peculiarities, extent of

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development and structure of the national economy, and so on. These problems also
occur when all other indices or systems of indicators are employed or proposed for use
in the assessment of sustainable development.

Human Development Index as One of the Sustainable Development Indicators

Another widely used index is the Human Development Index (HDI), which
has been employed by the United Nations Development Program Agency (UNDP)
since the beginning of the 1990s. This index is based on three relatively independent
components: level of education, per capita GDP, and life expectancy. Each of the
components has a subindex of its own with an equal weight in the formation of the
composite index. In other words, the subindices are equitable. As shown in Figure
2.1, they are formed within the limits of minimum and maximum levels, within the
range of 0 to 100, as far as education and the standard of living are concerned, and
from 25 to 85 years of age for the life expectancy subindex. This is the basis on which
the UNDP annually makes and publishes a rating of its member countries, which, to
some extent and under certain provisions, gives an adequate idea of the sustainability
of these countries’ development.
Assigning equal weights to the three subindices is a compromise-seeking measure
inasmuch as it is difficult to defend models of quantified indices to which different
weights have been assigned. A similar methodological model comes up with every
attempt to aggregate two or more indicators, especially when they are of different
orders, i.e., when values from different subsystems (economic, social, political,
environmental, and so on) have to be made commensurate. In my opinion, both
quantitatively and qualitatively, the GDP per capita index directly or indirectly reflects
the other two indices or is rather strongly influenced by them. Should all remaining
conditions be equal, increased life expectancy will have a purely statistical impact
because the number of members of the population grows.
The expanding GDP creates prerequisites for longer life expectancy, however. The
larger per capita GDP enables the investment of more private and public funds for more
extensive education and better-quality healthcare services. The statistical data for most of
the countries categorically proves the dependence between the GDP per capita and life
expectancy. In this sense, the introduction of two indices, which in practice illustrate the
same dependencies, is pointless and only encumbers and complicates the analyses made.
For our analysis, what are the benefits of this indexing method and what are the
risks for the accuracy and reliability of its application? In principle, the measurement
of the degree of human development plays a defining role within the context of

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sustainability, although it does not address all of sustainability’s aspects by far. In

essence, this index fails to include directly the style and result of interaction between
society and nature, nor does it give any idea about the degree to which these indices
are commensurate with certain generally accepted criteria or objectives of social and
economic policy. At any rate, this index contains information that can be used if it is
disaggregated and structured in an appropriate way.
Literacy can hardly be a sufficiently reliable criterion for discerning qualitative
differences within the framework of individual groups of countries: high development,
medium development, and low development. As the rating indicates, no difference exists
among the first twenty countries, and the level of this subindex in each country is 99.
In fact, many of the countries from the medium-level development group have attained
a literacy rating of 99, as well. By agreeing that a positive dependency exists among the
literacy levels, standard of living, and life expectancy, we cannot fail to note that knowledge
measured in such a way gives no idea of what exactly its contribution is to the formation
of the other two subindices and the overall composite index. The rate of literacy and the
percentage of people who have completed various educational levels should be bound
with concrete results. These could include, for instance, labor productivity per worker or
the level of competitiveness, both of which to a great extent depend on the training of the
country’s workforce and on governance at a corporate or governmental level.
Countries such as Western Samoa, Guiana, Tajikistan, Kyrgyzstan, and Vietnam
register literacy rates of 94–98 percent, but this is far from a convincing argument for
a high level of development or for a high level of sustainability of this development.
In this way, this subindex does not answer important questions such as What is the
quality of education at the respective educational levels? How much does it cost?
How accessible is it? What are the job opportunities for the graduates to practice their
professions and attain self-fulfillment?
Germany and the USA have the same index of literacy (0.99), but access to the
three levels of higher education in these two countries differs and is effected under
different conditions. The annual tuition fee in a medium-sized US university amounts
to 10–12 thousand USD, whereas education in the state universities in Germany
is practically free or can be obtained at a merely symbolic price, which is actually a
registration fee only. Tuition alone would cost a US family about 70-80 thousand
USD for a bachelor’s degree for a single child, and if we include in it the price of
tuition for a master’s degree, the sum will exceed 110 thousand USD. Despite the
various forms of preference loans for students, the high cost of education is a significant
financial burden for the families’ budget. The cost directly binds the opportunities for

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education to the purchasing power for this type of service. Higher education, in this
sense, is accessible mainly for families of sufficiently high incomes. Moreover, where
certain differences in the quality of education in the above-mentioned two countries exist,
they become insignificant if we compare the monetary costs for this educational service.
Unfortunately, the HDI disregards these significant social and economic aspects.
The information revealed by the life expectancy subindex for the group of the top-
ranking thirty-five to forty countries is not sufficiently well-differentiated, and in some
cases, the causal relationship between life expectancy and the extent of development is
misleading. For instance, Sri Lanka and Armenia enjoy the same life expectancy as the
average indicator for developed countries, which is 73 years of age on the average. The
problem here is that this sub-index does not provide sufficiently reliable information
about the conditions and quality of life. Life expectancy in Cuba and Denmark is the
same, but this is not a sufficient condition for us to believe that these two countries
enjoy the same level of development. The picture is sufficiently distinctive only when
comparisons are made between countries of high and low development. At any rate, life
expectancy is not an unambiguous indicator for the level of sustainable development.
Nevertheless, given appropriate interpretation and further expansion of analysis, the
adequacy of this indicator may very well increase.
In expert circles, the most debatable subindex is the per capita GDP. What should
be pointed out first is that the index in question is regarded mainly as a measure of the
level of incomes and purchasing power of the population. Unfortunately, this context
does not cover in any way the GDP-environment relationship, and this relationship
is of greatest interest from the sustainable development point of view. Even with these
limitations in the formation of the indicator, however, other methodological and
factual problems still exist concerning the comparability of this indicator for various
groups of countries or for individual member countries. In my opinion, the limitation
does not lie in the difference between the actual purchasing power of incomes in
individual countries, which register different price levels and exchange rates, nor in
the percentage share of the gray economy. The recalculation of the purchasing power
parity per unit of the GDP, or per household or per capita income, has become a
routine operation in comparing this indicator for various countries, and the parity
purchasing power is a sufficiently-reliable indicator for this type of comparison.
The gray economy and its exclusion from the monetary measurement of incomes
do not bring about any significant distortions in the GDP picture. The problem of
less-developed countries does not lie in the fact that a certain percentage of created
domestic product has not been included in the statistically registered gross product but

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in the fact that this gross product (registered plus unregistered) is far too low, from the
point of view of both its magnitude and qualitative indicators. For the least-developed
countries, this difference amounts to tens or even hundreds of times in comparison
with the most-developed countries. In the conditions of a monetary economy, the
connection between the GDP per capita of the population and the population’s living
standard is markedly positive. The relationship between GDP per capita and living
standard is not a direct relation but is determined and conditioned by a number of
other factors and mechanisms.
When the per capita GDP levels in a given group of countries (highly-developed,
developing, least-developed) are close, a substantial role for determining the living
standard of the population is played by the conditions conducive to access to education,
healthcare, home purchase, social (and particularly pension) security, employment and
labor conditions, the length of paid leave, the level and mechanisms for compensating
temporary unemployment or temporary disability, the crime rate, possibilities for
travel, and so on. Very important in this respect are also what incomes can buy and
the quality and choice of consumer goods and services in a given country. In 2001,
Byelorussia enjoyed a per capita GDP standing at 7,620 USD, while the per capita
GDP in Bulgaria and Romania stood at 6,890 USD and 5,830 USD, respectively.
Byelorussia’s economy, however, is a quasi-market economy with a prevailing state
ownership share, coupled with serious customs and purely administrative constraints
on the import of consumer and capital goods; the most serious limitation concerns the
constraint imposed on consumer goods imports.
Bulgaria and Romania “lost” some of their GDP also because they are in the process
of restructuring their economies. One of the key directions in this restructuring is the
privatization of state-owned enterprises, which is a taboo in Byelorussia. In this sense,
the orientation to a modern market economy brings inevitable losses in the short- and
medium term because of the unavoidable restructuring of the economy in compliance
with the new market realities. This restructuring, however, is what creates prerequisites
for sustainable development in the long-term perspective. The question, then, is which
country or countries should actually get a higher HDI? Bulgaria and Romania are
associated member countries of the European Union and are scheduled at the beginning
of 2007 to become full and equitable members of the enlarged European Community.
At the same time, because of the limited political freedoms Byelorussia grants to its
citizens, this country is somewhat isolated from the democratic world.
Moreover, human development includes the process of artistic creation, further
development, and access to the attainments of culture and arts: cinema, theater,

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opera, publishing, fine arts, museums and exhibitions, and so on. Taking into account
the above indicators, which the HDI has not measured thus far, the higher rating
attributed to the Seashells and Bahrain before that of Hungary and Slovakia seems
unconvincing, especially having in mind that the latter two countries are now part of
the most-developed integrated community in the world, the European Union. What
should also be noted here is that, in principle, the GDP per capita is presented as an
arithmetical mean; it does not reflect the way in which income is distributed among
the households in the country. Unfortunately, the way incomes are distributed is
usually measured by the Gini coefficient, which is not reflected in the indicator we are
considering here.1 This makes HDI implementation unreliable for countries of strong
social polarization, which encompasses the majority of developing countries.
The economies of many of the developing countries rely solely on their extracting
and primary industries. For some—the petroleum extracting countries, for instance—
the national economies are of a monocultural nature, which makes the economies and
their per capita GDPs too dependent on the cyclical changes of world prices in this
particular commodity group. In this way, the HDI could fluctuate in rather broad limits,
not because of any changes in the standard of living of the population brought about
by the development of their national economies, but mainly because of the alterations
occurring in export prices. The drastic changes observed in the price of crude oil are
sufficiently indicative to this effect: from below 10 USD per barrel in 1998 to nearly
40 USD per barrel in 2003–2004. This is a part of the explanation as to why Bahrain
ranks before Hungary and Slovakia in the GDP subindex. According to UNDP annual
reports, the 1990 HDI index for Saudi Arabia was 0.716, and within three years it rose
to 0.771, after which it dropped to 0.746 in 1995. The 1993 level of the index was never
attained again through the years up to 2001, when it reached 0.769. These illogical
movements of the index are obviously because of fluctuating international crude oil
prices and the amounts of extracted and exported crude oil, rather than because of any
alteration in the direction or quality of the country’s human development.
The HDI would be much closer to reality if the GDP and the per capita GDP were
seen in light of the balance of payments and considered from movement of national
capital point of view in particular. What I mean is that in practice, the larger part of
incomes earned from the exports of raw materials and energy sources from developing
to developed countries remains in the developed countries. The huge revenues from
oil exports are redeposited in the banks of developed countries. The monocultural
economies of the petroleum-exporting countries from the developing world, which
are the product of the economic strategy their rulers or governments have chosen to

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pursue, have proved incapable of appropriating the large income earned from crude oil
exports in the form of investments. The per capita GDP of these countries is large but is
actually used for increasing the standard of living of other countries. Because of this, the
place of such developing countries in the UNDP rating is incompatible with the actual
level of their human development. The very approach of binding human development
with only the extraction and exportation of petroleum or other natural resources is rather
dubious, as both a method and a result. At any rate, this type of human development can
hardly be qualified as sustainable development at the same time.
The key GDP per capita index reveals another deficiency when applied to
developing countries characterized by high population growth rates. Such countries
include India, Bangladesh, Indonesia, Malaysia, Niger, and Honduras. The annual
population growth rate in these countries stands at 1.2–2 percent (India, Indonesia,
Laos, and the Philippines) and up to 3–4.9 percent (Yemen, Angola, Uganda, Niger,
and Afghanistan).In these countries, the population growth rate is higher or close to
the GDP growth rate, which automatically affects the magnitude of the GDP per
capita index. The result of this manner of measurement is that even when certain
economic development has been registered, as in the case of India, the HDI may
remain unchanged or could even deteriorate, all other conditions being equal. This
gives us sufficient reason to think that for this group of developing countries, the GDP
per capita index reveals the changes in the average indicators measuring the standard
of living rather than changes in general development.
Another indicator—the GDP per employee—would be more expedient than the
GDP per capita index. We believe that this indicator could outline actual development
to a much better extent than the GDP per capita index because the GDP per employee
results from the changes in labor productivity, which, for their part, depend on the
level of technologies employed, the effectiveness of management, the educational level,
the state of healthcare in the country, the competitiveness of the economy, and so on.
The higher labor productivity underlies a higher potential for the implementation of
social programs, the development of science, and the solution of issues concerning
environmental protection and restoration of the natural environment. This system of
dependencies has found a broad statistical confirmation in all groups of countries. The
reliability of this indicator can increase, should it be corrected with price fluctuations
(if the real GDP is used for calculating it).
The above considerations concerning the model of HDI formation do not challenge
in any way the deployment of this index in principle for determining the level of
human development, and through it, the sustainability of this development according

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to the adopted criteria and indices. Despite the analytical problems encountered in
the handling of nonweighted average indicators compiled on an arithmetical mean
basis, the HDI contains useful information for the purposes of analyzing sustainable
development. The correct interpretation of the indicator—an interpretation that is
carried out in conformity with the concrete specificity of the environment subject to
analysis—is undoubtedly a step forward to finding aggregated values for the assessment
of the level and quality of social and economic development.

Fig.2.1. Human Development Index for Country Groups, 2001

Legend: OECD–Organization for Economic Cooperation and Development,

LDC–least-developed countries, DVNG–developing countries, CEC–Central
European countries.
Source: UNDP (2004).
Figure 2.1 contains a chart based on the Index of Human Development (HDI) for
2001, which illustrates the respective trends in the development of this index throughout
the last quarter of the 20th century. This data outlines the difference, which is far too large,
between the various groups of countries. This difference is of the highest order between
the low-developed countries and the OECD countries. The numeric expression of the
different HDI values for these two groups of countries is 0.905 and 0.448, meaning the
ratio between their levels of human development exceeds 2:1.
The chart illustrating the trends in the development of the index reveals another
negative tendency as well—namely that the index for the least-developed countries
has remained almost unchanged over the 1975–2001 period and has stayed at an
unacceptably low level.

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Fig.2.2. Human Development Index (HDI) for Selected Countries

Source: Based on data from Human Development Report. (2003). Washington,

D.C.: World Bank, p.240. Retrieved 23 July 23 2004 from [Link]
reports/global/2003/pdf/hdr03_HDI.pdf
The first five countries (Norway, Iceland, Sweden, Australia, and the Netherlands) in
the 2003 HDI rating published by the UNDP mark a growth rate of 8–10 percent over
the period 1975–2001. Some of the countries in the report (Portugal, Malta, Cyprus,
Israel, Singapore, and Ireland) that have recently been included in the group of High
Human Development, have improved within this index by an average of 15–20 percent,
which made it possible for them to move forward at a considerable pace during the
period under observation. The five countries of the lowest HDI in 2001, at first glance,
have marked quite a good growth rate—between 15 and 31 percent; unfortunately,
the increase has been measured from an extremely low initial base recorded in 1975.
Undoubtedly, such a development of the indicator for the developing countries is rather
low to still register such a difference when compared with the most developed countries
or even the Medium Human Development countries. In Figure 2.2, these trends are
illustrated for Norway, Brazil, and Niger. These countries represent different country
groups—countries with high, medium, and low levels of human development.
The index of the five countries at the bottom of the UNDP’s HDI rating—
Sierra Leone, Niger, Burkina Faso, Mali, and Burundi (all of them in Africa)—ranges
between 0.275 and 0.337. In the five most developed countries—the Netherlands,
Australia, Sweden, Iceland, and Norway—the index ranges from 0.938 to 0.944. In
this case, the ratio is almost 3:1. Taking into account the rate of development in the

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least-developed countries, this ratio could not possibly change in any significant way
in the short- and medium-range perspectives.
Analysis of the current situation and trends in the development of the HDI does
not make it possible to consider that, given the social and economic policy pursued at
present, the ratio between the indices could improve over the short- or even medium-
term periods. The desired change could take place under a different type of policy
and other mechanisms of international economic relations, which will be subject to
discussion in the following chapters.

Alternative Indicators for Sustainable Development

he Index of Sustainable Economic Welfare
Like the HDI, the Index of Sustainable Economic Welfare (ISEW) is an
aggregate index. Its major function is to determine the parameters and quality of
development in a broad aspect and in the context of the development-environment
relationship. Salah El Serafy et al. (1989) suggested substituting nonreproductive
capital by created (human) capital. He suggests that a portion of the revenues from
the sale of nonreproducible natural capital should be reinvested in the production of
reproducible capital so that the disturbed balance in nature could be restored. On the
basis of this methodology, Daly (1989) has expanded an index of a sufficiently high
degree of aggregation:

ISEW = Cadj + P + G + W – D – E – N

Where Cadj is consumer spending adjusted for income inequality, P is nondefensive

public expenditures, G is capital growth and net change in international position, W
is nonmonetarized contributions to welfare, D is the defensive private expenditures,
E is the cost of environmental degradation, and N is the value of depreciation of the
environmental capital base.
ISEW is a useful step forward in the effort to find appropriate ways of aggregating
indices from various subsystems by bringing them down to comparable monetary
values. Of special interest to our discussion is the attempt of ISEW to determine
the degradation of the environment and its effect on the socioeconomic sphere in
monetary terms. The index has been tested in several countries, and the preliminary
results are encouraging. They reveal significant differences in monetary terms between
the classical GDP indicator and ISEW. Jon Matthews et al. (2003) from Cardiff
Business School have implemented this index in analysis of the development of Wales
over the period 1990–2000.

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Fig.2.3. Wales: GDP and ISEW per Capita, 1990–2000 (in Pounds).

Source: Based on data from Matthews, J., Munday, M., Roberts, A., & Williams,
A. (2003). An Index of Sustainable Economic Welfare for Wales, the ERSC Centre for
Business Relationships Accountability Sustainability and Society. Cardiff Business School,
p. 3. Retrieved June 2004 from [Link]
The results from this study have been used to show the significant difference
between the top indices, inasmuch as the ratio between them is approximately 4:1
in favor of the GDP per capita index. What is also impressive here is that, while the
GDP per capita index has marked a 12.5 percent growth over the period 1990–2000,
the ISEW has risen by only 6.3 percent for the same period. Based on this, researchers
have reached the conclusion that economic growth is insufficiently sustainable and
that the adverse environmental consequences and unfavorable, secondary social effects
from this growth have remained at a high level.
Having agreed with the conclusion that, in principle, the GDP per capita index
cannot measure the entire variety of factors that have some bearing on sustainable
development, we would like to comment on certain debatable aspects concerning
the creation of this index’s model. Consumer expenditures are corrected by only the
so-called defensive spending, which will be treated in greater detail further on in the
text. The question to consider here is what makes it possible to assume that each rise
of these consumer expenditures also means an improved standard of living or, to be
more precise, that these expenditures meet the criteria for sustainable development?
It is possible for these expenditures to rise because consumer prices have risen or

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because the conditions for savings and investments have deteriorated. This model
makes no distinction between the consumption of environmentally friendly products
and goods polluting the environment, nor between technologies, production facilities,
and conditions of supply that harm the environment and those that do not.
Another thing not considered is the phenomenon of consumerism, which has
been growing by unacceptable rates in industrialized countries. The manifestations
of consumerism are manifold, but suffice it to mention the maniacal drive to acquire
and amass material wealth and personal belongings, such as the increased demand for
luxury sports cars and heavy Jeeps. The manufacturing of such goods is connected
with high material and energy costs, and their exploitation involves high fuel
consumption per every 100 km run. Is the rise of this type of consumption a sign
more of nonsustainability than not? On the contrary, the improved quality of durable
consumer goods leads to lower replacement costs, lower maintenance costs, and so
on. Over the past 10–15 years, numerous positive changes like these have occurred,
brought about by keener market competition and the growing role of consumer
protection organizations.
In principle, the division of expenditures into “defensive” and “nondefensive”
spending is methodologically correct, as it assumes that the former are effected as a
reaction to some unfavorable consequences or as a means of protection against such
adverse effects. As a result, household expenditures for devices to filter water and air,
for example, are defensive spending. Expenditures to treat illnesses caused by smoking
also qualify as defensive spending, but such a formulation of defensive spending and
its exclusion from the GDP is, to say the least, strange. It turns out that expenditures
on air-conditioning equipment, which by rule now comes from the manufacturer with
built-in air treatment filters, air ionizers, or both, are considered “unsustainable.” Water
filters have now become an indispensable attribute of the design and construction of
modern residential and industrial buildings, regardless of the purity of water supplied
by water companies. In fact, the cost of these filters compared to the cost of housing or
taken as a percentage share of overhead costs is statistically negligible in monetary terms
but has an especially important contribution to improved quality of life. The authors of
the research project studying the development of Wales over the 1990–2000 period have
once again adopted a compromise approach, used earlier by Jackson et al. (1997), and
calculate these defensive expenditures as a percentage of overall consumer expenditures.
The example above contains yet another aspect of defensive versus non-defensive
expenditures that calls for reconsideration, especially when making international
comparisons. If we compare two countries with an equal degree of air and water

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pollution and equal consumer expenditures, and only one of them can afford to
spend on air and water filtration, then the country that makes no expenditures on
air and water treatment will come up as a country with a higher level of sustainable
development. Hundreds of millions of people have no access to clean drinking water,
and this is the reason why, in principle, water treatment costs should be assigned a
positive, rather than negative, sign.
Another debatable approach is the one concerning healthcare expenditures,
although here, some distinction is made between defensive and nondefensive
spending. The way healthcare costs are treated in both their forms is often misleading.
It is unacceptable to believe that more funds invested in healthcare can be considered
a sound indicator that people suffer from ailments and diseases—that the population’s
health has been deteriorating. We cannot agree with such an assumption stemming
from the way the index is calculated because this would lead us into the following
absurd situation: If two countries register the same levels of GDP but one of them
employs highly skilled medical professionals and provides modern medical equipment
and consequently incurs higher healthcare costs while such health resources in the
other country are provided in far more primitive conditions, then the latter country
would come up with a higher ISEW level.
We can reasonably conclude that the monetary approach implemented in such a
way is unreliable. The claim that the relationship between the costs of medical services
and human health is inverse is, to say the least, rather vulnerable. Life expectancy
rises with the improvement and expansion of medical services, but at the same time,
is accompanied by growing costs, both private and public. Probably because of the
inability to apply a reliable criterion for the suitable structuring of medical costs in the
adopted interpretation of ISEW, the ratio between defensive and nondefensive healthcare
expenses has been assumed equal. How the costs have been divided into exact halves is
far from clear unless we assume that the accepted division was aimed at facilitating
the arithmetic calculation; however, I think that such an approach of dividing medical
expenditures is inaccurate and, therefore, unacceptable. Whether the expenses incurred
are intended for the treatment of diseases provoked by genetic factors; family and work
environment; polluted environment; or street, domestic, or industrial accidents is
irrelevant. The defining factor here should be that medical treatment improves the level
of healthcare and the quality of life of the people. This is absolutely sufficient for medical
expenditures to be taken as a positive factor for sustainable development.
The same should also apply to the classification of expenditures incurred for
environmental programs. According to the terminology suggested by the ISEW,

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environmental protection expenditures fall into the group of “nondefensive

expenditures,” but spending on cleaning and restoring the natural environment falls
into the group of “defensive expenditures.” We share the opinion that, in the final
account, considering the end result, such a division of expenditures is inadequate,
especially taking into consideration that in both cases, environmental quality improves.
Moreover, the negative impact on the natural environment has lasted for quite a long
period of human history, whereas the costs for restoring the balance of the environment
are current expenditures. In addition, much like the case with healthcare, a country
that spends only on environmental protection and does not invest in the clean-up of
the environmental pollution of the past would have a more favorable ISEW.
ISEW is an interesting endeavor to adjust the GDP in monetary terms with a view
to obtaining a more accurate monetary definition of sustainable development. Finding
an adequate instrument for such an assessment is extremely difficult, controversial,
and disputable, and yet it is imperative that the proposed indicators be defined in
quantitative terms such as loss of natural capital and cost of environmental damage.
The results from the application of the index in the comparative analysis of Wales
(for the 1990–2000 period) and their possible use for implementing policy measures
confirm that many methodological issues have remained open and unclarified,
including the method of obtaining sufficiently reliable quantitative parameters. The
conclusion of the Wales project is that no immediate conclusions should be drawn
from the direct comparison between the reported GDP and the modified GDP—
ISEW. This conclusion is quite reasonable, given that GDP formation follows the
fluctuations of the business cycle and can be affected by a number of processes in the
world economy. In this sense, the possible decrease of the difference between the two
indicators could be rather undesirable under certain circumstances.

The RioJo Dashboard System

In 2001 the Consultative Group on Sustainable Development Indicators
(CGSDI), with the International Institute for Sustainable Development (IISD),
elaborated and presented before the UNCSD the Dashboard (Appendix 1), which
is a system of indices covering all aspects of sustainable development that have been
aggregated in a Sustainable Development Index (SDI). The elaboration and adoption
of this approach by the UNCSD took place in connection with the preparation of the
World Summit for Sustainable Development (WSSD) held in Johannesburg in 2002
and the presentation of a report on the comparative analysis for the period 1990–2000.

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The assessments and conclusions in the report have been made in compliance with
the Millennium Development Goals (MDG).2 Countries and regions implemented
this Dashboard system of indicators to show the diverse nature of sustainable
development, on the one hand, and to assess the policies pursued by individual
countries or regional communities, on the other. This highly aggregated indicator of
sustainable development is made of three relatively independent subindicator clusters,
which reflect the situations of three spheres, which include
Environment—quality of water, air, and soil and levels of toxic waste;
Economy—employment, investments, productivity, income distribution,
competitiveness, inflation, and efficiency of material and energy use;
Society—crime rate, health, poverty, education, governance, military spending,
and international cooperation.
As the suggested system of linked clusters indicates, each cluster is represented by
an index, aggregating the indicators included in the respective sphere (environmental,
economic, and social). The three cluster indices are aggregated again into an overall
Sustainable Development Index (SDI). The indicators themselves are also represented
in an index form. The environment-related index, then, is based on the Environmental
Pressure Index (EPI) and the Ecological Footprint Index (EFI),3 and the economy-
related index is based on the GDP and the Index of Economic Performance (IEP). The
Consultative Group on Sustainable Development at the IISD thinks that the highly
aggregated index they suggested should be able to reflect the stock, flow, and related
interactions and management decisions. In essence, the third cluster concerning the
social sphere is under-developed, although some possible indicators such as “happiness”
and “fulfillment of the human potential,” have been put forward.
The question about how so many subjective assessments will be measured and will
fit into the overall index has remained unanswered. Every assessment of development’s
sustainability that claims to be objective and is based on an econometric model that
includes a single system of indicators of different orders and measurable in differing
values (monetary and nonmonetary) that are capable of mutually excluding each other
at times cannot possibly be accepted without reservation. In addition to the question
of subjective assessments, another question arises here: What is the point of such an
index if its numeric value is 0.387649, for instance, but requires a thorough analysis
of the entire system of indicators and subindicators for anyone to know what the
numeric value means? That is, many relative weights have not been indicated, and
where such indications exist, they mark only the beginning this issue’s discussion.

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The Synthetic Meta-Index

L. Cherchie and T. Kuosmanen (2002) have made an interesting attempt to
aggregate and integrate several subsystems of sustainable development indicators
in their Synthetic Meta-Index, which could serve as a benchmark for sustainable
development. Inasmuch as the question about determining the weight with which the
numerous subindices participate in the Meta-Index is inevitably debatable, the authors
suggest that this weight be flexible and be determined for each country individually.
Their aspiration has been for this weight to be made dependent on the priority system
of the individual country and to reflect to the maximum extent the positive trends in
the country’s development. The authors call this method “the benefit of the doubt.”
What remains open with the Synthetic Meta-Index, however, is the issue about
international comparisons, which cannot rely on this index as it will have to be calculated
for different priorities. Understandably, individual countries will strive to increase the
index weights in the spheres that have better indicators in their development and will
shrink the weights in which domestic problems remain unsolved. At any rate, such an
index cannot be accepted as a universal methodology because the individual indicators
and processes for individual countries will have different quantitative characteristics.
For this reason, this index can be taken as “a country index” based on common
principles, the quantitative expression of which, however, is determined by the
priority system of each country with respect to the various dimensions of sustainable
development and the appropriate indicators used to this effect.
For less than a decade, a number of interesting and certainly useful models for
the quantitative measurement of sustainable development have been suggested. The
difficulties pertinent to such measurement are not unexpected, as they are encountered
every time we try to combine quantitative and qualitative indicators. The search for
the suitable model and methods of measurement will continue because the precision
of the indicator system and the respective benchmarks and indices are of decisive
importance for assessment accuracy and appropriate policy formulation. We believe
that the search for new approaches should not rule out some of the indicators,
such as GDP, which remain underutilized; these indicators have not been bound in
a sufficiently convincing way with the indicators from the other three dimensions
(social, environmental, and institutional).

GDP: Is it a reliable indicator for sustainable development?

The claim that the GDP is a poor and even misleading indicator of sustainable
development is frequently encountered in the specialized literature devoted to problems

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of sustainable development. This argument does not seem to consider the fact that the
GDP indicator has not been created to measure sustainability. It is highly illogical to
define the GDP as a “devilish” or “misleading” indicator, although such qualifications
can still be heard or read. There is little surprise in the fact that we cannot measure
atmospheric pressure with a thermometer. The indicator in question works perfectly
well for the job it was created to do. To a large extent, the model for calculating the
GDP has been made universal; in other words, it is one of the most reliable indicators
for the purpose of performing international comparisons.
Besides, an available, accessible, and reliable database for each country and
region exists, and GDP data compiled therein encompasses a sufficiently long period
of time for trend analyses. Having been disaggregated in an appropriate and targeted
way, the GDP and its relative derivatives can serve as a basis for performing a precise
assessment of sustainable development. The advantage of this indicator is that it
directly or indirectly reflects the environmental, social, and institutional aspects of
sustainable development. The problem, then, is not whether, but rather how, the
system of disaggregated indicators should be employed. My firm belief is that the
GDP is not a misleading indicator but has frequently been misused.
We believe that from a methodological and factual point of view, looking for the
ecological and social footprints contained in GDP would be even more expedient than
other newly developed aggregates. Development results mostly from the interaction
between society and nature for the purpose of manufacturing and consuming certain
goods and services. In this sense, the quantitative, and especially qualitative, parameters
of the manufactured product and its distribution reveal to a large extent the intensity,
nature, and consequences of this interaction. In practice, the alternative models of
aggregated indices, including a subsystem of indicators that characterize various
walks of life, have also confirmed this assumption about the relationship between the
manufactured product and sustainable development.
The problem, however, is that non-GDP indicators either do not reveal or
insufficiently reveal the interdependencies and mutual impacts between these walks of
life. For instance, indicators of water purity give an idea about the state of water today
or in the past, but they do not clarify what exact economic processes and decisions have
brought about such a state and how this state could be changed. Similar is the problem
with analyzing social or institutional indicators. For their part, the economic indicators
have a social and environmental footprint of their own, which can be revealed following
the comparative analysis of the ratios between qualitative and physical indicators such as
inflow and outflow of materials, energy and waste, and so on.

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If direct and indirect links exist between the environment and the processes of
manufacturing and consumption, trying to find the complex of physical and monetary
GDP characteristics related to them is more than logical. Neither the links nor the physical
and monetary GDP characteristics indicate the exact state of the natural environment
but give an adequate idea about the nature of the processes of interaction taking place,
including the interactions from the sustainable development point of view.
Which arguments support this thesis? All experts agree that without economic
growth, no social and economic development is possible. The development of
technologies, social relations, the quality of life, and so on, is connected precisely with
economic growth. One of the preconditions for the rise in the standard of living is
the increase in the production of capital and consumer goods and services. In fact, the
expanded production of capital goods and services is indispensable for the increased
output of consumer goods and services. For people to consume more, more should
be manufactured—what should be maintained is the growth of production. Because
of this dependency, the level to which the social sphere is developed, as an important
aspect of sustainable development, has a close positive relationship with economic
growth. To eliminate factors such as the scale of the national economy and the varying
number of the country’s population, we accept the GDP per capita indicator at this
level of analysis. The international statistical comparisons convincingly show that the
countries enjoying a high social status (high standard of living) are countries of a high
per capita GDP. To date, no exclusion to this rule has been found.

Table 2.2. HDI and GDP per Capita, Selected Countries.

GDP/capita (PPP$, 2001) HDI

Developing countries 3,850 0.655

Least developed 1,274 0.448
CEE & CIS 6,598 0.787
OECD 23,363 0.905
High human development 23,135 0.908
Medium human development 4,053 0.684
Low human development 1,186 0.440

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Legend: PPP–Purchasing Power Parity, HDI–Human Development Index.

Source: Based on Human Development Report (UNDP). (2004). Retrieved 7
November, 2004 from [Link]
The data from Table 2.2 above clearly confirms the distinct correlation between
economic growth and development of the social sphere. The more detailed analysis
of the data from this report indicates that the top twenty countries from the Human
Development Index rating coincide with the list of countries enjoying the highest GDP
per capita in the world. The indicators for the other two aspects of HDI—social and
economic—introduce some shifts in the rating of the countries subject to comparison,
but these shifts occur only within the limits of the same group—that of the countries
enjoying the highest GDP per capita in the world. The same unequivocal dependency
can be distinctly observed with respect to the countries with the lowest HDI, which,
without a single exception, have a record-low GDP per capita. This is sufficient proof
for us to accept that the GDP carries enough information about the social and economic
development of a country, should it be interpreted in an appropriate way.
As far as the social sphere is concerned, this indicator is usually adjusted by the Gini
index, which indicates the way the GDP and incomes, in particular, are distributed.
If an insignificant difference exists in the Gini coefficient, the country with a higher
GDP per capita enjoys a higher standard of living. The GDP per capita should be
recalculated through the purchasing power parity (PPP) to eliminate the exchange
rate, price, and purchasing power differences to the maximum possible extent.
As we already noted in connection with the analysis of HDI, the next step of
disaggregation should be the deployment of the GDP-per-employee indicator. This is
the way in which the impact of the population factor can be avoided and the analysis
can shift to value-oriented dimensions, which indicate qualitative aspects. The GDP-
per-employee indicator is a resultant value stemming from the level of technologies
in use and the efficient use of energy, raw materials, inputs, and the workforce. It
also depends on the organization of production, competitiveness, the entrepreneurial
spirit and attitude of management, and so on.
Should all other conditions remain equal, a higher GDP per employee indicates
a higher social and economic efficiency. Moreover, the countries with the highest labor
productivity as a rule are also among the leading countries for labor conditions and income
per employee. It has been statistically proven that a certain positive dependency exists
among these different GDP subindicators. In their study encompassing 114 countries,
Darmstadter and Lile (1997) have come to the conclusion that a strong and clearly
manifested positive relationship exists between GDP per capita and quality of life.

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The precision and reliability of information carried by the GDP-per-employee

indicator would be enhanced if it were first disaggregated by major sectors of the
national economy (industrial, agricultural, services) and then further disaggregated
by industrial branches, subbranches, and types of production. The latter is a
mandatory stage in the systemic analysis because of the different economic structure
of various countries and regions. Understandably, the productivity of an employee
in telecommunications is higher than the productivity of an employee in steel
production. Also understandable is that productivity, measured on the basis of return
on investments (ROI) and the input-output model, varies in the different sectors of
the economy, all other conditions being equal.
With few exceptions, the various groups of countries (industrialized, of medium
development, and of low development) in essence have similar economic structures.
The greater differences occur in the cases where a given country is endowed with
substantial natural resources and these resources (crude oil, natural gas, minerals,
timber, and so on) have become the prevailing share of output, the dominant exports
of the country, or both. Another important indicator in this respect is the level to
which the exporting country has processed these resources.

Ecological Footprint of GDP

The GDP carries abundant useful information about its ecological footprint
if the output value is compared with the physical dimension (total and per unit)
of the used input. The concept of ecological footprint was first introduced by Drs.
M. Wackernagel and W. Reese in 1996. The energy and raw material consumption
for production of a unit of GDP is one of the leading indicators for GDP’s spin-
off effect, measured as an ecological footprint. Given that all other conditions are
equal, the countries registering the lowest level of consumption per unit of GDP are
among those with the highest industrial development and have the highest standard
of living and high HDI. The Eastern European countries, for instance, register
from five to eight times more electricity consumption per end-product unit than
do the developed countries. Factor analysis shows that this is because of two main
factors: lower technological level and under-developed market incentives. Study
of output sustainability presupposes a further disaggregation of indicators such as
renewable and non-renewable energy consumption, consumption of other natural
resources, and so on. It would be useful to prioritize the non-renewable sources
according to the degree of their depletion or the degree of their harmful impact on
the environment.

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In my opinion, the input-output model of W. Leontief (1936, 1966), Nobel Laureate

in Economics, and its concrete orientation to the impact of the material and energy flow
on the environment are mandatory instruments in the measurement of sustainability.
Nowadays, this approach to measuring physical flows by intensity, direction, and effect
on the economic process and the environment finds an increasingly wide application
because it operates with specific, objective, and verifiable data, which gives reliable
information about the ecological footprint of GDP production. The German scientist
Schmidt-Bleek (1998) has suggested a differentiated approach that measures both the
quantity and type of material resources that go into the production of a product unit
(or a service unit) and the waste emissions from the production of a product unit (or
a service unit). Two interrelated measures have been proposed by Schmidt-Bleek: the
Material Input per Service unit indices (MIPS) and the “Ecological Rucksack” unit.
As an alternative approach, Bailey et al. (2000) divide the domestic supply of raw
materials into scrap and newly extracted resources. This is an important differentiation
as far as the use of nonrenewable resources is concerned. This model measures the
ecological footprint through an input-output model which shows the material flows
in industrial systems. This method has enormous potential in studying the relationship
between economic activity and the environment. The authors of these methods have
succeeded in including other factors such as the international division of labor and the
share of natural resources used as factors of production—which are either imported or
obtained by the domestic extracting industry—in their analyses.
The results from analyzing the physical flows that go into GDP output can be
easily presented in the form of energy and material costs per physical GDP unit
and then compared with a monetary GDP unit. As mentioned above, the results
can be directly applied only to countries of the same group (i.e., of high, medium,
or low development, or countries of monocultural economies, which export natural
resources). Besides, climatic conditions are an important variable. Geographic latitude
has an impact on energy consumption of both businesses and households. It would be
groundless to think that countries of the same GDP per capita but of different energy
intensity per unit of product have different levels of sustainable development.
In fact, it may be that a country registering higher business and household energy
intensity because of the climate-specifically, lower temperatures and longer autumn
and winter seasons—is closer than tropical countries to the criterion for sustainable
development if it meets the other criteria and indicators. In other words, the analyses
of the indicators must be in correspondence with the country-specific natural and
economic conditions. We should not underestimate the need for separating the effects

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of more productive and environmentally friendly technologies from the effects of

overseas reallocation of production. If country X has exported its steel mills abroad
or has reduced or frozen its own steel production by using import steel, this country
will naturally register a higher degree of environmental cleanliness per unit of its GDP.
Such clarifications would be pointless if the comparative analysis became sufficiently
disaggregated to the level of type of output such as specific types of steel, cast iron,
alloys, fertilizers, and pesticides, for instance. Optimization of the economic structure
and the export/import of sustainability will be treated in the next chapters of the book.
At any rate, factor analysis of quality per GDP unit is mandatory for the formulation
of an appropriate sustainable development policy.
I would like to stress the need for other important characteristics to be included in
studying the relationship between GDP and the environment. These characteristics include
environmental cleanliness and utility per GDP unit. Analysis of the relationship between
GDP and the environment should include the entire process of production, irrespective of
what we mean by the term “end product”—whether semi-manufactures or final output. All
kinds of variants are possible here, including the variant of an organic or environmentally
friendly end product manufactured by means of polluting manufacturing technologies or
the imports of semi-manufactures, the production of which is environmentally hazardous
but was effected in the exporting countries. The optimal variant is when the end product
and the entire technological chain, including production, storage or warehousing,
transportation, and delivery, meet the respective standards.
Measurements exist that indicate the presence and level of harmful emissions
in soil, air, and water encountered in the various types of production. The presence
and volume of harmful emissions depend on two major factors: the nature of the
manufactured product and the technological level of production. What should also
be taken into account are the conditions of warehousing, transportation, delivery,
and consumption control, should the technological level of production be connected
with certain risks. An increasingly great number of countries make an assessment
and publish indicators about the degree to which the various groups of production
facilities can be harmful. This harm is measured by the emission of specific pollutants
such as carbon dioxide, sulfur, acids, toxic and radioactive materials, and so on.
In the process of the deepening internationalization of production and the
globalization of the world market, numerous companies from various countries and
regions of the world get involved, ranging from raw materials and energy sources
extraction to end-product manufacturing and delivery. This means that a differentiated
analysis should be made of the participation of individual countries in the various

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stages of goods and services production. Conclusions are misleading if sustainable

development in the final account is measured only for each country individually. With
the advance of globalization processes and the increasing interrelatedness of national
economies, the need to regard sustainable development as a resultant value from the
functioning of the overall world economy will be constantly growing. This does not
rule out country-specific analyses altogether, but it should be seen as only a stage in
the overall analysis and as a means for assessing the trends observed in an individual
country or integrated community.
Furthermore, pollution is often of a transborder nature. This means that the
liabilities of pollution are also borne by countries that have nothing in common with
the process of pollution itself. Acid rains fall hundreds of kilometers from the place
where air was polluted; liquid waste travels for hundreds, even thousands, of kilometers
before flowing into oceans and seas, the resources of which (in international waters)
are shared by all nations; the logging of tropical forests impacts the quality of air and
climate of the entire planet, and so on.
Because of the above-mentioned considerations, I express the following
conviction: The final stage of the analysis of the sustainable development level and
trends should be transferred to a global scale. This is because the reduction of air
pollution in Switzerland by 10 percent per annum, for example, will change nothing
in the quality of life and equilibrium of the environment if air pollution is increasing
in neighboring countries or globally. If polluting manufacturing facilities are relocated
from the USA or Canada to Mexico or Brazil, the overall disequilibrium will not
change by a notch; rather, the disequilibrium will become greater because even if the
technologies are the same, the individual countries will continue to abide by different
environmental protection laws, and the differences in the skills of the workforce will
not be overcome.
The highly aggregated indicators expressing the relationship between the GDP and
the environment should be applied on a territorial principle because the concentration
of production facilities and their territorial distribution is such that the harmful impact
on the environmental equilibrium in the region of production or of consumption or
both varies. For instance, the indicator may be favorable and close to the standards
established for country X, but in some of the country’s regions, the indicator may
be well above the permissible maximum. For example, the local environment in the
vicinity of steel mills and chemical works is polluted much more than in a region some
distance away. Along the same lines, the air pollution from the exhaust gases of motor
vehicles in the big cities is far greater than it is in the countryside.

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A GDP Matrix: An Attempt for Systematic Approach

I am convinced that the system of GDP derivative indicators contains sufficient
analytical and informational potential for analyzing sustainable development. This
system can be called the GDP Matrix of Sustainable Development and may include
the measurements and indicators listed in the matrix below.

GDP Matrix of Sustainable Development

GDP/PPP GDP/ GDP unit GDP unit GDP unit GDP/cc GDP/D GDP-real
in S sector(i,a,s) (GDP/Dp, growth
GDP/c GDP/Dpr)

GDP/c by branches CEm, CEf CMm, EP Ec (ECr, GDP/Dd G: Ext

CMf ECnr, by
type)

GDP/e by type of CEr by CMr by EPt, EPta, MCc GDP/Df G: Int

(MCcr,
production type type EPtl, EPtw
MCcnr, by
type)

GDP/ei by main CEnr by CMnr by EPnt, Gini GDP/Dds, G: HDI

companies type type EPnta, coefficient GDP/Ddl
EPntl.
EPntw

GDP/ea by location R:NR ratio EPa by GDP/Dfl G: ESI

types GDP/Dfs,

GDP/es Mu:Mnu ND GDP/c:

ESI

NEE NME

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Legend: GDP/c–GDP per capita; GDP/e–GDP per employee, ei–industry,

ea–agricultural, es–services; GDP/cc–GDP consumption per capita; GDP/D—
percentage of debt to GDP, Dp–public debt, Dpr–private debt, Dd–domestic debt,
Df–foreign debt, Dds–domestic short term debt, Ddl–domestic long term debt,
Dfs–foreign short term debt, Dfl–domestic long term debt; CE–consumption of
energy; CEr–consumption of renewable energy; CEnr–consumption of non-renewable
energy; NEE–net energy export (export minus import); CE–consumption of energy
(m–monetary and f–physical dimensions); CM–consumption of materials (m–
monetary, f–physical dimension); CMr–consumption of renewable materials; CMnr–
consumption of nonrenewable materials; Mr:Mnr–ratio between renewable materials
and nonrenewable materials; Mu:Mw–ratio between the utilized and nonutilized
materials during the production process; NME–net material export; EP–emitted
pollution; Pt–toxic pollution; Pta–toxic air pollutions, Ptl–toxic land polluters, Ptw—
toxic water polluters; EPnt—emissions, nontoxic; Pnta–nontoxic air, Pntl–nontoxic
land, Pntw–nontoxic water polluters; Ec—energy consumption; ECr–renewable energy;
Enr–nonrenewable energy; MCc–materials consumption per capita, MCr–renewable
materials, MCnr–consumption of nonrenewable materials; ND–net debt; G–
economic growth, in percentage; G: Ext–weight of the extensive factors for economic
growth, G: Int–weight of the Intensive factors for economic growth; HDI–Human
Development Index; ESI–Environmental Sustainability Index; NI: Gini–national
income distribution, measured by Gini.
The proposed matrix contains indicators that are connected with the GDP in
a direct, indirect, or relative way. As indicated earlier, the indicators are expressed
in an absolute or dynamic form (in percentage terms) and as GDP derivative
indicators, which reflect the interaction between the economic sphere and the other
three dimensions of sustainable development. The comparative analysis of the stated
indicators for an individual country, for a group of countries, and especially at an
international level would make it possible to assess with a sufficient degree of accuracy
the state and trends of development in compliance with the goals and criteria of
sustainable development.
In my opinion, the most useful tool for assessing the ecological footprint of GDP
production would indicate the energy and material intensity per unit of the GDP
disaggregated by sectors, industrial branches, and types of production. Undoubtedly,
the countries registering the lowest material and energy costs per unit of output are
those enjoying the highest living standards. They also possess the biggest real and
potential possibilities for maintaining, restoring, or maintaining and restoring the

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environment. The comparative analysis of countries considered to be significant

exporters on the world market merits special attention. For instance, it is natural for
the countries exporting large volumes of industrial and agricultural goods to consume
more resources and, all other conditions being equal, register larger emissions of
pollutants. This peculiarity presumes a final phase that completes the analyses, which
should include the participation of the respective country or group of countries in the
international division of labor and its contribution to the provision of useful products
and its negative contribution to the infringement of environmental equilibrium.
The above considerations give us sufficient ground to believe that greater
attention should be paid to this system of indicators for sustainable development.
The search for substituting indices of one or another degree of aggregation pursues
the same objectives, but the likely outcome of such a new, highly aggregated index
is much less reliable than the GDP matrix. The indicators from the suggested matrix
above are easily accessible, and substantial experience has been accumulated in the
collection and processing of data. All this shows that this information from the GDP
matrix is reliable and that most countries have such information available. In fact,
without this information, it would be unthinkable to apply various indices or models
of assessment.
Serious objections have been made by a number of authors that the GDP
does not reflect the full monetary cost of the natural resources which the national
economy exploits. We fully agree with these objections but are also of the opinion
that this GDP problem does not affect the comparisons of relative costs and values.
Besides, the comparative analysis presupposes the employment of preliminary
physical measurements of resources, which serve as a certain corrective tool for
avoiding distortions. Whether a barrel of crude oil costs 30 USD or 53 USD is of
no consequence for determining the energy and material intensity of a GDP unit in
physical terms, and it is precisely this relationship that determines the environmental
footprint of the production and consumption, as well.
It is a completely different matter whether the full cost of natural resources is also
necessary to determine the level of revenue distribution or the adequacy of managerial
or governmental decisions that have a bearing upon sustainable development. This is
a serious challenge, and the search for models that would permit us to determine this
cost to the fullest is a priority task for the expert economists working in this sphere.
Certain aspects of this problem will be treated in a later chapter.
In conclusion, the methodology for elaborating and analyzing sustainable
development indicators should include the indicators’ consistent aggregation and

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disaggregation so studies can approximate reality as much as possible. This undoubtedly is

a necessary precondition that makes it possible for correct managerial and governmental
decisions to be made at the local, national, regional, and international levels.

A P PE N D I X 1

List of Indicators Developed by the International Institute for Sustainable Development in Canada

RioJo Dashboard:

Theme: Social
Population Living below Poverty Line (1PPP$/day)
Gini Coefficient of income distribution
Unemployment, total
Female:Male Manufacturing Wages
Underweight children
Child mortality rate
Life expectancy at birth
Adequate sewage disposal
Access to piped water
Access to healthcare
Child immunization
Contraceptive prevalence
Persistence to grade 5
Secondary schooling
Literacy rate, adult total
Floor area in main city (Benchmark)
Homicides (Benchmark)
Population growth rate
Percentage of population in urban areas

Theme: Environment
CO2 emissions from fuel
Other GHG
Consumption of CFCs
Urban air pollution

Arable and permanent crop land

Fertilizer consumption
Use of pesticides
Forest area
Wood harvest intensity
Deserts & arid land

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Informal urban settlement (squatters, and so on)

Phosphorus in urban water
Population in coastal areas
Aquaculture & fish production

Use of renewable water

Biological Oxygen Demand (BOD) in water bodies
Fecal coliform in urban water
Selected key ecosystems
Protected land area
Abundance of mammals & birds

Theme: Economic
Income per capita
Investment
Current account balance
External debt, book value

Aid given or received

Direct material input (DMI)
Commercial energy use
Renewable energy resources
Energy efficiency of GDP
Adequate solid waste disposal
Hazardous waste generated
Nuclear waste with, without treatment
Waste recycling (one or some cities)
Private motoring to work

Theme: Institutional
Strategic implementation of SD (plans and so on)
Memberships in environmental intergovernmental organizations
Internet users
Telephone mainlines
Research and development expenditure
Human cost of natural disasters
Damage from natural disasters
Number of series in CSD framework
Source: European Statistical Laboratory. Retrieved 4 November 2004 from [Link]
db_teach.htm#Q_link

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References
Bailey, R., Allen, J. K., & Bras, B. (2000). Material flows in industrial systems. Georgia Institute of
Technology, George W. Woodruff School of Mechanical Engineering. Retrieved 6 February 2005 from
[Link]

Cherchie, L., & Kuosmanen, T. (2002). Benchmarking sustainable development: A synthetic meta-index
approach. (Working paper, pp. 2–26). Retrieved 16 June 2004 from [Link]
papers/0210/[Link]

Daly, H. E., (with Cobb, J. B., Jr.). (1989). For the common good: Redirecting the economy toward
community, the environment and a sustainable future. Boston: Beacon Press.

Darmstadter, J., & Lile, R. (1997). GDP: Does it matter? Resources, 127, 6.

El Serafy, S., Ahmad, Y. J., & Lutz, E. (Eds.). (1989). Environmental accounting for sustainable development:
Selected papers from Joint UNEP/World Bank Workshops. Washington, D.C.: World Bank.

Friends of the Earth Policy and Research Unit. (2004). Measuring progress: ISEW explained. Retrieved
February 2005 from [Link]

Hardi, P., & Zdan, T. (Eds.). (1997). Assessing sustainable development: Principles in practice. Winnipeg,
Canada: International Institute for Sustainable development.

International Institute for Sustainable Development. (n.d.). Highly aggregated sustainable development
indices. Retrieved 1 February 2005 from [Link]

Jackson, T., Marks, N., Ralls, J., & Stymne, S. (1997). Sustainable economic welfare in the UK 1950–
1996. London: New Economics Foundation and Centre for Environmental Strategy, University of
Surrey, UK. Retrieved 7 December 2004 from [Link]

Leontief, W. W. (1936). Quantitative input-output relations in the economic system of the United States.
The Review of Economics and Statistics, 18, 105–125.

Leontief, W. W. (1966). Input-output economics. New York: Oxford University Press.

Matthews, J., Munday, M., Roberts, A., & Williams, A. (2003). An index of sustainable economic
welfare for Wales. ERSC Centre for Business Relationships Accountability Sustainability and Society,
Cardiff Business School. Retrieved 12 November 2004 from [Link]

Moldan, B. (1997). The UNDP Human Development Index. In B. Moldan & S. Bilharz (Eds.), Sustainable
indicators: Report on the project on indicators for sustainable development (pp. 47–53). New York: Wiley.
Retrieved 4 July 2004 from [Link]

Schmidt-Bleek, F. (1998). Das MIPS-Konzept. Weinger naturverbrauch—Mehr lebensqualitat durch

faktor 10. Munich: Droemer.

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UNDP. (2004) HDI Reports. Retrieved 3 December 2004 from [Link]

United Nations Population Division. (2003). Data tables. Retrieved 6 August 2004 from http://
[Link]/pdf_library/data_tables/pop2_2003.pdf

Wackernagel, M. & Reese, W. (1996). Our ecological footprint: Reducing human impact on the Earth.
Philadelphia, PA: New Society Publishing.

Notes
1
The Gini coefficient is a measure of income inequality developed by the Italian statistician Corrado
Gini. The Gini coefficient is a number between 0 and 1, where 0 means perfect equality (everyone has
the same income) and 1 means perfect inequality (one person has all the income, everyone else has
nothing). Although the Gini coefficient is used mostly to measure income inequality, it can be used to
measure wealth inequality as well, though it requires nobody to have a negative net wealth.

The Gini coefficient is calculated using areas on the Lorenz curve diagram. If the area between the
line of perfect equality and Lorenz curve is A and the area underneath the Lorenz curve is B, the
Gini coefficient is A/(A+B). This is expressed as a percentage or as the numerical equivalent of that
percentage, which is always between zero and one. Retrieved 7 November 2004 from WIKIPEDIA,
[Link]
2
The set of Millennium Development Goals (MDG) was developed by the World Bank and includes
the following goals: poverty, education, gender equality, child mortality, maternal health, HIV/AIDS,
other diseases, environment, and global partnership. The appropriate World Development Indicators
(WDI) include approximately 800 indicators in 87 tables, organized in six sections: world view,
people, environment, economy, states and markets, and global links. Retrieved January 2005 from
[Link]/data/wdi2004/[Link])
3
Redefining Progress’s Ecological Footprint Analysis (EFA) measures the amount of renewable and
nonrenewable ecologically productive land area required to support resource demands and absorb the
wastes of a given population or specific activities. From a sustainability perspective, when humanity’s
Footprint exceeds the amount of renewable biocapacity, a draw down in natural capital is required, and
this is considered unsustainable. Global Footprint accounts over the past forty years indicate a twenty-
five year growth trend beyond the amount of renewable biocapacity. In short, humanity’s Ecological
Footprint appears to have breached ecological limits and is thus unsustainable. EFA also raises several
important social equity concerns. When the total amount of ecologically productive land area included
in EFA is divided by the human population, about 4.5 acres (1.89 hectares) are available for each
person. Retrieved 5 December 2004 from [Link]

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C H A P T E R 3.
N AT U R A L R E S O U RC E S
A N D E C O N O M I C G ROW T H

Economic growth is a result of the transformation of natural resources into

means of production and consumption. The relation of economic growth to natural
environment is highly variable and is determined by the type of growth and its product
structure, used technologies, and dynamics. For thousands of years, interaction with
nature was viewed as a source of public wealth, the latter having absolute priority
over the condition of the environmental system. Until the emergence of large-scale
machine production in the 19th century, the conflict with nature was local and limited
in scope, but with the dynamic development of industrialization, the conflict acquired
quite different dimensions.
The dramatic increase in the scale of production has lead to the extraction and
processing of colossal quantities of natural resources. Five main factors have contributed
to this dramatic increase: the aspiration for profit maximization, the demographic
boom and growing consumption, the armament race, and market competition. These
factors globalize the exploitation of nature to an unprecedented scale. Almost all of
the space on the planet has been encompassed for utilization of natural resources. The
only exception, for the time being, is the Frozen Continent, Antarctica, whose natural
resources remain preserved pursuant to an international agreement.
The development of technologies for obtaining natural resources and the galloping
pursuit of further profits tore down such barriers as climatic conditions, terrain relief,
sea depths, required production capital, and so on. The close intertwining of geology,
radiology, aerospace technology, and electronics enabled a revolutionary improvement
in the methods for localization of deposits and the determination of their approximate
volume and quality. This facilitated the process of energy and material provision for
the growth of production and, respectively, consumption demand.

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The Invisible Hand versus Regulated Market

The result of the interaction between man and nature with regard to the production
of products for consumption is determined to a great extent by the economic model
of development. It is well known that no such thing as market economy exists “in
general”; general principles remain the same, but as the saying goes, “the devil is in
the details,” which means that the particular market environment and the tools and
mechanisms employed are decisive. My aim here is not so much to analyze market
models but rather to express my position on the choice between “the invisible hand
of the market” and regulated market economy from the viewpoint of the criteria for
sustained development and the possibilities for achievement of its basic goals.
In the brilliant research presented by Adam Smith in The Wealth of Nations (1776),
the growths of profit and wealth are mutually implicating, and they are assumed to
be the basic factors for raising the standard of living. Smith views the division of
labor as a factor of economic growth and international trade. He points out that the
efficiency of a market economy depends on the extent of economic freedom of market
subjects and the uninhibited manifestation of competitive mechanisms nationally and
internationally. To a certain extent, this view is a basic thread throughout contemporary
neo-liberal and neo-conservative economic schools. These schools view “the invisible
hand of the market” as a necessary precondition for economic prosperity on the basis
of the (1) full utilization of the market economy’s potential and (2) maximization of
the profits from production.
The major problem with Smith’s “invisible hand” is that the preservation of the
environment and the optimization of the distribution of proceeds are not among the
benefits that “the invisible hand of the market” may offer. I must agree that when the
other conditions are equal, the success of the market is the result of a sufficiently high
labor productivity level or, in other words, the production of a greater economic result
from a unit of input of production, including input of natural resources. In economic
reality, however, these “other conditions” are far from equal. We should answer the
question not only (1) about the quantity and quality of resultant product from an
economic unit of input, physical unit of input, or both, but also (2) about the price
of this production expressed in terms of environmental harm done, nonrenewable
resources lost, and social polarization caused. The latter will be subject to analysis in a
different chapter focusing on employment and the distribution of proceeds.
The data presented in the present monograph categorically proves that the positive
effects of “the invisible hand” are highly exaggerated compared to the visible damages
to nature and, hence, human health. The fruit of the “invisible hand” of the market is

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the unlimited and unscrupulous exploitation of natural resources in the age of initial
accumulation of capital. This capital accumulation is responsible for the rapacious
exploitation of mines, oil wells, timber, soils, water resources, and so on. The only
“restrictive” criterion in the dawn of capitalism is the correlation between costs and
revenues. The peremptory criterion for efficiency in the interaction between man and
nature is the return on investment and the effectiveness in the interaction model at
bringing greatest profits.
Market principles bear no relation to what the price of this return on investment
is, expressed in terms of impact on the environment. In other words, “the invisible
hand of the market” conducts the optimal allocation of capital, which would ensure
the achievement of maximum profit. This free market economy model does not
include any alternative models of interaction in the process of optimization, such
as to bind the final economic effect with the impact on the environment; the free,
unregulated market economy is based on one-sided economic criteria and indicators,
not reflecting the entire economic and social price of the growth of capital. The natural
resources used may actually have a zero or a symbolic cost for the entrepreneurs,
insofar as the resources’ price includes chiefly the extraction cost and the cost for
delivery. As a result, the highly underestimated public natural wealth is turned into a
source of additional profits for entrepreneurs, but, the consequences of the disturbed
environmental equilibrium are transferred to the whole of society.
As Wackernigel et al. (2002) point out, the assessment of the market economy’s
development should include the ecological footprint of economic growth. This
ecological footprint should be compared also to the carrying capacity of the natural
system. The latter is viewed as an ability of that system to absorb or recycle, or
both, the waste from human economic activity. When the load on the environment
exceeds its carrying capacity, the threshold of the biosphere’s capacity has been
overshot or overstepped.
According to Wackernigel et al., this threshold was overstepped as early as 1980,
and the overshooting exceeded the environment’s capacity by 20 percent at the end
of the 20th century. “The invisible hand of the market” emits tons of pollutants into
the biosphere, consumes nonrenewable natural resources at an ever-increasing rate,
decreases biological diversity, and detracts from the quality of living. Most the renewable
resources such as timber, pastures, water, and so on, are exploited near or beyond the
level of their reproduction. In fact, it is not important whether the overloading of the
biosphere is by twenty or by 32 percent, especially since no absolute precision in this
calculation is possible. Often, experts do the assessment; consequently, the assessment

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is subjective to a certain extent. Market economy has no built-in mechanisms for

reaction in those cases where growth conflicts with the ecological equilibrium; neither
can it change on its own the trajectory of growth toward sustainability.
The processes of disrupting the ecological balance escalated in the beginning of
the 20th century with the introduction of large machine production and the growth
of heavy industry, especially in the power industry, chemistry, metallurgy, ore, and oil
extraction. The consequences were especially serious in the first two or three decades
after World War II, which was the main period of dynamic industrialization and high
economic growth rates. Since then, the degradation of nature has entered a phase
where the limitless and irresponsible application of the “invisible hand” generates
unacceptably high risks.
The very foundations of the market system are threatened because its successful
functioning in the long term is possible only with the maintenance of certain
quantitative and qualitative parameters of the natural environment with which an
interaction takes place. The question is whether, when analyzing potential and actual
economic growth, the conditions of production that would ensure constant growth in
the long run are also considered.
Obviously, the latter would be possible only and solely if “the invisible hand of
the market” were subjected to a system of priorities of economic development and if
these priorities were implemented within a strictly defined framework of market force
operations. This framework should be wide enough so as to use the greatest potential
of private initiative and of the mechanisms of competition. Besides the growth of GDP,
the model of economic development should also ensure a gradual restoration of the
ecological equilibrium—it should create favorable conditions for long-term growth.
One categorical conclusion can be drawn from all of these discussions: Sustainability
of growth and maintenance of environmental equilibrium can be achieved only when
market forces are restrained within some framework, made compliant to some conditions
and standards, and subjected to direct and indirect regulation. Everything achieved to
date with regard to preservation and regeneration of the environment has been a result
of such regulation, but it is not satisfactory because of insufficient or inadequate market
regulation. I believe that the problem is not whether to regulate, but rather how to
regulate—by means of what mechanisms and tools; with what correlation between
economic incentives and technical and administrative rules; and through what scheme
to balance and synchronize the regulatory mechanisms at local, national, regional,
and global levels. The use of lead-free petrol, the suspension of use and production of
Freons, the transition to closed-cycle production, the availability of environmentally

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friendly engines and alternative power sources, the protection of natural parks, the sale
of products that are environmentally clean and harmless to human health, and many
more such advances have become possible because of market regulation.
The realization of a system of national priorities that considers the above
conditions presupposes the implementation of a purposeful investment policy. It is
generally accepted that the quantitative and qualitative parameters of production are
predetermined, being obligatorily bound to the condition of the environment, by
the model and the structure of investment. The approach as to how to define the
said priorities and by what mechanisms they should be implemented is the crucial
divider between the “neoliberal” and “regulationist” economists. Here, we view
not the theoretical discussions but the particular degree of integration between the
environmental and the economic policies, which nowadays is called the policy of
sustainable development. At issue is the integration of the two policies and not merely
their mechanical combination.
To avoid any misconception, I stress that the policy of sustainable economic
growth definitely does not exclude the basic market tools. On the contrary, basic
market tools should be optimally used for main reasons: first, the policy is
implemented anyway under the conditions of a market type of economic system,
which presupposes a market approach, and second, competition and the pressure for
ever-increasing economic efficiency may and should be used to achieve the goals of
sustainable development. Therefore, we must create the necessary preconditions and
incentives that will modify the market environment to induce the desired behavior
of market subjects, manufacturers, and consumers. With the continuing aggravation
of ecological disproportions, the number of advocates who believe that a substantial
modification of market conditions is necessary is growing. In spite of this, quite a few
differences remain about the extent and method of modifying these conditions.
The neoclassical approach of relying on the optimal cost-benefit assessment
proved inadequate. The formulation of poor sustainability involving some kind of
limitless interchangeability between produced and natural capital is in conflict with
the character of nonrenewable resources. The champions of this approach (Friedman,
2002; Weintraub, 1993) claim that optimization of the investment process can be
achieved most easily and effectively through the establishment of complete, or at least
sufficient, freedom of the market forces (see Friedman, 2002). They claim that the lowest
possible price of equilibrium is important, regardless of how this price is expressed,
be it degree of nonrenewable resource depletion or degree of loading (overloading)
of the environmental system, correlation between physical and value parameters of

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production capital, effects of social polarization, or effects on employment. Social

price and the irreversible loss of nonrenewable resources are generally not included in
these models of growth.
I believe that such self fine-tunings of market economy are not only
impossible but also extremely dangerous should the attempts to achieve sustainable
economic growth be based on these principles. As stated already in Chapter One, the
reason for this conclusion is the substantial difference between (1) sustainability of
growth, understood in terms of its constant upward movement and measured solely
by the magnitude of the actual GDP, and (2) sustainability, understood in terms of
the criteria and indicators adopted in Agenda 21 of the United Nations as discussed
in Chapter 1.
The problem of relying on the self-tunings of the market economy does not lie
only in the value-related dynamics of growth but also in other factors. Degradation of
the natural environment may take place both when the growth is positive and when
it is zero or even negative. Such an example of environmentally unfriendly economic
growth would be a great shrinking of demand for high-technology products and an
increase in the demand for low-technology products requiring great consumption of
feedstock and energy. In the past couple of decades, we have witnessed such sector
crises in even the most developed industrialized countries. In other words, the
achievement of any kind of equilibrium is not acceptable by the criteria for sustainable
development. Sustainable development involves achieving equilibrium with such
proportions to ensure implementation of the system of priority goals in the social and
economic spheres and with regard to the natural environment.
I believe that optimization of growth that conforms to the criteria for sustainable
development can be achieved through “perspective planning” or “investment policy”
(Kalecki, 1986; Wallace, 1995). The investment policy should encompass both private
and public investments—the whole investment process, irrespective of the sources
of funding, whether private or budgetary. Governments have enough monetary,
fiscal, and commercial means (foreign trade regulations; export incentives; technical,
health and environmental standards; and administrative procedures for import and
export) through which it can direct the whole investment process in the state’s desired
direction. Most of these tools are applied even now, but to insufficient extent, diversity,
and interrelation.
Public pressure has increased for national and international institutions to play
a more active and decisive role in achieving economic growth within a reasonable
ecological framework. Davies (2004) pleads for the elaboration and implementation

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of a public investment strategy to which economic growth should be subjected; thus,

the manageability of growth would be bound to the programming and manageability
of investment.
The tendencies for binding national economic policies to some specific
environmental and social goals can be positively assessed. It is especially important that
all international and regional and most private banking institutions and investment
funds should require environmental cost-benefit analyses of proposed investment
projects. As a rule, independent companies and agencies make these analyses to
ensure maximum objectivity; for big investment projects or for projects that are highly
sensitive regarding potential health or environmental hazards, the consent of the local
authorities and nongovernmental organizations is also required. No doubt, it is a
decisive step towards appropriate market regulation and more complete assessment
of the investment return, which includes the expected investment effect on both the
environment and human health.
The role of public control over the development of production is becoming more
important, and growth is viewed as a result of, or even as a means for, implementation
of a particular policy. Clearly, sustainable economic growth and development cannot
be achieved without active institutional intervention at the macro- and microeconomic
levels. Only an adequately regulated market economy can ensure the combination of
GDP growth with the wider objectives of sustainable development.

Energy Intensity of Economic Growth

It is not possible to include all economic sectors in our research, nor is it
necessary; therefore, we will focus on the production and consumption of energy,
which expresses to the greatest extent the complex interrelation between growth and
the natural environment. What are the grounds for making such a choice? First and
foremost, a direct positive relation exists between energy consumption and the quantity
of consumed resources and materials for the production of a unit of GDP. When all
other conditions are equal, the greater the consumption of material input, the more
energy is necessary for its output and processing. Any growth that is preconditioned
by resources is at the same time dependent on energy; hence, the energy intensity is
formulated, showing either (1) the consumption of energy for the production of an
additional unit of GDP or (2) the quantity of additional energy necessary for the
production of an additional unit of GDP. In the first instance, the average statistical
energy consumption per unit of GDP is measured, and in the second instance, the
energy consumption of growth is determined.

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Fig.3.1. World Energy Intensity by Region in Thousands of British Thermal

Units (Btu) per Unit of GDP (Constant 1997 USD)

Legend: IND–industrialized countries; EEU–Eastern European Countries,

including the countries from the former Soviet Union (FSU); DVPG–developing
countries.
Note: 2005–2025 are forecast values.
Source: United States Energy Information Administration (2004). Retrieved
January 2, 2005 from [Link]
I have selected three groups of countries for comparative analysis of energy
intensity. These groups are highly industrialized countries, developing countries, and
countries in transition toward market economies. Such a differentiation is grounded
on the dependence among the technological level, degree of industrial development,
and energy intensity. This dependence is observed also in the countries in transition
toward a market economy, and, in this case, we are examining mainly the countries
of the former Eastern European economic block COMECON (Council for Mutual
Economic Assistance). The countries in this group (EEU); however, have a specificity
of their own related to the fact that the transition itself leads to an inevitable loss of
GDP resulting from the need to restructure the whole economy.
Because of this restructuring, a clear tendency toward a decrease in energy
intensity has occurred since the beginning of the ‘90s. In these countries, a period
has begun wherein the heavy industry’s share in produced GDP has begun decreasing
substantially, and the heavy industry has the highest energy intensity. The shrinking

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of heavy industry’s share is because of two things: (1) a collapse of the heavy industry
because of its low competitiveness and inability to adapt quickly enough to new
market conditions and (2) the parallel process of the restructuring of this energy-
intensive sector of the economy.
The heavy industry of the former socialist countries used to operate under
centralized, directive-based planning with poorly functioning market elements, the
latter being related chiefly to the participation of these countries in the exchange of
goods on the world market. The sources of energy, as well as the electric power for
production and personal use, were supplied at prices fixed by the state, which were far
below the prices on the world market. This was possible because of the price policy
of COMECON and the enormous subsidies for the state-owned mining and power-
producing enterprises. The supply of power and power sources at such unrealistic
and highly subsidized prices actually created incentives for wasting power and for
producing at a low level of energy efficiency.
Energy efficiency was not among the priority tasks even for the engineers designing
the production of transport vehicles, machines and facilities, construction projects,
and so on. For examples, the fuel consumption of Soviet passenger airplanes was, on
average, 40 to 60 percent higher than that of similar Western models. Similarly, motor
vehicles had a 25 to 50 percent higher consumption rate of fuel per distance unit than
did Western models. Subsidies for household heating reached up to 80 percent of
the cost of heating, which used to be much below its market value. In other words,
the production of fuel was also heavily subsidized. This double subsidization led to
extreme price distortions.
Because of the distorted price policy for the energy sources and electric power, the
manufacturers and consumers were not interested in the level of energy consumption
of production means or of the household appliances manufactured. It was as late as
the beginning of the ’80s that this problem gained some attention. It became clear
then that the price policy of the Soviet Union, which had been maintained for decades
for cheap supplies of raw materials, fuel, and electric power to other member countries
of the COMECON and the Warsaw military pact, could not continue because of the
resulting enormous economic losses and rather low economic efficiency.
The increase of energy prices since the beginning of the ’80s was the reason for the
marked upward movement of energy consumption. In fact, it is not the physical volume
of power consumption that increased in this case but its consumption in terms of value.
Another factor having this effect, although not of the same importance, was aging
equipment. The serious economic problems of the former socialist countries since the

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beginning of the ’80s, and especially after 1985, limited the possibilities for investments
and renovation of technologies. With the lengthening of the equipment’s period of
depreciation and physical wear and tear, energy consumption started growing.
For many decades, the energy intensity of economic growth was not among
the main priorities in the economic policy of the EEU countries. Their economic
structure and the development of their production potential had been under
conditions such that the most important parameter was the volume of production.
The economic and military race with the West was taken as a basic reason, irrespective
of the socioeconomic and environmental cost, for achieving this goal. Because of
this, consumer habits and the inherited economic structure, way of thinking, and
managerial behavior did not enable a fast reorientation toward economic growth
based on low energy consumption.
The centralized and directive-based planning proved to be an economically
inefficient and unsustainable model of growth. Frequently in these countries,
protecting the environment was less important than industrialization, attempting
to get even with the West in the construction of production facilities, maintaining
military equilibrium between the countries of the Warsaw pact and NATO, and
solving current social or political problems. From this point of view, the directive-
based planning did not prove to be better than “the invisible hand of the market” with
regard to the natural environment.
Despite the burdening heritage of the command economy, a group of factors is
now in operation, contributing to the long-term tendency for decreasing the energy
intensity of GDP in the countries in transition toward market economies. Creating
and strengthening market institutions and establishing democratic principles provide
favorable conditions for the increase of foreign investments, creation of mixed
companies, access to new markets, and so on. The lowering of energy intensity
therefore becomes based on the perfection of technologies and the production of end
products, which would be closer to the criteria for energy efficiency and achievement
of sustainable economic growth. Maintenance of this tendency after the year 2025 is
a question of economic survival because the low energy intensity has already turned
into a precondition for market competitiveness. Alongside this, most countries in
transition already are or will shortly become full members of the European Union,
which presupposes the achievement of uniformity in the legislation for environmental
protection where high priority is granted to energy intensity.
Low technological levels lead to the higher energy intensity of developing countries.
This technological level is falling behind the improving technological standards in

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the developed countries. The insufficiently developed legislation for protection and
regeneration of the natural environment is one of the reasons for this status quo. We
can positively assess the tendency of these countries toward a slightly higher dynamic of
lowering energy intensity of GDP (35 percent in 2000–2025) compared to the highly
industrialized countries, where it is 25 percent. Is such a difference in the dynamics of
raising the energy efficiency sufficient? I don’t think so. The initial basis for comparison
is with a great difference in favor of the industrialized countries. A difference of only
10 percent in said dynamics will not manage to offset the heightened competitiveness
of the world market, nor the heightened international requirements for improving
environmental parameters, but the forecast for these countries is realistic, bearing in
mind that their economic capacities do not provide them greater flexibility in the
implementation of environmentally friendly technologies.
These countries remain in the trap of foreign debt; their access to financial
resources will remain difficult, which automatically implies insufficient investment
interest. Because of this, such countries as India and China, for example, will continue
to increase their GDP despite and irrespective of the higher energy intensity of GDP.
The energy intensity of growth in developing countries has a more unfavorable
structure than the structure in highly industrialized countries. Various energy sources
have different economic and environmental efficiencies. Unfortunately, for most of
these countries, the economic efficiency, i.e., the lowest cost, has absolute priority
over the expense of the environmental efficiency and health safety. It explains why
developing countries that have enough deposits of coal continue to use the coal as
a main energy source for the production of electricity. The low economic cost of
production do not include the devastating environmental and health effect from
millions of tons of sulfur and other pollutants emitted in the atmosphere.
In the ’90s, the share of coal in the overall power consumption of China still
remained at 72 to 75 percent with a tendency toward slight decrease since the
beginning of the 21st century after the introduction of more natural-gas-fueled
facilities. Considering that the forecasts for 2006 are for growth of the construction of
power up to 1.2–1.3 billion tons of oil equivalent, we can conclude that the tendencies
for growth of the quantity of pollutants emitted will be preserved, although at a lower
rate. The improvements in technologies, the introduction of treatment facilities, the
possibly increased control over pollution, and so on. China would hardly be able to
offset the dynamics of harmful emissions; hey would not manage to do so considering
the current policy of growth.

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Fig.3.2. Energy Consumption in China [million tons of energy equivalent

(Mtoe) and GDP (billion 1995 USD)]

Legend: Econs–energy consumption, Mtoe–million tons of oil equivalent,

GDP–Gross Domestic Product
Note: 2006 are forecast values.
Source: World Bank (2004).
China maintains some of the highest rates of GDP growth in the world
(approximately 10 percent average per year in the past decade), and the volume of
energy consumption is such that the country is turning from a net exporter to a net
importer of energy sources. The same tendency can be observed in India, with some
peculiarities that are not subject to analysis here. The possibility of achieving a turn
in the relation between growth and natural environment in both of these countries
would have a global positive effect as far as these are the two most powerful and
most quickly developing economies in the developing world, with a total population
of almost 2.5 billion people. The point to stress is that the decrease in the energy
intensity of growth can be said to be a positive phenomenon, but this alone does
not restore environmental balances. Lower intensity just means that the dynamics of
misbalancing the biosphere are slowed down in terms of percentage.
The higher the GDP in terms of value, the greater the physical volume of resources
used for the production of a product. A decrease in the energy intensity or material

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intensity of a unit of production does not also mean also that the absolute amount
of negative impact would automatically be reduced. Haugland and Roland (1994)
stress the importance the substantial decrease of the energy intensity of the Chinese
economic growth during the ’80s and ’90s compared to the previous two decades.
They estimated that the annual energy consumption growth decelerated to 5.5 percent
annually during the ’80s, which is half of China’s average GDP growth. Such decupling
between the economic growth and the energy consumption is definitely a positive
phenomenon, moving the growth toward a more sustainable road. Nevertheless, in
the ’90s, energy consumption per unit of GDP in China was ten times higher than
that of the member countries of the Organization for Economic Cooperation and
Development (OECD), and that relationship is expected to reach a maximum of 7:1
by the end of 2010.
Of special interest to this discussion are the examined tendencies for the most
developed market economy—the USA. Figure 3.3 shows the tendencies in the
development of three key indicators for the USA: the change in the GDP measured
in constant 1996 prices, the changes in the volume of energy consumption, and the
consumption of energy for the production of a unit of GDP measured in billions
of USD in 1996. The total consumption of energy has increased by 281 percent, or
almost three times, over slightly more than six decades—from 34.62 quadrillion Btu
in 1950 to 97.35 quadrillion Btu in 2002.
Definitely positive is the tendency for the energy intensity per unit of produced
GDP to decrease, from 20.51 thousand BTU in 1950 to 10.31 Btu in 2002—a
decrease of 50 percent. This reduction is not the result of only two factors-technological
renovation and higher labor productivity, although these have led to the reduction
of GDP’s energy intensity. To these two factors should be added the change in the
structure of GDP, expressed in the faster development of the services sector, which
generally has lower energy intensity than the heavy industry sector.
Unfortunately, these positive trends are not dominant, which is reflected in
the continuing growth of overall energy consumption. Even the per capita energy
consumption in 1950–2002 shows an increase of 32 percent from 229 million Btu to
338 million Btu. The increase in energy consumption is strongly evident in the period
1950–1970, after which a period of stabilization of the average level to some 335–340
million Btu per capita can be observed.

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Fig.3.3. Energy Intensity of the US Economy, 1950–2002

Legend: Econs–energy consumption in quadrillion Btu, GDP–in billion 1996

USD, EC/uGDP–energy consumption in thousand Btu per unit in 1996 USD.
Source: United States Energy Information Administration. (2004). Retrieved
January 4, 2005 from [Link]
Eventually, the technological improvements and growing efficiency of the US will
not solve the problem of the aggravating contradiction between economic growth and
environment. Neither qualitative improvement in energy resources, versification of
energy sources, or aspiration to increase the share of energy produced from renewable
sources can offset the volume of energy consumption. By the way, Figure 3.3, to a
great extent, also applies to all other member countries of the OECD. That these
countries manufacture the lion’s share of the global GDP means that they are also the
biggest consumers of energy.
As we have already pointed out, the production of GDP and the respective energy
and material consumption ensuring this production should not be viewed in only a
territorial aspect. The big producers are also big exporters and importers, meaning that
they contribute to satisfying the demands of the world economy; through the import
of goods and services, they stimulate development of the economies of those countries
from which they import goods and services. In this sense, it is imprecise to measure
the consumption of energy and other natural resources ensuring the production per
capita in the manufacturing country.
The USA and EU are not only the biggest producers of agricultural production

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in the world but also the biggest exporters of such production. Meeting the world
demand for agricultural goods would be unthinkable without the American export.
The production of steel is highly energy intensive, and this is reflected in the national
statistics for the countries producing it, but a substantial share of the steel and, thus,
the positive effect of growth is “exported” abroad, whereas the environmental problems
remain in the manufacturing country.
Unfortunately, quite a few examples exist in which the environmentally clean
factors of growth are implemented within the end-user country but the output and
transportation of raw materials and energy sources remain with the exporters. The
mining industry is characterized by the production of a considerably less added value
than the manufacturing industries. That is why mining receives a smaller share of the
generated added value compared to the countries manufacturing the end product.
In other words, many of the developing countries export raw materials and energy
sources under unfavorable economic and environmental conditions and import end
products made with the raw materials that the same country exported at a considerably
higher relative price.
Developing countries suffer other indirect losses in addition to lower added
value. They also manufacture steel, cast iron, synthetic fertilizers, cement, and so on,
but at lower export profitability than similar manufacturers in developed countries.
The reasons for the difference in this profitability are based on the different margins in
labor productivity. The better technologies in the developed countries are precondition
for higher labor productivity and vise versa. The growth of GDP at lower productivity
also means greater problems with the pollution of the environment and with the
efficiency of natural resource utilization.
The mechanisms of the world market enable developed countries to import
sustainable factors of growth and to export the unsustainable factors. There is a
tendency in developing countries to export “dirty” productions (metallurgy, chemistry,
construction materials, leather, and so on), which can be either direct or indirect. Direct
export is expressed in exporting productions through direct investment (subsidiary
companies, mixed companies, privatization); indirect export is expressed in shrinking
or shutdowns of production facilities and providing the necessary products through
import, thus stimulating an increase in the volume of “dirty” production in the
exporting country. In such a way, the importing country reports a more sustainable
economic growth, whereas the exporting country degrades its analogous indicators.
The truth is that some of the effects on the exporting country are controversial.
The export of metallurgical production, for instance, from the EU to Ukraine

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directly or indirectly creates new jobs for the receiving country (Ukraine, in this
case), which is a positive social effect. This creates conditions for increasing the GDP
and foreign currency receipts in the Ukraine. Ultimately, the net effect depends on
the production technologies in terms of the labor conditions they provide and their
impact on the environment.
In other cases, developed countries recycle in the developing countries by exporting
toxic by-products or rejecting end products. Two nongovernmental environmental
organizations—the Basel Action Network (BAN) and Silicon Valley Toxic Coalition
(SVTC)—disclosed disturbing facts regarding such situations: Tens of thousands
of worn-out computers containing highly toxic elements are being exported by the
USA for recycling to the Chinese province of Guangdong. More than 100,000 local
workers, chiefly women and children, dismantle and process the electronic garbage by
primitive technologies and without any protective means. BAN and SVTC concluded
that the workers do not suspect the enormous health risks that they are undertaking.
This operation is in gross violation of the international Basel convention banning the
export of hazardous wastes, but the USA still refuses to subscribe to the convention,
afraid that this would incur additional environmental costs on growth.
Some African countries are forced to import highly toxic wastes from developing
countries, turning whole regions into wastelands. The direct and indirect economic
damages and harm for nature and human health many times exceed the revenues
from these “services.” The use of least developed countries as a dung-hill for the toxic
waste from the developed countries is a brutal violation of all principles for sustainable
development. The dynamics and structure of growth have also some moral and ethical
dimensions, which should be accounted for when making estimates of growth from the
position of the requirements for sustainable development. This is also one of the proofs
in my argument that generalizations should, in any case, be made at a global level.
The transfer of positive and negative effects of growth from one group of countries
to another complicates the achievement of a sustainable character of growth, and
hence, of development as a whole. Whether carbon dioxide will be emitted from
the metallurgical plants in Pennsylvania or in Mexico has no importance when it
comes to the end result—global warming. It does not matter whether the pollution
of rivers is done within the territory of this or that country; at the end of the day, all
toxic wastes go to the seas and oceans and disrupt the overall environmental balance.
The conclusion, then, is that the import, export, or import and export of factors for
nonsustainability or sustainability of growth can solve local problems. At the same
time, however, they deteriorate sustainability indicators on a global level.

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The Depletion of Natural Resources as a Limiting Factor for Growth

The energy intensity of GDP is still too high, despite some positive trends
during the last ten-fifteen years. By my perspective, the appropriate assessment
of the energy intensity per unit of GDP supposes the use of two basic indicators:
(1) the dynamics and scale of depletion of nonrenewable and renewable natural
resources and (2) the level of extraction and consumption of energy resources
from the viewpoint of the natural environment’s capacity to absorb or recycle
waste products. I will use the example of fossil fuels (oil, natural gas, and coal)
because they are still a basic source of energy, an important raw material for
the chemical industry, and a chief polluter. The present high dynamics of their
consumption is extremely unsustainable, considering that they are being rapidly
depleted. The deficit of non-renewable resources is thus turning into a limiting
factor for growth.
The World Resources Institute (2004) estimated that the current the world
output of oil is more than 75 million barrels per day, or some 28 billion barrels per
year. Oil is pumped day and night at all latitudes—from the frosted regions of Siberia
and Alaska, through the hot sands in the Middle East, and to the floating platforms
in the seas and oceans. But how long can this process last, considering that oil
quantities are limited? Two main parameters can provide an answer to this question:
the available reserves and the rate of their depletion. Dr. M. Hubbert (1974) provides
an opportunity to determine the interrelations between these two parameters. He
also defines the time scale for reaching the maximum output and depletion of the
available resources—the complete cycle of production. If we assume that the available
resources already discovered are approximately 1,800 billion barrels of oil and that
the present consumption tendencies will remain the same, the complete depletion of
conventional oil will occur within 25 to 40 years. If nonconventional oil is included,
this term would be lengthened by about ten years.
The forecasts made by Adelman and Lynch (1997), Edwards (1997), Deffeyes
(2003), and others may be split into “pessimistic” and “relatively optimistic” Groups.
The process of discovering new deposits continues, and deposits that have already been
found but are not used because of economic reasons are beginning to be exploited. The
US Geological Survey claims that the actual reserves of petrol in the world are at least
three times greater than those already discovered, amounting to about three trillion
barrels of oil. The latter forecast is quite questionable the agency does not provide any
reliable arguments that such quantities do exist, and consumption continues to grow,
even at the expense of produced crude oil reserves.

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We can reasonably assume that it is possible that the governmental agencies

of the greatest oil-consuming countries (the US is undoubtedly the “leader” with
some 40 percent of the total consumption and only 13 percent of the output) could
intentionally publish more exaggerated forecasts about the oil reserves. The countries
consuming the largest amounts of oil use these forecasts as an excuse for the increased
absolute volume of oil-consumption, although the oil-consumption per unit of GDP
continues to decline. Maintaining optimistic moods regarding existent oil reserves has
its own strategic and economic motives, which reflect on the whole system of political
and economic relations between the countries importing and exporting strategic
natural resources, including energy sources.
I would rather back the moderate estimates, which claim that we have already
entered the period of maximum output and consumption. In the next five decades,
there will be inevitable reductions in the output and consumption of oil. The
main reason for this is the aggravation of the disproportion between the volume of
consumption and the available reserves. Eventually, this will cause problems in the
supply and a resultant rise of prices, which, in its turn, will further curb consumption.
The jump in prices in 2004 up to the record-breaking limit of 50 USD per barrel is
not a market whim, but rather a strong symptom of a lasting tendency.
These considerations about the expected levels of production and consumption
of crude oil are based on the data and tendencies shown in Figure 3.4, which illustrates
various scenarios (optimistic, pessimistic, and moderate). I prefer the moderate forecasts
since they are closest to reality, in my view. My task here is not to discuss or dispute
the accuracy of projections but to examine the tendencies. All forecasts—optimistic,
pessimistic, and moderate—positively claim that in a matter of several decades, we will
find ourselves in a situation in which the “black gold” will be irretrievably depleted.
As shown in Figure 3.4., the initial jump in the consumption of oil after
World War II coincided with the discovery of new deposits and the introduction of
highly productive technologies enabling the exploitation of deposits that had been
technologically inaccessible before. These are the reasons for underestimating the
inevitable discrepancy between demand and availability of oil. In fact, the depletion
of this resource is effected mainly in the period 1950–2025—less than a century.
The tendencies of depletion are analogous for natural gas, coal, and ore deposits.
According to estimates by the World Energy Council (2004), the world has a total of
984,453 million tons of coal in discovered deposits, which, at the current level and
tendencies of consumption, should last us for about 200 years. According to the same
organization, natural gas reserves amount to approximately 152 trillion cubic meters

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and should meet demand for about 100 years. These estimates take into consideration
the tendencies in the various resource consumption, including the increasing use of
natural gas because of its economic and environmental advantages.

Fig.3.4. Forecast of the World’s Conventional Oil Output

(in billion barrels annually)

Source: Data from Association for the Study of Peak Oil and Gas (2004). The
Global Hubbert Peak. Forecast of Future Global Oil Output. Retrieved 3 January 2005
from [Link]
Obviously the growth forecast for the next several decades should take into
consideration some substantial limitations, including the depletion of resources; the
technological and economic restrictions for interchangeability between the various
energy and raw material sources; the high territorial concentration of deposits, with their
management under the jurisdiction of a limited number of countries; and so on.
As early as the next two or three decades, we will witness a shrinking in the
output of fossil fuels because of resource depletion. Purely physical limits to growth
are created by traditional nonrenewable energy sources. No matter how the three basic
nonrenewable energy resources (oil, natural gas, and coal) are exchanged, they will last
for a maximum of 115–150 years. This period could quite possibly be shorter because
of (1) considerably higher consumption caused by the increase in purchasing power in
emerging economies, (2) too-high demographic growth (forecasts predict the planet’s
population to increase to as many as 11 billion people in 2050), or (3) failure to

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achieve a revolutionary leap in the technologies for production and application of

renewable alternative energy and material sources.
The consumption of oil per capita worldwide (4.5 barrels per year) has remained
relatively unchanged for the past two decades. Considering that the current tendencies
are for an annual growth of the earth’s population by 1.5 percent, any substantial
reduction in oil consumption can hardly be achieved without a substantial reduction
in birth rates and a qualitative jump in the improvement of environmentally clean
and economically feasible alternative technologies. One cause for concern is that,
in the past couple of decades, scientific and technological progress advanced at the
highest pace in history but did not lead to any changes in the tendencies in oil output
and consumption. Demand grew faster than labor productivity, energy intensity
improvement, and introduction of some environmental tax and trade incentives,
which will be discussed in detail in Chapters Five and Six.
Some developed countries, like the USA, did nothing to better relate oil prices
with oil consumption. The excise taxes on oil products in the USA are substantially
lower than in Europe, Japan, and much of the rest of the world. Some authors such as
Sterner (1994) argue that such peculiarity of the US tax policy must be explained only
by the motor lobby and the oil-producers lobby. I agree that the lobbies are among the
powerful factors in this situation, although it is only one of the economic, social, and
political factors that still keep the US oil and gas prices at one of the lowest levels. It
is an excellent example, supporting the conclusions of economists such as Bretschger
(1999), who believes that the over-consumption of natural resources and the resulting
pollution is caused rather by the wrong market signals than by the growth itself.
The interchangeability between coal, natural gas, and oil has some technological
and economic limits. The technological specifics of power plants require that they use
a particular kind of fuel, and any change involves adaptation or complete replacement
of facilities. This is a costly operation, considering that the power industry is one
of the most capital-intensive industries. In addition to this, national economies are
structured in accordance with the availability of particular kinds of resources. Any
change of the resource base of an economy supposes corresponding change in the
industrial structure. The latter would imply that, when making any forecasts about the
cost of “switching” from one source of energy to another, the indirect, macroeconomic
cost of the restructuring of production should be taken into consideration.
The relative prices of these sources are affected not only by their available
quantities but also by a number of other factors, including import costs—customs
duties, excise duties, transport costs, insurances, any additional expenses for

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environmental protection, expenses for requalification of the labor force, and so on.
Resource replacement will not always be expedient in terms of prices. If it were, the
transition from one source of energy or feedstock to another would contribute to
a reduction of the costs for environmental protection as a result of a reduction in
harmful emissions, which, in turn, would have a positive impact on human health and
hence, on the expenses for healthcare and the future earnings because of workforce
sick leaves. China, for example, despite its considerable coal reserves, began to increase
the import and use of natural gas at the end of the ’90s.
The data in Table 3.1 shows the absolute environmental advantages of natural gas.
The biggest polluters of those listed in the table are the coal-based technologies. The
use of coal causes the emission of almost 700 times more particulates, approximately
2400 times more sulfur dioxide, and more than eight times more nitrogen oxides
than the use of natural gas. When we consider that using natural gas, compared to
coal and oil, causes 50 and 20 percent less carbon dioxide emission, it becomes clear
why the tendency for wider use of natural gas at the expense of other fossil fuels will
be established in the years to come. In the beginning of the 21st century, the annual
investments for the construction of gas-transfer structures exceeded 25 billion dollars
and marked a tendency to increase.

Table 3.1. Air Pollution from the Combustion of Fossil Fuels

(kilograms emission per thousand Joules of energy consumed)

Natural Gas Oil Coal

Nitrogen Oxides 43 142 359

Sulfur Dioxide 0.3 430 731

Particulates 2 36 1333

Source: US Energy Information Administration. (2004). Retrieved 21 November

2004 from [Link]
The territorial distribution of energy and material sources is uneven, meaning
they have high territorial concentration. China and India, for instance, are among the
countries rich in coal, with 114500 million tons and 84396 million tons (world reserves
are estimated at 984,453 million tons). Their national oil and natural gas reserves are
considerably smaller, obviously insufficient an internal replacement. Considering that

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both countries have maintained high dynamics of economic growth in recent years,
the dependence of their economies on the use of coal will grow. This means that
China and India will not be in the position to export coal because using their own
national wealth will be far more profitable than importing replacement sources or
making enormous investments in alternative power facilities. We can expect that their
economic growth will continue to rely on their coal reserves, with all the resultant
unfavorable effects on the environment and human health. The implementation of
the current projects for a certain increase of the share of natural gas will have some
effect, but, unfortunately, it will be “offset” by the parallel use of more coal.
Countries rich in oil and natural gas have the same problems as India with coal.
Obviously, their national economies will continue to rely on the resources available
to them. Of course, countries rich in natural gas (see Table 3.2) are in the most
advantageous position. They will incur the fewest costs for making their national
production compliant to the international environmental standards and will provide
for themselves considerable foreign currency income from the export.

Table 3.2. Natural Gas Reserves in Trillion Cubic Meters

Russia 47.7
Iran 24.3
Qatar 10.9
UAE 6.0
Saudi Arabia 5.8
USA 4.7
Algeria 4.5
Venezuela 4.2
Nigeria 3.5
Iraq 3.1
Rest of the World 36.7

Source: US Energy Information Administration. (2004). Retrieved 6 August

2004 from [Link]
The high territorial concentration of fossil fuel reserves has its own strategic
dimensions with regard to its price and to ensuring growth. In any case, economic
growth will continue to be the key objective of each government. The electorate judges

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the quality of governance on the basis of various indicators, but the main indicator
remains the purchasing power of income. The governments need ever-increasing
budgetary proceeds to implement their programs, which is also directly dependent
on growth. It won’t be risky to assume that, regarding fossil fuels, natural gas has a
positive advantage as an energy source for growth because of its relative price advantage
compared to oil and the alternative renewable power sources, comparatively greater
reserves, and lower negative environmental impact (lowest of all fossil fuels). The
latter, on its part, has additional economic effect on relative prices.
I am convinced that precisely because of the high territorial concentration of fossil
fuel deposits—especially natural gas and oil—we witness an escalating polarization
of growth. It is clear that no country can be sure of the preservation or growth of
its GDP without having ensured an adequate energy and feedstock basis for itself.
A forecast can be made without much risk that the problem with access to these
strategic resources will become more and more complex alongside their depletion and
the inevitable rise in their prices. As illustrated by Table 3.2, the deposits of natural gas
are concentrated in two regions: Russia and the Middle East.
Among the first ten countries ranked, not one represents Western Europe. Of
the American continents, the only countries listed are USA and Venezuela, but their
total reserves are equal to only one-sixth of the reserves of Russia and approximately
equal to the reserves in the Middle East. In Africa, only Algeria and Nigeria have
significant reserves, amounting to a total of 8 trillion cubic meters. As we have already
discussed, coal, in which the USA and Western Europe are rich, cannot be considered
a technologically feasible and economically acceptable replacement, except if some
innovative, economically profitable technologies—including more-efficient treatment
facilities—for the use of coal are introduced. At present, any increase in the share of
coal in the energy balances of developed countries does not seem a plausible option.
Are there grounds to expect that economic growth can have political limiting
factors created by local and regional military conflicts arising about access to and
distribution of energy resources? Yes, definitely; World Wars I and II were led for
redistribution of market spaces and access to natural resources. Today’s development
of political relations is still a clear reflection of this dependence. The local conflicts
in Chechnya, Georgia, and Afghanistan are caused not only by ethnic or religious
opposition but also chiefly by the struggle for control over the gas transfer lines
connecting Russia and the Middle East with Europe. The never-subsiding conflicts in
the Middle East are fueled by analogous causes. In any case, if the tension in the region
is maintained, it will not influence the growth of the world economy favorably.

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The extraction, transportation, processing, and consumption of nonrenewable

energy resources are the chief polluters of the natural environment. It is not acceptable
to preserve even the current level of consumption of these resources because a number
of elements in the environment have already been brought to critical conditions. This
imposes the introduction of environmental laws and standards at municipal, national,
and international levels. Despite the resistance of certain interested economic and
political circles, the tendency of laws is for these legal and technical requirements to be
expanded and strengthened. In other words, legal restrictions arise regarding the growth
based on technologies and products not meeting environmental requirements.
Environmental limitations on growth should be examined as incentives for
restructuring growth in a certain direction. As far as these limitations have some
economic dimensions—fines, charges, taxes, import and export regulations, interest
rates, credit guarantees, subsidies, consumer credits, and so on—we can assumed that
the limitations lead to a significant modification in the relative prices of energy sources
and raw materials. Understandably, the introduction of such restrictions will cause
effects to vary in the short, medium, and long runs. Another factor that should be
considered is the scale of application of these restrictions. As long as the introduction
of restrictions leads to the loss of GDP and price competitiveness in the short run,
our goal should be to have the restrictions enforced simultaneously by all countries.
Otherwise, the countries that implement this environmentally friendly restructuring
would find themselves in a losing position on the global market.

Economic Growth Based on Renewable Energy

The possibility for an increase in the share of renewable energy resources at the
expense of nonrenewable ones will not be as unproblematic as it may seem. The
substitution of crude oil with vegetable oils is technically and technologically possible,
but the conditions for such substitution are rather unstable. It has been estimated
that 100 million hectares of fertile land—the area of Great Britain, France, Belgium,
Holland, and Luxembourg combined—should be seeded to produce 50 million tons
of castor seed oil. Such a quantity of renewable oil would satisfy only one-third of the
import necessary to the US. For the replacement of the entire world import, almost
the whole of Europe should be turned into a castor seed field—a perspective that
obviously does not seem rational and is absolutely impossible.

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Fig.3.5. World Consumption of Primary Energy by Energy Type, 2002

Legend: RENs–renewables (wind, solar, geothermal, wood, and waste electrical

power), ATOM–nuclear energy, HYD- hydroelectric power, GASd–dry natural gas.
Source: US Energy Information Agency. (2004). Retrieved 2 November 2004
from [Link]
The structure of the world’s primary energy consumption1 gives an idea of the
structure of energy provision for economic growth. This structure requires the highest
possible degree of realism when adopting various models of alternative provision of
growth. In the beginning of the 21st century, renewable energy sources are only 8
percent (1 percent by solar, wind, and geothermal sources combined, plus 7 percent
by “traditional” hydropower—see Figure 3.5) of total energy consumption. I use the
term traditional because this form of hydropower is not a result of recent technological
innovation or new policy implementation.
A total of 62 percent of total energy consumption is accounted for by such sources
as oil (38 percent) and coal (24 percent), with the depletion of these resources already
looming on the horizon and their burning causing emission of tens of millions of tons
of carbon dioxide, sulfur, and other elements that are extremely hazardous for human
and animal health into the atmosphere. These polluters are among the main causes of
changes in the chemical and physical composition of the atmosphere that is in turn
causing climate changes—namely, global warming.

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Climate changes already rather strongly influence the conditions for agricultural
and industrial production, tourism development, the insurance industry, transport,
and so on. The conditions for labor and recreation for hundreds of millions of people
deteriorate. In other words, unanimity is more than desirable for the structure of current
energy consumption to be modified in such a way for growth to become environmentally
friendly with all the ensuing positive economic and social effects. The problem is that
a substantial difference exists between people’s wishes and reality. The share of the
renewable energy sources used (including water) compared to overall consumption has
remained the same—about 7 percent—from 1980 to 2002. The absolute volume of
renewable energy has increased from 18.51 to 29.86 quadrillion Btu in the 1980-2002
period, but its share has remained the same because of the growth achieved in the output
and consumption of other nonrenewable energy sources.
The analysis of tendencies and of the possible economic and noneconomic tools
and mechanisms for influencing these tendencies does not give grounds for optimism
in the short or medium run. In fact, the electric energy produced by hydropower
plants accounts for only about 8 percent of the total quantity of renewable energy
used in 2002. We cannot seriously expect that the development of technologies for
producing electric power from solar, geothermal, wind or biomass energy can replace
the use of energy produced from nonrenewable resources. The current basis from
which renewables could start increase their share is practically negligible—only 3.28
quadrillion Btu, or slightly more than 1 percent of a total of 408.71 quadrillion Btu.
The expectations that renewable energy’s share could change substantially in the
short run are unrealistic. Such large-scale changes in power engineering are not possible
because of a number of economic, natural, and managerial reasons. Undoubtedly,
everything possible should be done for expanding the use of these renewable and
environmentally clean sources, but I would like to stress that accepting the desired
as possible without an impartial analysis of realities could bring more trouble than
help for solving the problems. After all, for 23 years, the share of all renewable energy
sources has changed from 5 percent to only 7 percent. It is absolutely irrational to
expect that this percentage could be changed in the next 10–15 years to such an extent
that would result in some qualitatively new structure.
You might ask what the grounds for my moderate pessimism are. Because
hydropower plants currently produce 9–10 times more energy than all other
renewable energy sources together, it is only natural to determine the possibilities for
their extended use. Aside from its environmental advantages, this electric power has

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one of the lowest production costs. (I use the phrase “one of the lowest” because the
discussion concerning the final cost of atomic energy is still open, and many people
believe it to be the cheapest renewable energy source.) Water resources are renewable
but are limited; we can assume that developed countries have exhausted or are close to
exhausting the potential of the water resources available to them for use in producing
electric power.
Had they not come so close to exhausting the potential of their water resources,
these countries would have long ago increased the share of hydroelectric energy
to a greater extent because of its environmental and economic expedience? They
have not done so because the share of hydropower in the total produced/consumed
quantity has increased over the 23 years of 1980–2002 from 6 percent to only 7
percent, or from 18.4 to 26.58 quadrillion Btu. In other words, the dynamics of
increase in the energy produced from nonrenewable sources has been many times
higher. We should also consider that the price of the resource itself is zero or, in case
of a concession, lower than that of natural gas or oil estimated for the production
of a unit of electric power.
When making a comparative analysis, we should take two other factors into
consideration: economic and environmental. The construction of power complexes
of such a type involves huge initial capital investment—the period for achieving a
sufficient rate of return on investments is quite long. Also, the ecological opportunity
cost is not to be underestimated because the construction of dams would leave enormous
forested areas, woodlands, and arable land under water, which is often related to the
relocation of thousands or even millions of people; the micro environment is changed;
damages are incurred to the biodiversity; and so on. The net positive or negative effect
of using this or the other type of power generating facilities cannot and should not
be accepted a priori. Each project presupposes a specific cost-benefit analysis that
integrates environmental criteria.
Some experts view biomass as a promising renewable energy source.2 Currently,
North America and Western Europe are playing leading roles in biomass conversion,
but Asia is the continent with the greatest potential for development. Expectations
are for worldwide installation of a total 12,172 megawatts of capacity in 2004–2013;
nearly 70 percent of this capacity will be based on thermal energy plants.

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Fig.3.6. World Capital Investments in Biomass Energy Production

(million USD)

Legend: 2000, 2004, and 2013–average annual investments; 2014–2023–total

investments.
Source: Westwood, A. & Knight, B. (November/December 2004). World
Biomass Review. ReFocus, 42–44.
Figure 3.6 supposes increasing annual capital investments by 863 million USD
in 2000, 1,276 million USD in 2004, and 2,145 million USD in 2013. In the period
2014–2023, a total of 18 billion USD is expected to be invested. Westwood and Knight
(2004) expect that Europe and North America will install energy plants with power
respectively 2.4 gigawatts and 4.4 gigawatts during that period, but this volume of
investments is insufficient for some radical restructuring of the energy sources. One
must have in mind that an increase in biomass production supposes high opportunity
cost. The available arable land is limited, which means that the increased production of
biomass has to be at the expense of downsized production of other agrarian products.
This unacceptable substitution of land from agricultural land to land used for production
of biomass raises questions because such substitution could result in problems with the
food supply. Contrary to solar or wind energy, the energy production based on biomass
supposes additional investments for pollution prevention equipment.

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Alternative energy sources meet broad public and political support in

developed (and a number of developing) countries because they are renewable and
environmentally friendly. According data of the American Wind Energy Association
(2004), since the mid-1990s, an enlivening has occurred in the installation of facilities
based on wind, solar, geothermal, and biomass use energies, with the US, Germany,
Spain, Denmark, and France being the leaders. By the end of 2002, the total output
of the commissioned wind electric turbines exceeded 31 thousand megawatts (Mw),
75 percent of these megawatts being produced in Europe and 15 percent in the USA.
Of the European countries, the greatest-capacity—about 12,000 Mw—facility has
been installed in Germany—about 12,000 Mw. Of developing countries, India has
the lead with a total of 1,702 Mw, or approximately 5 percent of the total capacity of
wind facilities. In the period 1996–2002, the average annual increase in these wind
turbines was 32 percent, but, unfortunately, this impressive figure is mostly because
of the rather low initial basis for development. Since 2003, a slowing tendency can
be seen in this growth for a number of reasons, chiefly budgetary limitations or a
need for further development of the fiscal legislation for providing incentives for the
installation and use of such energy.
The use of solar energy is still in its experimental phase and could not play a
substantial role in the desired qualitative change in the growth of renewable energy
use, at least not in the short and medium run. Aside from technical problems, which
are quite similar to those with wind turbines, especially the limited output, this energy
remains almost forbiddingly expensive. The currently existing facilities throughout the
world have a capacity of some 420 Mw, and almost 90 percent of these are located in
the US. California is the pioneer in developing and implementing alternative power
sources. Because of the rather high price of equipment, the price for one kW/h of
electric power reaches 50 cents, which is five times more expensive than the average
conventional electric power.
This explains why the quantity of energy produced is enough for satisfying the
needs of only about 30,000 households, or 0.4 percent of the total energy output of the
USA. The capital investments necessary for the construction of solar energy facilities are
close to those for the construction of hydropower plants, but the end production cost is
about fifteen times higher! Without achieving a revolutionary turn in the technologies
for production of electric power and for the reduction of equipment costs, the alternative
sources of energy at this stage will retain their esoteric nature.
At this point, we will emphasize that using solar energy should be encouraged
but that it can have some effect only within certain geographical regions where the

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natural requirements—enough sun or solar energy—are available. Some technical

restrictions exist that should be considered. Currently, the capacity of these facilities
is limited, and the facilities can meet only local energy demands. They are an ideal
solution for the provision of electric power to individual households, small farms,
and companies with low energy consumption. It is unthinkable to replace the large
power plant complexes with such alternative facilities; therefore, the main consumer
of electric power—big industry—remains dependent on traditional power plants, at
least until some revolutionary changes take place in current technologies.
The specific conditions under which the output of electric power from alternative
sources can be ensured should also be considered a part of the technical problems.
Wind energy is inconstant, and solar energy depends on changes in the weather and
climatic conditions. The accumulation of “reserve” energy is possible, but in limited
quantities; therefore, it is unrealistic to rely on it for maintaining large-scale industrial
productions. The production of storage batteries is expensive and includes the use
of nonrenewable, nonferrous metals. Production of these metals is among the most
polluting industries, and the elements of batteries themselves are highly toxic.
The current price per one megawatt of installed capacity using wind energy
amounts to approximately one billion EUR, or 6.3 billion USD (at the August 2004
exchange rate). Considering that the annual world output amounts to some 13,300
billion Mw, it is easy to conclude that the world economy does not have so many
free resources at the moment, nor the production capacity to make a replacement of
facilities in the medium run. The losses from premature decommissioning of power
facilities using nonrenewable resources should be added to the cost of replacement.
What is at issue here is how to account for expenditures and losses amounting to
trillions of dollars.
In the medium run, these losses cannot be borne even by the most developed
countries, and for the developing countries, the losses are absurd from an economic
point of view for, say, a 15-year period. It is unrealistic to suppose that countries having
sufficient quantities of fossil fuels of their own—China, India, Russia, Ukraine, and so
on—will agree to a large-scale restructuring of their power industry, which would slow
down their economic growth and make the production of one unit of GDP considerably
more expensive. Countries having a monoculture economy based solely on the output
and export of fossil fuels would find themselves in complete economic collapse.
In spite of its great industrial basis, Russia also continues to rely on receipts of
stable currency on the export of oil and natural gas—some 60–70 percent of these
receipts come from these exports. The scope of losses and the consequences for this

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country with a population of 160 million are hard to foresee if the country were
deprived of these receipts. For countries such as Russia, stopping the export of oil and
natural gas would be a disaster for their balance of payments and their entire economy.
The shrinkage of the coal export from Ukraine would have similar effects.
Another significant economic restriction—budgetary capabilities—must be
defeated before the broad and ubiquitous introduction of alternative energy sources.
If we calculate what subsidies are necessary to produce current worldwide energy needs
from new sources, we will clearly see that even the budgets of the most developed
countries do not have at their disposal the necessary colossal financial means. There is no
way to change the structure of budgetary expenditure in such a scope, nor to have a leap
in budgetary income. At least for the time being, no such economic model is known.
The countries of the EU have a legal restriction of their budgetary deficit of
up to 3 percent of GDP, and the United States has already reached critical limits of
deficit, exceeding approximately 500 billion dollars. Japan is still undergoing a long
and exhausting recession and destabilization of state finance. With the exception of
some oil exporting countries, the major part of the developing countries are, and will
remain for a long time, in the trap of foreign debt. In brief, there are absolutely no
grounds to believe that the world economic system can finance such enormous (in
terms of scale) projects, no matter how environmentally friendly and promising they
are. Because of these limitations, I deem realistic the projections of the World Energy
Council (2004) that coal will remain the second most important source of power,
next to oil, at least until 2050. What is more, the volume of coal output in 2050 is
expected to be twice as much as in 1990. This forecast also takes into consideration the
substantial “advantage” of this coal resource, expressed in its availability in considerable
quantities, guaranteeing the supplies for a period four to seven times longer than that
for oil and natural gas.
In the next few decades, economic growth will continue to rely on the provision
of energy from nonrenewable resources. The share of alternative sources in energy
production will grow, but their current level is so low that it would be unrealistic to
expect achievement of some sudden change in the foreseeable future. The direct and
indirect, including budgetary, costs for the commissioning of such facilities are still
too high. Even with the current tendencies for price increases for oil and natural gas,
the relative prices of the renewable energy sources will remain high.
I have great hopes in hydrogen fuel cells as a new technology for chemical
transformation of hydrocarbon compounds, including oil products and coal. The
advantage of these technologies is that this chemical transformation emits only water

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and a small quantity of carbon dioxide and heat, the latter of which is utilizable.
The fuel cells can be used not only in the engines of transport vehicles but also in
production of electric power. Through new technologies, the desired compromise
in the use of carbon-rich nonrenewable natural resources is achieved to minimize
environmental pollution; the useful power of engines and generators is increased,
which improves the correlation between cost and final economic result.
The prospects for use of hydrogen cells are great, especially if a considerable
reduction in the price per unit of power is achieved. For the time being, this price
amounts to an average of 4,000–5,000 USD per kilowatt, but for some types
of facilities, it reaches 10,000 USD per kilowatt. The lowest price is that of their
application in various automobiles —approximately 50 USD per kilowatt power; yet
if we take even the maximum price of 10,000 USD per kilowatt, the price per one
megawatt of installed capacity will be 10 million dollars, or 100 times less than the
price for the same output capacity using wind energy. If we take the lowest price of
50 USD, the price relation is 20,000 times in favor of hydrogen fuel cells. Of course,
the precision of this comparison implies that in the final price, the costs for delivery
of carbon fuel for these fuel cells should also be included, and the fact that this carbon
fuel is nonrenewable should also be considered.
In some developed countries, namely the US and Japan, management decisions
are already being made to introduce standards for the replacement of the present
internal combustion engines with engines based on hydrogen energy. Perhaps this
will strongly influence the world automobile market and will make the necessary
structural changes in the auto manufacturing industry branch, including those due
to a change in the standards for the international trade with transport vehicles. In this
sense, the increase in the share of hydrogen energy production will lower the energy
intensity of GDP and diminish the environmental price of growth, especially in the
long run. After accounting for the technical, technological, and economic factors, we
may conclude that the restructuring of the energy sector and the change of the energy-
related characteristics of economic growth will probably be accomplished through the
priority development of hydrogen energy production.
Some institutions and individual experts see a solution to the problem of
conversion from non-renewable to renewable energy with the “right” choice of energy
source in (1) the formation of a “full price” of nonrenewable resources or (2) the
inclusion of the external cost (externalities) into their market price or, in other words,
an internalization of external cost. They reasonably base their argument on the status
quo that these nonrenewable resources are a product of nature, and that, generally,

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their production cost includes only the cost for their extraction and delivery. In fact,
this is generally true, but we should still consider that in most cases, the extraction
is done on a concessionary basis. This is so especially after the privatization of the
extraction business in the former Soviet Union and the granting of these concession
rights to foreign companies.
In its essence, the concession fee can be taken as the initial price of the resource,
especially bearing in mind that the concessions are bound to a particular volume of
extraction or to particular shares of division of the output between the concessionaire
and the producer, or both. Consequently, the producers and consumers pay for the
resource through the concessions. It is a different issue whether the concession fees are
high or low, but fees are determined by the market conditions, as is the mechanism
for the other kinds of resources.
The main element in the structure of oil prices, for instance, is excise duties from
35 to 60 percent. A universal percentage increase in the price would probably be
offset by a proportionate decrease in excise. For the owner of natural resources—the
state—it does not matter whether the money will come to the state’s budget in the
form of excise duties or concessions or any other type of price addition; all of them
are budgetary receipts. A more specific case is the one in which the nonrenewable
resource is exported because the importing country receives the excise duties. This is
not a problem of the product’s end price, however, but of distribution of the receipts
from production and trade.
We should also bear in mind that the elasticity of demand for non-renewable
resources is not great in the sense that the increased prices will have an impact on
the overall price levels, but the impact is not so much on the physical volume of
demand. Another important consideration is that in the past four decades, the prices
of oil as a basic nonrenewable source of energy have changed substantially in both
directions—from the price jumps in 1973–1974 and 1980–1982 to the dramatic
downfall at the end of 1998 (below 10 USD per barrel) and the jump above 50
USD at the end of 2004 and the first quarter of 2005. In this sense, the price margin
is influenced much more by the demand fluctuations, which are caused by complex
factors, than by any increase in the initial price by a certain percent. Finally, it is well
known that the economic system has the ability to “adjust” to the new price level
in the long run. This does not exclude some desired structural changes in economy
in the short run, as was the effect of the past oil price shocks, but such an approach
would not solve to a sufficient extent the problem with the growing consumption of
nonrenewable energy sources.

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Another unwanted effect of any price increase by a certain percent is the inevitable
additional stimulation of the producers. The higher prices and receipts will make producers
expand the production, including some areas that had been economically unprofitable
for exploitation until then, and the increased supply will exert the reverse pressure for
price lowering. The possible final result might be additional capital investment for
extraction under worse conditions, increased supply, and lower profitability from a unit
of output and more harm to the environment. In addition to the above considerations,
the difference in the relative prices of traditional and alternative energy sources is so
dramatically great that, to change these correlations, some unthinkable increases of the
process should be made, not by percents, but by multiples.
No doubt, such a step would cause more negative than positive effects. Lastly,
advocates of the “full price” idea have not yet explained how the producers of
traditional energy resources will be made to introduce these prices and eliminate their
own sectors to the benefit of alternative energy resources. The economic and political
realities exclude such a development, however logical and useful, in general, these
wishes might be.
I would not exclude even the reverse tendency—with the development of
technologies and with a more material application of alternative energies—which
would be the oil-producing countries reacting by reducing supply prices to preserve
the relative competitiveness of their own product. The possibilities of the Middle East
countries are especially great since their production costs are currently four to six times
lower than those of the oil producers in Russia. They can afford quite broader limits of
price reduction while retaining sufficiently high profitability. For instance, extraction
costs per one barrel of oil in Iraq or Saudi Arabia are 1.5–2 USD per barrel, which
currently accounts for less than 4 percent of the market price.
The disproportions in the costs for the extraction of oil are much greater than a
possible increase of prices so that they form the “full price,” and yet the production
volume is determined by demand, which is mostly nonflexible. Economy is not able
to show flexibility in the consumption of power because both the production and
consumption of a particular kind of energy source are “anchored” for a long period
of time because of (1) the huge capital investments already made and (2) the time
necessary for any possible replacement of technologies. To these causes we should add
the instability of energy source prices, meaning that in a year or two, the “old” energy
source is once again sold at the most favorable prices. The comparative analysis of
the prices of traditional and alternative sources also involves some risks related to the
budget funding of their production and consumption.

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In the case of any change in the budgetary policy or legislation or in case of

financial hardships for the governments, these subsidies can turn out to be insufficient
to cover the difference between actual and supply prices. It is not very probable that
private business will agree to a long-term energy strategy that would depend on the
budgetary policy because different governments have different budget policies. This is
why private investors prefer a strategy that guarantees high degrees of independence
from such policies. If, for the most developed countries, this risk is not so great, such
a risk for the developing countries should not be underestimated in any way.
The problem should be considered also from the viewpoint of the world
economy and market competitiveness. It does not matter that the budget covers
the price differences in the countries that can afford such subsidizing. Eventually,
company competitiveness will be related to competitiveness at a national level.
Whether the energy costs for the production of a unit of GDP will be done at the
corporate or national level, it makes no difference in the world market. To avoid such
a contradiction, international trade and direct foreign investments should account
properly for not only the energy consumption to produce a unit of imported or
exported GDP but also for the type of energy consumed. The use of renewable energy
and material resources should be stimulated by suitable economic incentives, but this
could hardly be practicable in the short run, as we will discuss in further detail in the
chapters focusing on the policy for sustainable development.
Another factor to consider in increasing share of renewable energy is not
underestimating the costs of materials for facility construction. As shown in Table
3.3, solar energy is a renewable resource, but the construction of a solar (photovoltaic)
power plant that produces one gigawatt hour of electricity requires some 3,690–
24,250 kg of steel (13,970 kg average), 210-510 kg of copper (360 kg average), and
240–4,620 kg of bauxite (2,430 kg average). The material consumption varies broadly
because it depends on the geographic location of the facilities, the solar intensity of
the location, the design of the facilities, and so on. Facilities using wind energy are
also characterized by comparatively high material consumption, unlike nuclear power
plants, which use nonrenewable energy but have a lower material consumption.
As we can see from the discussion of all these factors, comparative analysis and
the conclusions about the economic and environmental advantages of the various
kinds of facilities for energy production, including electric power, should consider the
material consumption of constructing the power facilities (in terms of volume and
types of resources—renewable versus nonrenewable); the costs for purchasing, supply,
and storage of these resources; the energy yield per unit of resource input (expressed in

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physical terms); the rate of return of investments (period of full return); the hazardous
emissions per unit of energy produced; the hazardous emissions per unit of energy
used (other than electricity as far as electricity is a secondary energy resource and is
homogeneous in terms of quality); production cost per unit of energy product and
price of a unit of supply price (including the necessary subsidies for the producers and
the consumers of environmentally clean energy); and degree of risk for human health
and life (in economic terms).
The contemporary techniques for cost-benefit analyses provide good opportunities
for transformation of the physical and risk parameters into monetary expressions.
In most cases, though, this is not enough or not entirely reliable, and this makes
necessary the use of expert assessments.

Table 3.3. Material Consumption for the Production of One Gigawatt Hour
of Electricity
Energy Source Iron (kg) Copper (kg) Bauxite (kg)
Coal 1,750–2,310 2 16-20
Lignite 2,100-2,170 7-8 18-19
Gas 1,207 3 28
Atom 420–490 6-7 27-30
Solar 3,690–24,250 210-510 240-4,620
Wind 3,700–1,140 47-140 32-95
Water 1,560–2,680 5-14 4-11
Source: Primary data from Vob, A. (2001, April). Liberalization and sustainable
energy supply: Perspectives of nuclear energy and renewable energy sources. ILK
Symposium on Opportunities and Risks of Nuclear Energy, Baden-Baden. Retrieved
11 November 2004 from [Link]
When assessing “environmentally-clean products,” the assessment approach should
be analogous to that of determining facility construction feasibility. Transport vehicles
with an electric motor use environmentally clean electric power, but use precious
nonferrous metals for the batteries. The correlation of useful and nonuseful freight,
then, is worse than in regular vehicles, meaning that the actual price of production,
which includes all externalities, is underestimated. One must compare the cost of the
effectiveness ratio based on the total actual price covering the expenses for the new car
components, including special batteries, composite materials, and so on.

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Often, the complete price of production is underestimated by those making an

analysis, including the whole chain of production and consumption of the end product.
We emphasize this not so as to belittle the perspectives of the use of alternative energy
sources or end products for consumption, but to bear in mind that the assessment
should be based on thorough and multilateral cost-benefit analysis, which includes
both the direct cost and the externalities.
The system of indicators that I proposed is an object of broad analysis and
discussion, which is understandable because every change in the relative weight of
one indicator changes considerably the conclusions about the energy sustainability of
economic growth. One thing is clear—there can be general principles for assessment,
but the selection of a particular basic structure of growth has a particular dimension in
each country or group of countries. Norway does not develop nuclear power industry
because it has sufficient water resources and other natural preconditions for the use of
hydropower plants. The neighboring Sweden, however, continues to rely on its nuclear
power industry. The thirty years old decision for closure of the nuclear reactors was
not implemented yet in Sweden till mid 2005. Many Swedish politicians and business
circles insists that the nuclear energy is cleaner than the other non-renewable energy
sources. The fate of the Swedish nuclear reactors depends rather on the strength of
current political power of the different pro and anti-nuclear camps than on complete
cost-benefit analyses.
It is indicative that several other countries, including France, England, Germany,
USA, Canada, India, and the whole of Eastern Europe continue to rely on nuclear
energy. The US President announced in May 2005 that new nuclear reactors most
probably must be built. He stressed two main advantages of such a decision—greater
energy independence from oil import and lower carbon dioxide emissions as required
by the Kyoto Protocol. At the same time, other countries have chosen different
alternatives for their energy sectors. These alternatives are based on the disposable
resources in their countries. Therefore, the preferences are based mainly on economic
incentives. For example, the rich coal deposits in China, India, and Ukraine tip the
balance in those countries in favor of the choice of thermal energy plants based on
black coal and lignite. The state of California increases the use of solar energy thus
combining the favorable sunshine climate with its ambitious program for development
of environmentally friendly energy sector. Today, California is becoming the world
leader in the development and use of solar energy.
The above analyses focused on the interrelations between economic growth and
natural resources based on the quantity and type (renewable versus nonrenewable) of

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used natural resources and energy. Although obvious improvements have been made to
the qualitative indicators for these interrelations in both developed and some emerging
economies, the absolute volume of used natural resources and energy is still increasing.
The development of renewable substitutes and the process of recycling tend to slow
the depletion of natural resources, but the expectations for miraculous substitution of
nonrenewable resources with renewable resources must be realistic and must consider
that the renewable ability has its own restriction. Also, the production of one kind
of renewable resource may require the consumption of other precious renewable or
nonrenewable resources. There are very many examples for such interdependencies,
and the production of cotton is just one of them: The production of a single pound
of cotton takes two-and-a-half tons of water and, in some cases, may cause erosion
of forty-four pounds of topsoil.1 In other cases, the exhausted renewable resources
must be viewed as a natural limit to growth if the regeneration function is taken into
account. Bretschger (1999) expresses this function as

DV/dt = F(V)

where V represents the stock of the renewable natural resource (biomass), Z is the
“harvest volume” of those resources, and F is the “natural regeneration.”
In their series of studies, Meadows et al. (1972, 1992, and 2004) developed different
models of growth and its impact on the balance of natural resources. The depletion
of natural resources is shown as a major limit to growth. In the presented scenarios
of interaction between the growth and the environment, they see two main limits to
growth: depletion of the natural resources and continuing increase of pollution.
Meadows et al.’s forecasts, though sometimes too pessimistic, must be taken
into serious consideration. Obviously, the current model of economic growth is
environmentally unfriendly and rapidly consumes the remaining quantities of priceless
natural resources. The market forces are winning the battle with sustainability and
continue to deepen the environmental disequilibrium. We shall see in the next chapter
that the growth output further deteriorates the relationship between production
and the environment. Obviously, many more radical economic and non-economic
incentives must be applied to reverse these dangerous trends.

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References
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Bothun, G. (1998). Large scale solar energy production. Physics 162: Alternative Energy and Renewable
Energy Sources course page, University of Oregon. Retrieved 6 November 2004 from [Link]
[Link]/1998/ph162/[Link]

Bretschger, L. (1999). Growth theory and sustainable development. Northampton, MA: Edward Elgar (pp.
187–193, 225–228).

Davies, G. (2004). Economia: Global good housekeeping; Restoring economies to their place within Earth’s
living system. Sydney: ABC Books. Retrieved 21 December 2004 from [Link]
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Deffeyes, K. S. (2003). Hubbert’s peak: The impending world oil shortage. Princeton University Press.

Edwards, J. D. (1997). Crude oil and alternate energy production forecasts for the twenty-first century;
The end of the hydrocarbon era. AAPG Bulletin, 81(8), 1292–1305.

Friedman, M. (2002). Capitalism and freedom. Chicago, IL: University of Chicago Press.

Haugland, T., & Roland, K. (1994). Environmental considerations for Chinese energy policy. In T. Sterner
(Ed.), Economic policies for sustainable development (pp. 212–214). London: Kluwer Academic.

Hauwken, P., Lovins, A., & Lovins, H. (1999). The natural capitalism: Creating the next industrial
revolution. New York: Little, Brown and Company.

Hubbert, M. King (1974). Hubbert on the nature of growth. National Energy Conservation Policy Act of
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Kalecki, M. (1986). Selected essays on economic planning. Cambridge University Press.

Meadows, D. H., Meadows, D. L., & Randers, J. (2004). Limits to growth: The 30-year update. White
River Junction, VT: Chelsea Green.

O’Mad, H. (2004). Renewable energy: Alternative consumption and the consumption of alternatives.
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Smith, A. (1776). The wealth of nations. New York: Prometheus Books.

Sterner, T. (1994). The price of petroleum products. In T. Sterner (Ed.), Economic policies for sustainable
development (p. 312). London: Kluwer Academic.

Wackernagel, M., Schulz, N., Galleias, L., Linares, A., Deumling, D., Martin, A., et al. (2002). Tracking
the ecological overshoot of the human economy. Proceedings of the National Academy of Science (PNAS).
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Wallace, D. (1995). Environmental policy and industrial innovation: Strategies in Europe, the USA and
Japan. London: The Royal Institute of International Affairs.

Weintraub, E. (1993). General equilibrium analysis. Ann Arbor, MI: University of Michigan Press.

World Energy Council. (2004). Work program, cleaner fossil fuels systems. Retrieved 21 September 2004
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World Resources Institute. (2004). Research topics: Climate change, energy, and transportation: Data and trends.
Retrieved 23 November 2004 and 3 January 2005 from [Link]

Notes
1
Primary energy use includes energy used by the final consumer, intermediate uses of energy, energy
used for the transformation of one type of energy into another (oil to electricity, for example), and
energy used by suppliers to provide energy to buyers. Secondary energy use is the energy used by the
final consumers in the industrial, agricultural, commercial, residential, and transportation sectors.
2
The biomass sources include crap residues and animal, municipal and industrial wastes, forestry and
agricultural residues, marine and aquatic biomass and silvicultural energy farms.

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C H A P T E R 4.
G ROW T H A N D E N V I RO N M E N T: E C O LO G I C A L
A N D E C O N O M I C O U TC O M E S

We discussed in Chapter 3 the dependency between the dynamics and magnitude

of GDP growth and the influence of them on the environment. We assumed that
the aspect best expressing this interaction was the production and consumption
of energy, including electric energy. Research on this particular direction of the
interaction between GDP growth’s dynamics and magnitude provides a reliable idea
about the consumption of material resources as far as a strong positive relation exists
between the quantity of the material resources used and the energy necessary for
their processing. In other words, material consumption and energy consumption are
mutually presupposing. It can also be claimed that the emission of carbon dioxide in
the production process is one of the leading indicators of environment air pollution.
Of course, at issue is a representative extract of this interaction of dynamics and
magnitude of GDP, which includes hundreds of other pollutants of the soils, water,
and air, which can each have a more important or representative role for a particular
country, region, or settlement. Our goal is to use carbon dioxide as an illustrative
example of the quantitative and qualitative characteristics of the examined relationship
between economic growth and the environment.

Ecological Footprint of Economic Growth

Figure 4.1 shows the strongly expressed positive interdependence between the
increase in the GDP (in constant 1995 prices) and the quantity of emitted carbon
dioxide. In the period from 1960 to 1980, this dependence is almost linear, which
provides grounds for the conclusion that growth was achieved mainly because of
extensive factors, meaning that the increased volume of GDP was achieved by an
analogous increase in the consumption of materials and energy. The consumption
of energy and materials are interrelated because energy is needed for obtaining the
materials and is also necessary for processing the same materials. Because the use of

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fossil fuels has absolute domination for the period, the result is unsurprising—the
carbon dioxide emitted in 1980 amounted to 18,568 million kilotons, which is twice
that of emissions in 1960.

Fig.4.1. World Carbon Dioxide Emissions (million tons) and GDP

(1995 USD), 1960–1980

Legend: CO2–carbon dioxide, GDP–Gross Domestic Product.

Source: World Bank. (2004). Retrieved 19 October 2004 from [Link]
[Link]/data/onlinedatabases/[Link]
For the same period (1960–1980), the increase in GDP is almost 2.5 times—from
7,912 billion USD to 19,420 billion USD. From 1975, we can see the growth of GDP
overtaking carbon dioxide emissions. This can be explained by the first oil price shock
of 1973–1974, which caused technological and product renovation targeted at higher
energy efficiency. This positive process grew better and turned into a stable tendency
in the period 1980–2000. GDP marks a lasting growing tendency, at 76 percent,
followed by growth in carbon dioxide emissions by 24 percent, meaning that the
relation in the change of the dynamics is about three times in favor of GDP. Another
factor contributing to this effect is the improvement in production organization and
management and a heightened public sensitivity toward environmental protection.
The latter results in the partial introduction or perfection of green legislation, which
set legal restrictions on the level of hazardous emissions, adequacy of technologies,
environmental qualities of the products manufactured, conditions for storage and
possible recycling of the dangerous byproducts, and others.

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The interrelation between economic growth and hazardous emissions of carbon

dioxide in countries with high and low incomes or between the highly developed
countries and the developing countries manifests itself in quite a different way than
the global trends. The positive dependency is preserved in both groups of countries,
but the low-income countries show much more alarming tendencies for instability.

Fig.4.2. Trends in the Growths of GDP (billion USD) and Carbon Dioxide
Emissions (million tons) in High- and Low-income Countries, 1960–2000

Legend: CO2h–carbon dioxide emissions of high-income countries, CO2lw–carbon

dioxide emissions of low-income countries, GDPh–GDP of high income countries, GDPlw–
GDP of low income countries.
Source: World Bank. (2004). Retrieved 18 July 2004 from [Link]
data/onlinedatabases/[Link]
Several factors precondition the difference in the tendencies for the high- and low-
income countries. A lower degree of economic development predetermines two effects:
lower volume of GDP and greater damages to nature by the production of each unit of
GDP. Both effects are results of the difference in the productivity of labor, which reflects
the energy and material intensity of production. The higher the labor productivity, the
lower the material and energy consumption per unit of product. The energy and material
intensity determine the quantity of emitted pollutants, including carbon dioxide. The
production structure of developing countries is unfavorable—the share of the mining
industry that has a low degree of product processing remains dominant. This, combined
with the low technology levels used, results in a stronger alignment between the growth
of GDP and the deterioration of environmental parameters.

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The majority of low-income countries are facing serious financial hardships.

Their huge obligations for servicing their foreign debt do not allow them to allocate
sufficient funds for scientific and applied research or for developing or purchasing
modern, environmentally expedient technologies. These countries’ economic instability
undermines their capacity to make up for this financial deficit by means of foreign
investments. Their governments justify the delayed introduction of environmental
standards by the inevitable rise in production costs, which would eliminate their price
competitiveness. According to these governments, any collapse in export would cause
more damages than the benefits that were caused by the improvement of environmental
parameters of production. For these reasons, the curves of GDP and carbon dioxide
emissions in low-income countries move in synchrony.
Let us see how these general regularities are manifested in both groups by
comparing the relationship of GDP growth and carbon dioxide emissions in Sweden
and Brazil (see Figure 4.3).

Fig.4.3. Carbon Dioxide Emissions in Brazil and Sweden (kilotons)

per One Billion 1995 USD, 1980 and 2000

Source: World Bank. (2004). Retrieved 1 August 2004 from [Link]

org/data/onlinedatabases/[Link]
I chose to compare Sweden and Brazil for a representative extract of the developed
industrial countries and the newly developing markets. Sweden is among the leaders
in environmental protection, measured in terms of initiative of governmental and
nongovernmental organizations, success in rehabilitation of the environment, volume

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of the financial resources allocated for ecological programs, sponsoring of international

initiatives in the sphere, and so on. Brazil is one of the South American countries
demonstrating the greatest dynamics of industrial and economic growth, with an
expanding internal market and a tangible presence on the international markets.
Brazil was also host to the historic conference of the United Nations Organization
in 1992, which gave impetus to the policy for sustainable development, and Brazil
is still playing the part of one of the catalysts for sustainable development. The
tropical forests in the Amazon valley produce about 25 percent of the planet’s oxygen.
Protection of these forests depends on the environmental expediency of economic
growth in Brazil, including solving the problem of huge emissions of carbon dioxide
from production activities.
Another reason for choosing these two countries is that the structures of their
power industries are analogous in their contribution to carbon dioxide emissions.
As you probably know, in many cases, the power industry based on thermal sources
(oil, natural gas, coal) is the main polluter. In Brazil (2002), electricity is produced,
respectively, by hydropower plants (83 percent), nuclear reactors (4 percent),
alternative sources (solar, wind, biomass—4 percent), and only 10 percent by thermal
sources. In Sweden, the share of thermal sources is also very small—about 4.2 percent.
The nuclear and hydropower plants produced 46 percent of Brazil’s and 45 percent of
Sweden’s electricity in 2002.
No considerable difference exists in the kind of internal combustion engines used
by the transport vehicles in the two countries because the local motor car and other
productions in Brazil are, in their essence, licensed productions, meaning that the
production facilities are owned by leading foreign investors. The efficiency of engines and
their qualities regard the emissions of hazardous substances are very similar in the two
countries. The considerable climatic differences between the two countries, changing the
conditions for production and household consumption, should also be borne in mind.
Sweden consumes a considerable quantity of energy for the heating of corporate premises
as well as for household heating. Under other equal conditions, this presupposes greater
consumption of electrical and other kinds of energy per unit of GDP.
As can be seen from Figure 4.3, however, even with a similar share of thermal
energy sources, the quantity of carbon dioxide emitted during the production of one
billion dollars in compatible prices is different in the two countries. This difference is
390 kilotons in Brazil and 160 kilotons in Sweden in 2000—a correlation of nearly
2.5:1! The tendencies for the changes in the selected parameter for a period of two
decades, from 1980 until 2000, turn out to be in reverse directions. In Sweden, the

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intensity of carbon dioxide in GDP has decreased by 430 percent, or 4.3 times, and in
Brazil, it has increased by 11 percent. The preliminary data for 2001–2003 shows that
this tendency continued in the beginning of the 21st century, as well.
You might be asking about the causes of the differences in Brazil and Sweden’s
growth. Brazil has a considerable share of consumption of “nonelectric power”
produced by fossil fuels—62 percent of the total energy consumption. The country
occupies first place in terms of total volume of energy consumption in Latin America
and third place in the Western hemisphere, after the USA and Canada. Unfortunately,
the country takes a leading place also in regard to carbon dioxide emissions, which,
from 183 million tons in 1980, have increased to 307 million tons in 2000—an
increase of 168 percent. This process has a better-expressed dynamic than that of GDP
growth from 518 to 787 billion USD, or 152 percent. I conclude that the structure
of Brazil’s growth and its technological basis have not been environmentally expedient
and that such branches of production were developed that are characterized by high
energy intensity and high rates of carbon dioxide emission.
For Sweden, the relation of economic growth to growth of carbon dioxide
emissions is entirely different, with a similar structure of the produced GDP and
a similar contribution of industry, agriculture, and services. Synthetically, the
considerably better standing of Sweden with regard to the environmental effects of
growth can be explained by the following peculiarities. First, the creation of higher
added value to a unit of energy and material production resource is preconditioned by
the level of technologies and the product structure. For instance, in the last decades,
Sweden has continued to specialize in the production of steel, as has Brazil, but Sweden
has gradually increased its share of special steel grades; for these special grades, more
energy is required, but the added value is higher than that of traditional steel grades.
The latter leads to lower energy intensity of the economic growth and lower intensity
of carbon dioxide emissions per unit of GDP.
Second, Sweden has a better-developed system of stimuli for application of
energy-efficient and environmentally friendly productions because of its considerably
greater budgetary capacity. Third, the share of expenses for scientific research is
almost 4 percent of GDP, or about three times greater than those for Brazil, which is
reflected in the technological and product renovation and efficiency. It is indicative
that the share of the steel and chemical industries in the emission of carbon dioxide
remained about 14 percent in the period 1980–2000, despite the increased volume of
production. Fourth, the public opinion and the established corporate environmental
culture of Swedish companies are more developed toward environmental expedience

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of economic growth, which is reflected in the entire organizational and managerial

system steel production in Sweden.
Despite Sweden’s improvements and methods, a tendency remains for the
volumes of emitted carbon dioxide and most other environmental pollutants to
increase worldwide. For the period 1980–2000, the carbon dioxide emitted in the
atmosphere increased from 9,156,002 kilotons to 22,994,530 kilotons, or 2.5 times!
The good news about reducing the intensity of this pollution per unit of GDP in
developed countries cannot offset the worrying situation regarding general tendencies
for continued aggravation of environmental misbalance and the unsatisfactory
rates of energy and material efficiency. The accumulation of carbon dioxide in the
atmosphere has already entered a critical zone. We know that the process of carbon
dioxide absorption and neutralization by nature takes centuries, meaning this will be
a problem for many future generations, as well. The same situation exists for heavy
metals emitted, toxic waste, and others.
Current growth continues to deteriorate the overall conditions for life and for
production in conformity with sustainable development criteria. It is necessary for us
to turn economic policy into a policy of sustainable development so that the natural
environment can become an element in the equation into an organic element of this
policy of sustainable development. The achievement of environmental efficiency in
individual countries or a group of countries is insufficient if global indicators keep
on deteriorating; the transformation of economic growth into an environmentally
expedient process can be achieved only through joint efforts, common criteria,
and approaches by common legislative and regulatory bases of the national and
international economic relations.
Solving the problem of the growing quantity of emitted carbon dioxide is related
to the use and reproduction of forests. Besides being sources of timber for the industry,
woodlands are the lungs of the planet, helping to absorb and neutralize harmful carbon
dioxide. Their areas, structures, and conditions are important factors in maintaining
favorable climatic conditions, preserving biodiversity, developing recreation, and
producing tourism. Unfortunately, the current condition of woodlands is a direct
result of centuries of the nonsustainability of growth.
Deforestation in Western Europe is a typical example of the high environmental
price of industrialization. According to data from satellite research published by
the Food and Agriculture Organization of the United Nations (2004), the triangle
between the mountain ranges of the Sudety (Poland and the Czech Republic),
Erzgebirge/Sumava (Germany and the Czech Republic), and Herz (Germany) can be

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called “the black triangle.” Observations in the last three decades show a tendency of
deforestation in high mountain areas caused by climate change, acid rain, and other
negative factors. The same organization estimates the annual loss of forested areas to
about 9 million hectares, or more than 12 percent of the overall woodlands in the
period after World War II.
Drigo’s (2003) analyses state that the Amazon valley, which produces almost 25
percent of the oxygen on the planet, is in one of the most sensitive regions on the
planet. He concludes that in the past three decades, deforestation of the region has
continued at alarmingly high rates because of the expansion of economic activity—the
advancement of market economy. The continuing concentration of economic activity
causes urbanization, which means expansion of the “living space” per capita of the
population at the expense of the natural environment. Unfortunately, such a tendency
aggravates the conflict between economic development and nature. Climate change is
one of the manifestations of this conflict.
In its annual report, the United Nations Environmental Program Agency (UNEP,
2003) points out a number of indicators confirming deforestation as one of the causes
of climate change. Among them is the intensified melting of the Arctic ice sheet. The
tearing off of the Ward Hunt Ice Shelf (a huge mass of floating ice that had been in
place for about three thousand years) from the north coast of Ellesmere Island in the
Canadian Arctic in September 2003 is one of the many confirmations of this process.
Brown (2001a) gives as an example the floods in the Yangtze River Valley in China in
1998, caused by the deforestation that had been going on for decades and destroyed
more than 85 percent of the country’s woodlands. The direct losses caused by the
natural calamity have been estimated at more than 30 billion USD—two to three
times more than the receipts from the razed forests.
Scientists warn that the melting of ice in the Arctic will surely lead to an increase
in average annual worldwide temperatures by 2–4 degrees Celsius and in the levels
of seas and oceans by 5–8 meters until the end of the 21st century. It is clear even to
a nonexpert that such climatic changes would have devastating effects on not only
agricultural production but also on all economic activity and the standard of living.
The heaviest economic losses will be suffered by the small island countries in the Pacific
and the least-developed countries because of the more frequent natural disasters, such
as the increase in the levels of seas and oceans.
The probable losses for countries such as Fiji and Kiribati have been estimated
at 25–35 percent of their current GDPs. Considering that about 80 percent of
the territory of the Maldives in the Indian Ocean and more than three-quarters of

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Bangladesh are at only one meter above sea level, and a considerable part is below it,
imagining the dimensions of such a disaster is not difficult. The increase of sea levels
will not leave developed countries unaffected—whole regions in Northern Europe,
Great Britain, Japan, and North America are in danger of being submerged. According
to data from the Japanese Meteorological Agency (JMA), the sea level around Japan
has been rising since the mid-1980s, and the average sea level in 2003 was the highest
in 100 years.
Similar trends are observed when the dependence between economic growth and
sulfur dioxide emissions is considered. Sulfur dioxide is the main cause of the acid rain
phenomena, which strongly jeopardizes environmental equilibrium and human health.
The data included in the next two figures clearly indicate the relationships between
the quantity of sulfur dioxide emissions with GDP (Figure 4.4) and GDP per capita
(Figure 4.5). I selected one of the Western European countries, the United Kingdom,
for three main reasons. First, this was the most industrialized market economy in
the mid-19th century; the country’s energy production was based mainly on coal,
which has very high sulfur content. Second, this country has very well-established
environmental legislation and is among the leaders in that field within the European
Union. Third, reliable statistical data for the country is available for the past 150 years,
including the beginning of the industrial revolution about 150 years ago.
In the initial period of 1850–1990, which was characterized by the transition
from manufacturing to large-scale industrial production, the absolute amount of
sulfur dioxide emission substantially outstripped the growth of the country’s GDP.
The sulfur dioxide emissions increased by 390 percent from 731 thousand metric
tons in 1850 to 2,870 thousand metric tons in 1990. During the same period, the
GDP (in 1990 purchasing power parity–PPP–dollars) rose from 63 million to 185
million dollars—293 percent. The growth of emissions has been much lower than
the growth of the GDP since the beginning of the 20th century. This means that the
“sulfur intensity” of the unit of growth began to shrink. In fact, the absolute volume of
sulfur dioxide pollutions started to decrease in 1956 from 3,924 metric tons to 3,903
metric tons, or by 21 units. The most dramatic shrink in the volume of pollution took
place in the period 1975–2002, from 2,650 to 1,002 metric tons, or 265 percent.
As shown in Figures 4.4 and 4.5 below, the GDP and the GDP per capita move
in different directions from the volume of the sulfur dioxide emissions. No doubt, such
diverted trends illustrate a mismatch between the trends of the volume of sulfur dioxide
pollution and economic growth. In other words, we witness environmentally friendly
growth during the past few decades, especially in the last quarter of the 20th century.

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Fig.4.4. Trends in the United Kingdom’s GDP per Capita (1990 PPP Dollars)
and Sulfur Dioxide Emissions (Thousand Metric Tons), 1850–2002

* GDP per capita in current dollars.

Legend: GDPC–GDP per capita, Sem–sulfur dioxide emissions.
Sources: Data from Maddison, A. (May, 2005). Historical statistics: Population, GDP
and GDP per capita. Retrieved 27 July 2004 from [Link] Stern,
D. (2004). Sulfur and GDP per capita database. Retrieved 3 January 2005 from [Link]
[Link]/~sternd/[Link]; Global Britain. (2004). Global Britain: Statistics. Retrieved
6 January 2005 from [Link] UK
Department for Environment, Food and Rural Affairs (2004). Retrieved 3 November 2004
from [Link]
I believe that the simultaneous analysis of the observed correlations, including
both the GDP and GDP per capita, is a necessity. A possible decrease of the sulfur
dioxide emissions per unit of GDP wouldn’t be less alarming if the absolute volume
of pollutions were increasing. Fortunately, this is not the case. The pollutions are
decreasing substantially while the GDP is steadily increasing, from both the relative
and absolute points of view.

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Fig.4.5. Trends in the United Kingdom’s GDP (Million 1990 PPP Dollars)
and Sulfur Dioxide Emissions (Thousand Metric Tons), 1850–2002

* GDP in current dollars.

Legend: GDP–gross domestic product, Sem–sulfur emissions.
Sources: Data from Maddison, A. (May, 2005). Historical statistics: Population, GDP
and GDP per capita. Retrieved 27 July 2004 from [Link] Stern,
D. (2004). Sulfur and GDP per capita database. Retrieved 3 January 2005 from [Link]
[Link]/~sternd/[Link]; Global Britain. (2004). Global Britain: Statistics. Retrieved
6 January 2005 from [Link] UK
Department for Environment, Food and Rural Affairs. (2004). Retrieved 3 November 2004
from [Link]
A number of technological, economic, and legislative factors contributed to these
positive effects, especially after World War II. First, an important shift was made in the
energy base of economic growth from coal toward much cleaner and sulfur-free energy
sources, including natural gas and nuclear energy. Second, the coal-based electrical
power stations introduced control technologies as flue gas desulphurization. Similar
control technologies were introduced in the oil refining process, industrial combustion,
transportation, and others. The switch from coal-based to alternative energy sources
proved its cost-effectiveness, keeping in mind the price trends in the world market and
the final cost of the energy production based on coal when the total cost is taken into

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account. (Total cost includes “externalities” and reflects additional payments such as
environmental taxes, fees, charges, import duties, and other incentives.) At the same
time as the switch, the separation of the sulfur from the coal, crude oil, and other
sources enabled the sources’ safe use in other environmentally friendly production
activities, but strong causal relations exist between the pollution abatement and the
economic growth, especially in the long term.
The data illustrated in Figures 4.4 and 4.5 confirm that higher economic growth
does not automatically lead to worsening of the environmental equilibrium. The
appropriate economic policies, the setup of reliable environmental standards and
legislation, and finally, the higher public awareness are capable of securing higher
economic output at a decreasing environmental price. Trends in other developed
countries are very similar, although some peculiarities are caused by the differences in
the industrial structure, the affluence of various energy sources, and so on. For example,
the emissions of sulfur dioxide are constantly declining in Western Europe.1 Their
volume was 8,670.489 thousand tons in 1990 and 3,706.318 thousand tons in 2001,
which is a decrease of nearly 60 percent. Interestingly, the introduction of national
environmental laws and agreements concerning the sulfur dioxide emissions played a
crucial role for the turn of bad trends after 1950. The Oslo Protocol (1994) and the
Gothenburg Protocol are among these decisive agreements. In the UK, various national
legislation initiatives—among them the Clean Air acts (1956, 1968), Environmental
Action Program (1972), Control of Pollution Act (1974), Environmental Act (1995),
and National Air Quality Strategy (1997)—played an important role.
Unfortunately, other countries exist where the economic growth coincides with
the steady growth of sulfur dioxide emissions—the most severe examples being China
and India. In China, sulfur dioxide emissions increased by 30 times in the period
1950–1995, especially in the past two decades, when annual economic growth was
above or about 10 percent. The total sulfur dioxide emissions of the Chinese economy
were 12,849 thousand tons in 1995, or 3.5 times more than the countries of Western
Europe combined. The Chinese energy sector relies heavily on the affluent domestic
coal deposits, and most of the households, even in the large cities, use coal for heating
and cooking.
Although at a lower scale than that of China, Indian sulfur dioxide emissions
reached 2,804.75 thousand tons. This amount is equal to three-quarters of the sulfur
dioxide emissions of the Western European economy. If the dramatic difference in the
volumes of real GDPs is taken into account, we can easily conclude that the sulfur
intensities of the economic growths in China and India are extremely and unacceptably

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high. True, a weak trend of some decline of these emissions has emerged since 1995.
The decline is more visible in China, where the emission decreased by 20 percent for
the period 1995–2000, while in India, the decline was just 3 percent.
According to estimations from the World Bank (2004), the Japanese economy
produced 4,764 billion USD in 2000, which is more than three times higher than
the combined GDP of China (1,081 billion USD) and India (457 billion USD).
Also in 2000, Japan emitted 410 million tons of sulfur dioxides, which is 25 times
below the emissions level of China and six times below the emissions of India.
Simple calculations show that, compared to Japan, both China and India have too-
high sulfur dioxide intensities per one billion dollars of GDP. In fact, the main cause
for that dramatic difference is the structure of the economic growth rather than its
percentage figure. Emerging economies such as China and India may achieve better
environmental standards only if the economic growth is based on purer energy sources
and environmentally friendly and energy efficient technologies. An appropriate
environmental legislation supported with adequate economic incentives for these
countries is a must if international standards are to be met.
Markandya et al. (2004) did an extensive econometric analysis of the correlations
between the GDP per capita and the volume of sulfur dioxide emissions worldwide.
They concluded that the interdependence of GDP per capita and volume of sulfur
dioxide emissions has a typical U-shaped Kuznets curve, illustrating that the relationship
between these two variables is positive only for certain periods of time. Although the
authors apply various precise econometric techniques, including panel regressions and
separate ordinary least squares, the attempt to directly quantify the values of GDP
per capita and the volume of emissions is questionable. It is obvious that, even for
the same country, the relationship is different and often negative for different periods;
however, the countries with the highest GDP or income per capita have lower sulfur
intensities per unit of GDP. It is logical, then, to assume that many other factors
(structural, technological, legal and so on) contribute to this relationship.
I consider it inappropriate to measure any dependence between the unit of
income and the unit of any pollutant because income results from these factors and
conditions rather than being a factor for the determination of the pollutions. The
available data for countries within the same range of income per capita confirms that
substantial differences exists in the volumes of the countries’ emissions of pollutants,
including carbon dioxide or sulfur dioxide. Germany’s GDP was 42 percent higher
than that of France in 2000, the GDP per capita was higher by 3 percent, and the
sulfur dioxide emissions were higher by 3 percent. This is a good illustration of the

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differences between two EU member countries with similar incomes per capita
and similar levels of economic development. These countries are producing under
common or similar environmental standards but, nevertheless, have different volumes
of pollutant emissions.
Germany emitted 416 thousand tons of sulfur dioxide in 2000, while France
emitted 341 thousand tons in the same year or 18 percent less. The main difference
between the countries is the structures of the energy sectors. The French economy
relies much more on sulfur-free nuclear power while Germany still utilizes its vast
reserves of coal, which secure 23 percent of its energy source needs. In comparison
with the other fossil fuels, coal has the highest sulfur content. The determining factor
for the volume of emissions, then, is not the level of income but the used energy
sources and applied technologies.
Similar to those of carbon dioxide, sulfur dioxide emissions have transboundary
characters; the acidity caused in one country appears as acid rain and acid deposits in
neighboring countries. The Czech Republic is among the most industrialized nations
in Eastern Europe. Unfortunately, this country has one of the highest acid deposition
levels in Europe. At the end of the ’90s, the annual emissions of sulfur dioxide were
440 thousand tons. Half of the emissions are transported to nearby countries: Poland
(39.2 thousand tons), Germany (20.6 thousand tons), Russia (15.1 thousand tons),
Ukraine (10.4 thousand tons), and others. At the same time, the Czech Republic
receives about 97 thousand tons of sulfur dioxide emitted from Germany (31.3
thousand tons), Poland (28.9 thousand tons), and other countries. The comparison
between the emitted and received quantities shows that the Czech Republic is a net
receiver of this type of pollutants.
The economic effect of these acid depositions is substantial. Today, more than
52 percent of the Czech Republic’s trees are classified as moderately to severely
damaged, and nearly 100,000 hectares of forests are lost. Some additional losses have
been caused by contamination of underground and surface water and by accelerated
corrosion of buildings and the infrastructure. No doubt, the acid depositions worsen
the conditions for economic growth and increase its environmental price, including
the damage on human health.
In 2000, the sulfur dioxide emissions in the Czech Republic were twice as
low as the 1990 emissions. This positive trend is mostly because of the substantial
losses of GDP and much lower industrial output cause by the transition toward a
market economy. The Czech Republic is a typical example of what happens when
the deterioration of the indicators from the social and economic dimensions of the

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sustainable development are accompanied by the improvement of the indicators in

their environmental dimension. One cannot rely on that causation because the country
has recovered from the structural stress and the economy is gaining momentum
again. With full membership in the EU, the Czech Republic’s industry is restoring
its growth capacity, and therefore, the danger of restored polluting trends is not to be
underestimated.
It is telling that the net balance of sulfur dioxide exchange between the Czech Republic
and Poland is 10,000 tons more received pollutions from Poland. This information
is an important indicator because the Polish energy sector is heavily dependent on its
domestic coal reserves. The combined hard coal and lignite coal secure about 60 percent
of the primary energy sources, and this percentage is expected to remain the same until
about 2012–2015. Despite this fact, the Czech economy produces and transports more
sulfur dioxide toward Poland because of the Czech economy’s relatively faster recovery
and more successful adaptation to the new market conditions.
We may expect that the acceleration of the economic growth in these countries
may cause further increase of carbon dioxide and sulfur dioxide emissions.
Nevertheless, a number of factors may secure the fulfillment of a different, more
optimistic scenario. The signatories of the United Nation Economic Commission
for Europe (UNECE) Protocol for “Further Reduction of Sulfur Emissions” (1994),
including all Eastern European countries, took the obligation to substantially
reduce these emissions toward their 1980 level. According to this protocol, the
Czech Republic must decrease its emissions by 72 percent by 2010. The EU
enlargement toward the east eased the transfer of technologies and knowledge and
improved the conditions for capital and production allocation. The environmental
legislation of the EU is among the most developed in the world, and it will give
additional pressure for further technological innovation, better energy, and resource
efficiency in new member states. From that point of view, the decline of polluting
emissions is more a regional agenda than a national objective. Only collective and
well-synchronized measures may develop the appropriate conditions for high and
sustainable economic growth.
Desertification2 is among the greatest challenges ensuing from the inadequate
interrelation between man and nature. Deforestation and the use of inadequate
methods of irrigation and cultivation lead to physical, chemical, and biological
changes in the soil, which then loses its fertility (for more detail, see Lal et al, 2004).
These changes are caused by salinization, wind, and water erosion, which lead to a loss
of organic material. Some researchers and specialists claim that desertification and the

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collapse of agriculture have been among the crucial factors for the disappearance of
many ancient civilizations, such as that in Mesopotamia.
The present model of growth is inadequate also with regard to the sustainable use
of water resources. The fate of the already-dead Aral Sea in Central Asia is one of the
most vivid examples for the fatal consequences of growth when it is not coordinated
with ecological principles. In the time of the Soviet Union, the water from two
rivers—Amu Dar’ya and Syr Dar’ya—flowing into the Aral Sea, was diverted for
irrigation of the expanding cotton plantations, which provided considerable receipts
from export. After several decades, the level of the sea decreased by 50 percent and
the restricted inflow of fresh water caused a sharp increase in the concentration of salt
and, therefore, the death of most organisms in the sea. From a wonderful nook of
nature and a favorite place for fishing, recreation, and tourism, the Aral Sea became a
monument of humanity’s irresponsibility.
Deforestation is another example of the catastrophic outcomes of economic
growth that does not meet the criteria for sustainable development. UNEP (2003)
estimates direct annual worldwide losses from deforestation at about 42 billion USD,
including 5 billion in North America alone. The indirect losses are even greater
because they include the losses from nonproduced foods—a curbing of agricultural
production. The annual costs for stopping deforestation are estimated at some 10–22
billion USD, meaning that the expenses for preserving forests are twice as low as the
monetary losses from deforestation. Therefore, deforestation is not acceptable both
from environmental and economic point of view.
Economic growth and the concomitant urbanization exert a strong pressure on the
natural environment, including renewable resources. I would like to mention before
we go on—as I have briefly mentioned in a previous chapter—that “renewable” does
not mean nondepletable under all kinds of conditions. If, for instance, the volume of
resources used exceeds the resource’s natural regeneration, the resource may become
deficit and block growth. The Earth Policy Institute (2003) analyzes the condition of
China’s water tables. As is well known, China is divided in two zones—a southern part
that has a population of about 700 million people, one-third of the nation’s cropland,
and four-fifths of the nation’s water resources. The northern part of China has a
population of about 550 million people and it has two-thirds of the total cropland but
only one-fifth of the nation’s water resources. The capital, Beijing, is in the northern
part of the country; the water tables of the north have decreased by 59 meters below
their 1965 level as a result of the industrialization and urbanization of the region and
the increased consumption of groundwater (Brown, 2001b).

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Because of the accelerated increase in the consumption of groundwater, the

water table levels continue to decrease by 1.5 meters per year. Demographic forecasts
indicate that, by 2010, China’s population will increase by 126 million people above
the population of 2000, which means a leap in the consumption of water for household
purposes from 50 billion to 60 billion cubic meters. The World Bank (2004) expects
the industrial demand to also increase by more than 60 percent from 127 billion cubic
meters to 206 billion cubic meters of water, but a sufficient quantity of water does not
exist in the region so as to meet such a demand, even with deeper probing for water.
In such a case, the government will have to choose between meeting the population’s
demands for potable water and meeting the demands of agriculture and industry for
an increase of production. This dilemma is exceptionally hard to solve because short-
term political goals will probably tip the balance in favor of the population of large
urban centers, but the losses for production will turn out to be unbearably great.
Another peculiarity of the situation is that plant growing provides a living for
hundreds of millions of Chinese, and great unemployment will hardly prove a good
alternative to the deficit in foodstuff production. In this case, the solution to the
conflict between economic growth and natural resources should be sought in the
new technologies for production and in gaining command over the processes of
urbanization and excessive demographic growth. Otherwise, the limits of growth will
turn into the growth of limits.
The huge population of China needs not only water but also foodstuffs and other
consumer goods for household purposes. Brown (2001b) has concluded that the rate
of return on the use of one ton of water in industry is seventy times higher than that in
agriculture, but, obviously, many other factors will influence the decision-making process
concerning water’s end use. The problem in China is that the technological advancement
in agriculture falls very much behind the growing demand for grain. This forces the
producers of wheat and maize to continue to rely on irrigation for achieving satisfactory
yields instead of staking on genetic engineering and contemporary agronomy.
Only 30 percent of China’s grain-producing areas are cultivated without irrigation,
whereas in the USA, irrigated areas account for only 15 percent of grain production.
The production of wheat in China continues to decline, although demand is growing.
In 2001, 93,876,234 metric tons of wheat was produced, whereas in 1995, the volume
of production was 102,211,429 metric tons. Wheat production was greater than that
of 2001 even in 1990, at 98,231,940 metric tons.
China is trying to overcome its backwardness in technology; scientific and
applied research in agriculture; and labor productivity that is lower than in developed

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countries by using greater water resources. This compensatory mechanism has its
physical limits, however, and these limits continue to shrink and cause other structural
and social problems. Whereas the irrigated areas for grain production are decreasing in
countries employing up-to-date technologies, they continue to grow in less-developed
countries at rather high rates. In 1950, these irrigated areas were 94 million hectares;
in 2000 they reached 272 million hectares—a threefold increase. In the beginning
of the 21st century, more than 40 percent of China’s grain-producing areas rely on
irrigation facilities.

Economic Effects of Dwindling Pollution

The ratification or nonratification of a particular international agreement for
environmental protection is an economic, and not so much a political, decision. The
Kyoto Protocol from 1997 for stage-by-stage reduction of carbon dioxide emissions is a
good example of the problems of solving the conflict between environmental objectives
and the economic price for their achievement. Naturally, the countries that are the biggest
polluters would be the most affected by such environmental protection. The United
States is responsible for almost 40 percent of total worldwide carbon dioxide emissions,
which, according to the experts, is the main factor for the global warming effect and the
climatic changes affecting the whole planet, which also have some economic dimensions
of their own. Two subsequent governments of the United States have refused to ratify
the agreement, thus blocking its implementation. The reason for this does not lie in
neglect for the condition of the environmental balance, but rather in the unwillingness
to bear its cost expressed in loss of GDP and hence in slowing down of growth.
My analysis of the relation between the decrease of carbon dioxide emissions
and economic growth is based on the information published by the US Energy
Information Administration (2004). This publication systematizes the results of the
application of several econometric models prepared by the National Energy Modeling
System, Charles River Associates, the Pacific Northwest National Laboratory, the
Massachusetts Institute of Technology, the Electric Power Research Institute, and
Data Resources, Inc. Two main scenarios underlie the projections about the dynamics
of economic growth and the related emissions of carbon dioxide. The first projection
suggests the reduction of carbon dioxide emissions in 2020 compared to 1990 by
7 to 14 percent, with any “side factors” such as a possible benefit of sinks, offsets,
and permit trading on the world market being excluded. It is also assumed that the
reductions in carbon intensity of the American economy will be between 24 and 29
percent in 2010 from 1990 and from 32 to 39 percent in 2020 from 1990.

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The effect of carbon dioxide emission reduction is measured by the loss of

GDP. In the medium run—from now until 2010—this cost varies within 265–295
USD GDP loss for each metric ton of reduced emissions, depending on the various
projection models. In the long run, until 2020, this loss will grow to 316–360 USD
per ton. Only the projections of MIT are considerably more optimistic, with a 147
USD loss per metric ton in 2020, which is an almost two-and-a-half time below the
rest of the forecasts. Leading experts from MIT expect that the implementation of
qualitatively new low-carbon or carbon-free production will take place in the near
future. Because of the low price of tradable permits3 compared to losses from emission
reduction—109 to 129 USD per ton against 265 to 298 USD per ton—the US will
prefer to purchase tradable permits from the international market over the domestic
market. The expected volume of these tradable permits amounts to an average of
111–250 millions of metric tons per year.4
The loss estimates expressed in terms of value and percentage show considerable
discrepancy because of the strongly prognostic nature of the underlying data and the
influence of most of three parameters: the expected economic growth, the price of
tradable permit per one metric ton of carbon dioxide, and the rates of implementation
of replacement technologies. All experts take into consideration the need for purchasing
tradable permits because of “irreducible losses.” The latter are expected to reach 60–94
billion USD in 2010 and 75–130 billion USD in 2020. The US losses from ratifying
the Kyoto Agreement would amount to about 4 percent of the nation’s GDP in 2010.
This value is subject to discussion, not only because of the provisional nature of the
initial data used for the projection, but also because of the manner of accounting for
the direct and indirect losses.
Determining indirect losses is more problematic than determining direct losses
so far, as indirect losses include so-called macroeconomic losses generated in the
process of adapting the whole economy to the changing conditions of production
and consumption. It is believed that these losses are in fact 3–4 times higher than the
direct losses. Such a volume of losses means a zero, or even negative, economic growth
in the period until 2010, and even until 2015. This explains to a great extent why
American administrations refrain from ratifying this international agreement. At this
stage, the refusal of the US to ratify means that it would not be possible to curb the
levels of atmospheric carbon dioxide pollution.
We can use some results of the above-quoted Pacific Northwest National
Laboratory and MIT research to identify some general relationships between growth
and pollution, as well as the specificity of their manifestation for the various groups of

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countries. Undoubtedly, the “environmentalization” of growth has some conflicting

economic effects, both positive and negative. The positive economic effects can
be direct and indirect. The direct positive effects can be said to include the more
complete or thorough utilization of resources in waste-free technologies or energy
production technologies, which leads to a decrease in costs per unit of production and
higher price competitiveness. The production costs decrease because of the lower or
nonexistent environmental charges and possibly because of some additional revenues
from target subsidies.
Another direct positive effect is the easier access to international markets that is
brought about by the higher environmental standards introduced by the World Trade
Organization. The indirect positive effects on growth include fewer costs for rehabilitation
of the environment, stabilization of climatic conditions, cleaner agricultural production
(better priced and healthier), household power consumption and tourism, lesser expenses
for healthcare, a decrease in the dependence of growth on nonrenewable resources
(placing growth on a long-term, sustainable basis), and so on.
If other conditions are equal, a linear dependence exists between the cost of
curbing harmful emissions and the dynamics of growth. The greater the dynamics are,
the higher the cost. This means that the economic burden of curbing pollution will
be greater for countries having higher economic growth, but the conditions are not
equal for various groups of countries. Unfortunately, the economic losses for the less-
developed countries will be greater, and, for some of them, even beyond their abilities,
without some international financial and technological assistance. The main reason is
the lower technological level in these countries; for the production of one ton of steel,
cement, or synthetic fertilizers, less-developed countries generate a bigger quantity of
harmful emissions than do more-developed countries.
The same applies to the production of energy, which has a higher level of
consumption per unit of production. What is more important in this case is that less-
developed countries’ capacity for technological innovation is far more limited because
of their shortage of convertible currency, huge foreign debts, financial instability, low
levels of scientific and technical applied research, political instability, insufficient
foreign investments, and so on. Technological innovation is especially important for
developing countries. Many of these developing countries do not have energy and
material sources of their own, and their production depends on their imports. The
tendencies are for rising prices of all nonrenewables in the medium run and long run
in developing countries. For some of them, this already has become a lasting tendency.

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The difference in the efficiency of production will make these high prices even more
“forbidding” for third world manufacturers.
In this situation, the countries will find themselves incapable of applying some
flexible fiscal policy for environmentally friendly production because of the high
production costs. In other cases, the abrupt increase in prices of oil, natural gas, or
both makes the relative prices of coal lower. History shows that in such cases, the
structure of energy consumption would change in favor of the cheaper energy sources,
but the environmental indicators would deteriorate badly.
Does this mean that the blocked the growth of these countries has been
predetermined? I don’t think so. This conflict could be overcome with an adequate
fiscal, monetary, trade, and investment policy; these changes could be effective
if some qualitative modifications were made in the “new economic order.” The
developing countries, which have for decades been in the trap of their foreign
debt and in the periphery of the investors’ interests, are not and will not be able
to coSpe with this challenge.
To the costs of putting growth on an environmentally friendly basis should be
added costs for scientific and applied research, renovation of out-dated technologies
before their depreciation period has expired, development and application of systems
of legal and regulatory restrictions, financial provision of budgetary incentives,
qualification of personnel, alternative energy and raw material source provision, and
others. These costs may seem like a lot, but the environmentally friendly growth of
GDP brings some especially important economic advantages:
Achieving a closed cycle of production means eliminating energy and waste
materials losses;
Multiplying the effect of production and reducing production costs in the medium-
and long runs;
Saving natural resources (especially nonrenewable resources) and ensuring sufficient
availability for future generations;
Improving market positions in view of the increasing tendency for preferential
trade conditions for environmentally clean production and products;
Saving from nonpayment of charges and environmental pollution fines;
Reducing costs for environmental restoration;
Improving the environment for labor and living while also reducing expenses for
healthcare.

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Challenges before the Economic Growth in the Agrarian Sector

Agriculture is a specific sector of a national economy. The volume and quality of
agriculture’s end product depends on the intertwining of natural (climate, soil fertility,
forests, water resources, natural calamities, and so on), biological, and production
factors. The two main branches of agriculture—plant growing and stockbreeding—
are interrelated. The demand for agricultural production continues to grow because
of demographic growth and increases in purchasing power. Unlike other kinds of
production, agricultural production varies within not very flexible natural factors, in
the sense that any deficit in these factors cannot be offset by more human or financial
capital. Undoubtedly, one of these crucial factors is fertile land.
The processes of industrialization and urbanization of the population lead to
losses of millions of hectares of fertile land. This process continues, despite efforts to
impose administrative restrictions and apply economic incentives for the adequate use,
conservation, and preservation of fertile land. Despite the assumption that the loss of
these areas is, to some extent, an inevitable and logical result of the development of
industry, the losses of fertile land caused by ecologically inexpedient industrial production
can and should be terminated. Today, more than one billion people are directly affected
by the loss of fertile lands, and Saharan Africa remains the most threatened region, where
the desertification and extreme poverty are in constant aggravating interrelation. The
exhausted soil makes farmers poorer and poor farmers are forced to keep using the soil
in a manner that has nothing to do with sustainable development.
The highly developed countries have not been spared, either. In the United States,
the greatest world producer of agricultural products, desertification started to manifest
itself as early as the 1930s, during the Dust Bowl, when tens of thousands of farmers
were forced to leave the Southwest Great Plains region. Today, the same fate threatens
China, which, if it does not take some timely measures, risks losing hundreds of
thousands of hectares of fertile land. The consumption of a 5,700-kilometer-long
protecting green wall was commenced, which should stop the expansion of the Gobi
desert that takes away some 4,000 square miles of arable land each year. The wall is
expected to protect the agriculture in broad regions from collapsing, which ensures the
balance of foodstuffs for the country. The planting of such a green belt will be at the
expense of about 10 percent of the arable land, but such a tradeoff effect is worth the
effort because ultimately, a many-times-greater area of arable land will be saved.
Achieving balanced growth presupposes maintaining certain sector and
production proportions in accordance with the changes in market demand. The
proportion between demand and production of foodstuffs is of special importance,

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especially considering the fact that the earth’s population continues to grow and its
feeding becomes more and more difficult. The peculiarity of agricultural production
is such that the production of grain is of crucial importance so far as it has a direct
relation to the production of animal foodstuffs.
For thousands of years, the increase in agricultural production resulted chiefly from
the expansion of cultivated land. In the second half of the 20th century, the main factor
in the increase was the productivity of labor because of (1) the physical exhaustion of the
possibilities for cultivated land expansion and (2) the leap in agricultural technologies.
Cultivated land is shrinking as a result of urbanization, the consumption of industrial
facilities on arable land, and the fast expansion of infrastructure.
In the past forty years, Japan has lost almost 60 percent of its arable land; South
Korea, about 50 percent; and Europe, about 35 percent. In some countries, part of
the cultivated land is “voluntarily” taken out of the production process to prevent its
complete erosion and degradation in those areas where this process is already at an
advanced stage; for instance, in 1985 the American Congress ratified the Conservation
Reserve Program (CRP), which comprises approximately 45 million hectares of
cropland that will be planted with woods, grass, or both. Obviously, meeting the
growing demand by further increasing the seeded areas will be impossible, simply
because the possibilities for this have already been exhausted.
Is it possible for this purely physical restriction to be offset by higher productivity
of labor per unit of area? The answer is moderately pessimistic: The intensive factors
of growth in agricultural production also have threshold limitations. The average
yield of a unit of grain land increased by 1.6 times in the period 1950–2003. Of
interest is that the productivity growth in this period is nonlinear. In the first four
decades of the period, average yield was slightly more than 2 percent per year,
whereas in the past 10–15 years, it has decreased to 1 percent. The initial high annual
growth is the result of a number of achievements in the development of agriculture,
including improvements in the selection of seeds and the creation of new varieties,
new soil cultivation technologies, the introduction of the rotation-of-crops principle
(alternating the cultivation of various grain foods on the same area from year to year),
the mass use of synthetic fertilizers and pesticides, the technical leap in the agricultural
machinery and equipment used, the preferential economic conditions for the farmers
in developed and some developing countries, the turning of grain production into a
state policy, and the establishment of a unified world market.
The mass use of synthetic fertilizers after World War II was one of the key factors
for the sharp increase in land fertility. Now, in the beginning of the 21st century, annual

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world consumption of synthetic fertilizers reaches up to 140 million tons, which

constitutes a 1,000 percent increase compared to 1950, but the reverse tendency for use
of fertilizers can be observed. What causes this tendency? First, the positive dependence
between the quantity of fertilizers applied and the fertility of soil has a maximum limit
determined by the physiological limits of the plants grown. In other words, the rate of
return limit is very much decreased, possibly even becoming negative, above certain
quantities of fertilizers. In addition, the possibilities for substantial improvements in
plant varieties have been exhausted to a considerable degree, considering that the natural
and climatic conditions for growing these crops have also been deteriorating because of
global warming, acid rain, insufficient water resources, and so on.
Second, hundreds of millions of farmers from developing countries do not
have, and are not expected to soon gain, access to the technical and technological
achievements of agrarian science. In other words, the lack of economic access to
the achievements of agrarian science does not provide grounds for optimism about
substantial labor productivity increase in the developing countries. In addition, a
tendency can be observed toward depopulation of agricultural regions because of
high migration toward the big industrial centers and because of the degradation of
cultivated lands. The very fragmentary nature of land in developing countries does
not enable the implementation of modern farming due to the absence of conditions
for the effect achieved by the scale of production.
Third, consumer pressure in favor of ecologically clean foodstuffs is gaining
strength, especially from the markets of highly developed countries. It is well-known
that the excessive use of synthetic fertilizers and pesticides changes the chemical and
genetic composition of products along the whole chain of foodstuffs—grain, meat,
milk, eggs, and so on. Commercial standards regarding the import and export of
foodstuffs are also becoming higher, as is the policy of the World Trade Organization.
Consequently, the more ecologically clean a product is—that is, the less “chemistry” it
contains—the greater its chances for realization
Although it is still very small, the share of organic agriculture—developed mainly
on the basis of natural, and hence, environmentally sound production factors—is
growing. In 2002, the sales of agricultural products from approximately 24 million
hectares of organic areas reached 23 billion USD, and they continue to grow. The
greatest realization of organic agriculture’s market share is in Europe and North
America, because the productivity in the use of organic methods is considerably
lower, which makes the price per unit of production higher. It is logical to expect that
the demand for such organic products will be highest in the countries with higher

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incomes. This tendency has an effect of internal contradiction from the viewpoint
of sustainable development. First, the expansion of these croplands at the expense of
chemically intensive production cannot but shrink the volume of output in the short-
and medium run, which would further aggravate the disproportion between supply
and increasing demand. Even an increase in the current deficits of foodstuffs can be
expected because all this will affect stockbreeding, as well.
Second, the average level of price for the consumer will increase, under equal
other conditions, because of the increasing share of the more expensive production.
Third, such a development makes the situation of the lowest-income population in the
developed, and especially developing, countries more difficult, particularly considering
that even now, more than a million people suffer from starvation worldwide.
Organic production’s expansion and the demand for such products will not
have a one-sided effect on developing countries. In some of them, the share of this
production is traditionally high. The reason for this does not lie in any advancement
of their production toward sustainability or in any increase in the environmental
and health standards, but simply in the fact that the farmers cannot afford to buy
fertilizers, pesticides, and genetically modified seeds. Because of this, data on the share
of worldwide organic production should be accepted selectively, with consideration of
the particular levels of development in the various countries and geographic regions.

Fig.4.6. Total Area under Organic Management, by Continent, 2003 (Percent)

Legend: AU–Australia and Oceania, AF–Africa, AS–Asia, SA–South America, EU–

Europe, NA–North America.

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Source: Primary data from Organic Agriculture Worldwide (Germany). (2004, February).
Survey. Retrieved 7 July 2004 from [Link]
Only 5.7 percent of North America’s croplands are used for organic agriculture,
which is about seven times less than the level of Australia and four times below the
level of Latin America. In the European Union, before its expansion in 2004, only 3
percent of the areas were cultivated in this environmentally sound way. The dynamics
of increase of these areas—42 times—for a period of fifteen years (1985–2000) is
impressive. In fact, this increase is due to the quite low initial levels. In terms of
absolute dimensions, Australia takes the leading place (10,000,000 hectares), followed
by Argentina (2,960,000 hectares), Italy (1,168,212 hectares), and the US (950,000
hectares). I expect that in the medium run, a gradual change in the share of foodstuffs
produced on organic farms will take place and that this restructuring will happen at a
rather high pace in industrially developed countries. I do not believe this process will
have any material impact on the world balance of foodstuffs because the change will
take place slowly enough to create possibilities for adapting the economic system.
The possibilities for growth of grain production may have been exhausted for
several reasons: the biological maximum of productivity has been reached; the soil
has reached maximum saturation with synthetic fertilizers; the expansion of seeded
areas is physically impossible; problems exist with climatic conditions, expressed in a
tendency for global warming; and a disturbed balance exists between grain production
and environmental systems. The disturbed balance includes excessive chemical
saturation of the grain and the risks for the health of the people consuming the
product, faster exhaustion of the soils and their physical and chemical degradation,
destroyed woodlands for expansion of the areas for grain production, and so on.
Given this information, a question arises about how and under what conditions balance
can be achieved between the increasing consumer demands for foodstuffs, particularly
grain and animal products (meat, eggs, milk, leather, and so on) and the industry’s
productivity levels. A direct relationship exists between the production of grain and the
production of animal products. The development of stockbreeding and the feeding of the
animals take place through the provision of pastures, using grain and grain products for
feeding, or a combination of both. The physical possibilities for expansion of pastures have
been exhausted for reasons already discussed. No reserves exist for their further expansion;
rather, no economic and environmentally expedient reserves exist.
According to data from the World Watch Institute (1998), the production of meat
has grown five times in the past 50 years and exceeds 211 million tons per year. The
demand for meat continues to grow with the growth of income in the developed and

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emerging economies. The problem is how an adequate supply of meat can be ensured
when the increasing meat production requires an increase in the share of grain, which,
instead of going for direct consumption, would be redirected to the production of
meat products. A different quantity of grain is needed for the production of one
kilogram of each type of meat—veal (7 kilograms), pork (4 kilograms), or chicken
(2 kilograms). The tendencies underlying the development of consumer demand and
the potential of supply presuppose adoption of an adequate policy regarding (1) the
structure of growth in grain production and meat production and (2) proper modeling
of the volume and structure of the demand of the two interrelated groups of goods.
In general, the direct consumption of grain is most effective from the viewpoint
of the provision of foodstuffs for the widest possible social basis (the quantitative
relation of raw material to end product is practically 1:1). The increased consumption
of meat, however, is related to the increased purchasing power of particular social
groups. The classical price mechanisms cannot solve the problem with the conflict
between the too-fast growth of demand for meat and the supply of meat.
The increased prices will not cause restructuring of the use of grain products but
will rather make consumption of meat products a privilege of the social strata having
sufficiently high incomes. Even now, the average consumption of meat in industrial
countries is 72 kg per person (123 kg per person in the USA) and only 24 kg per
person in developing countries, meaning the average relation is 3:1. Any further
restructuring of consumption toward an increase in the specified relation 3:1 is by
no means sustainable because it will make the provision of food for the population in
less-developed countries considerably more difficult.
The environmental effects are not to be underestimated, either. Unfortunately,
stockbreeding has an intensely negative effect on the natural environment in the
environment’s contamination with waste products. In the research mentioned earlier
by the World Watch Institute, an example is given that one large-scale pig-breeding
complex in the state of Utah (US) that is built on an area of 50,000 acres produces more
harmful wastes than the city of Los Angeles. Consequently, the proper management of the
consumption structure could bring some desirable changes in the production structure
and, at the same time, could alleviate the pressure on the environmental system.
I have chosen to discuss just a few aspects of the dependencies between economic
growth and the natural environment, but these aspects illustrate sufficiently the
growing complexity of the problems that growth is facing and the acute need for
changes in its model. It is worth encouraging some changes in the interaction with
environment and the modification of the end products, thus making possible some

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improvement in the energy intensity and the resource intensity of growth, and thus
also in its negative effects on the environmental equilibrium. These positive changes
are quite insufficient in terms of scope and intensity of application, however; often,
the various tools of the investment policy are contradictory, and the end effect is
compromised.
It can be said that we are witnessing in a number of economic sectors or
in individual countries the serious limits of growth and the growth of limits
simultaneously. The earlier this vicious circle is broken, the lower the price for
achieving sustainability of growth will be. Enough positive examples of the way out of
the aggravating contradictions exist, and one of the most vivid is the establishment of
“eco-industrial complexes.” The creation of industrial complexes with higher energy
and material efficiency and zero waste emissions is among the greatest challenges in
the organization of a new type of growth model.
Eco-industrial complexes thoroughly change the model of interaction between man
and nature to an interaction that saves resources and is environmentally friendly. The
purely technical “deciphering” of this new growth model follows. The waste products
from the intermediate or end production of a certain company will be used as feeding
stuff for the production process of another company of the eco-industrial complex; the
product thus produced is designed so that it can be recycled or regenerated for multiple
uses. Is the creation of such complexes a utopia, or is it a prospective development
direction that conforms to the sustainable development objectives?
The answer to this question may lie with the eco-industrial complex in
Kalundborg, Denmark, which has been experimenting successfully for twenty years
with the complete utilization of byproducts included in a common technological line.
The complex includes companies producing cement, gypsum wallboard, oil refinery,
power plant, pharmaceutical products (insulin); numerous local farmers; and a fish
farm. To date, more than 25 such eco-complexes have been created worldwide, with
their numbers rapidly increasing. Of course, the construction of more complexes
can and must be quickened through the creation of appropriate conditions and the
respective fiscal, monetary, and legal incentives.
Many leading world companies apply appropriate measures for taking their
business activity on the rails of sustainability. Xerox, for example, buys back or leases
back the copy machines that it offers so that it may recycle, modify, and introduce
them for use once again through the same or other users. It is impressive that only 5
percent of the equipment returned in 2000 was not recycled because of its complete
physical wear or impossibility to be modernized according to new standards.

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The eco-industrial complexes are still limited in number in the global economic
system, but, they do prove the enormous potential for combining the environmental
expediency of growth with its purely economic efficiency. The main task now is to find
a way to adapt this positive experience to the countries with a different production
structure and different access to one or another kind of natural resources. In any case,
the market economy cannot and will not solve the described contradictions on its
own. The transformation of the entire world economy into an eco-industrial complex
is, undoubtedly, a difficult goal that can be achieved only if an adequate social and
economic policy is carried out, integrating the environmental norms and standards.
The contradiction between economic growth and ecology is deepening despite the
substantial improvement in production technologies and the appropriate environmental
and technical standards. As discussed earlier, the main cause of these contradictions is the
very essence of the market economy: Often, profit maximization objectives are fulfilled
at the expense of the environment. Unfortunately, the environment is not a part of the
market equation. A complex of regulative instruments is necessary for the softening and
elimination of that contradiction. Some of these regulative instruments, both market-
and nonmarket-based, will be matters of concrete analyses in the next two chapters.

References
Brown, L. (2001a). Eco-economy: Building an economy for the earth. New York: W.W. Norton.

Brown, L. (2001b). Falling water tables in China may soon raise food prices everywhere. Earth Policy
Institute. Retrieved 7 February 2004 from [Link]

Drigo, R. (2003). Population dynamics and the assessment of land use changes and deforestation. Retrieved
17 March 2005 from [Link]

Earth Policy Institute. (2001). Raising land productivity. Retrieved 12 August 2004 from [Link]
[Link]/Books/PlanB_ch8_landprod.pdf

Food and Agriculture Organization (FAO). (1999). SD dimensions: Forest decline assessment and monitoring.
Retrieved 17 September 2004 from [Link]

Food and Agriculture Organization (FAO). (2004). Agricultural production-Crops primary. Retrieved 1
August 2004 from [Link]

The Gully. (2000). The US cut greenhouse gasses? When pigs fly. Retrieved 4 November 2004 from http://
[Link]/articles/2000/4th/[Link]

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Japan for Sustainability Digest. (2004, August). Japan’s sea level highest in 100 years. Retrieved 11 August
2004 from [Link]

Lal, R., Sobecki, T. M., Iivary, T., Kimble, J. M., & Lal, R. (2004). Soil degradation in the United States:
Extent, severity and trends. Boca Raton, FL: CRC Press.

Markandya, A., Pedroso, S., & Golub, A. (2004, January). Empirical analysis of national income and sulfur
dioxide emissions in selected European countries. Working paper. Milan: Fondazione Eni Enrico Mattei.
Retrieved 3 February 2005 from [Link]

Rodole Institute. (2004). The New Farm. Retrieved 25 February 2005 from [Link]
[Link]/international/news/020104/2.23.04/world_acreage.shtml

Smulders, S., & Gradus, R. (1996). Pollution abatement and long-term growth. European Journal of
Political Economy, 12, 505–532.

Stern, D. (2004). Global sulfur emissions 1850-2000. Retrieved 3 January 2005 from [Link]
edu/~sternd/[Link]

United Nations Environment Programme (UNEP). (2003). UNEP annual report. Retrieved 6 February
and 1 June 2004 from [Link]

United Nation Environment Programme (UNEP). (2004). UNEP annual report. Retrieved 8 April 2004,
from [Link]

US Energy Information Administration. (2004). Comparing cost estimates for the Kyoto Protocol. Retrieved
28 October 2004 from [Link]

US Environmental Protection Agency. (2004). Conservation. Retrieved 5 December 2004 from http://
[Link]/ebtpages/[Link]

Weiss, H., Courty, M. A., Wetterstrom, W., Guichard, F., Senior, L., Meadow, R., et al. (1993). The
genesis and collapse of third millennium North Mesopotamian civilization. Science, 261, 995–1004.

World Bank. (2003). World development indicators 2005. Retrieved 21 November 2004 from [Link]
[Link]/data/wdi2005/index

World Watch Institute. (1998). United States leads world meat stampede. Retrieved 4 September 2004
from [Link]

World Watch Institute. (2004). State of the World 2002. Retrieved 13 August 2004 from [Link]
[Link]?pubs/pdf/

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Notes
1
The Western European region includes Austria, Belgium, Cyprus, Denmark, Faeroe Islands, Finland,
France, Germany, Gibraltar, Greece, Iceland, Ireland, Italy, Liechtenstein, Luxemburg, Malta, Monaco,
the Netherlands, Norway, Portugal, Spain, Sweden, Switzerland, European Turkey, and the UK.
2
The UN Conference on Desertification in 1997 defines desertification as diminution or destruction of
the biological potential of the land, which can lead ultimately to desert-like conditions.
3
The European Environment Agency defines tradable permits as “An economic policy instrument
under which rights to discharge pollution or exploit resources can be exchanged through either a free
or a controlled permit-market. Examples include individual transferable quotas in fisheries, tradable
depletion rights to mineral concessions and marketable discharge permits for water-borne effluents”.
See for more detail EEA (2005). Tradable permits. Retrieved 3 June 2005 from [Link]
[Link]/EEAGlossary/T/tradable_permits

4
The essence and mechanism of the emissions tradable permit are analyzed in Chapter 7.

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C H A P T E R 5.
F I S C A L P O L I C Y F O R S U S TA I N A B L E
D EV E LO P M E N T

The achievement of sustainable development objectives is impossible without

the application of a system of economic mechanisms and tools, by means of which
an adequate behavior of market subjects can be modeled. Fiscal policy is one of the
main tools for achievement of these objectives because it enables direct intervention
in those spheres where environmental balance is disrupted or where social conflicts
are aggravated. The use of fiscal policy for the purposes of sustainable development
is still in its initial phase. For decades, some elements of fiscal policy led to the
deterioration of environmental equilibrium. Thus, for instance, for heavy industry,
which is characterized by the highest energy and material consumption, direct and
indirect subsidies were, and still are, being allocated. In this chapter, we focus on the
various fiscal instruments and the mechanisms of their implementation in selected
developed and developing countries. The effectiveness of those fiscal instruments will
be discussed in Chapter 6.

Specifics of Environmental Fiscal Policy

I believe that the fiscal policy category must be seen as broader than the budget
policy category because seeing it this way means both providing additional budget
receipts and restructuring budgetary outlays. These receipts and outlays are the tools
through which a change in the model of the overall fiscal policy can be achieved, and
through that, also in the macroeconomic model of growth. In this sense, budgetary
policy is part of fiscal policy but does not exhaust fiscal policy’s content. As far as
sustainable development integrates both social and environmental dimensions, the
establishment of a comprehensive model of fiscal policy for sustainable development
presupposes an analysis fiscal instruments’ specificity in these two dimensions. In this
chapter, we will dwell on only the environmental aspects of fiscal policy.

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Generally, the tools of budget receipts comprise the environmental taxes,

surcharges, and levies. The Organization for Economic Cooperation and Development
(OECD, 1997) defined ecotaxes as all taxes that are “environmentally related regardless
of the motives behind their introduction, their names, and so on.” This definition
comprises all kinds of taxes, the levying of which helps to achieve environmentally
friendly production and consumption. Clearly, the criterion applied is the possible
effect of the levied taxes on the environment. This approach is expedient, although, in
general, all kinds of taxes are indirectly or directly reflected in environmental balance.
Should the indirect effects be included, it will be that all taxes are environmental.
For instance, such purely economic taxes as the corporate tax and the income tax
limit or restructure supply and demand or do both, which, in turn, is reflected in the
quantitative and qualitative parameters of interaction with the environment. Let us
examine now the structure, nature, and effects of these taxes by using the mechanisms
and results of their application.
The initial criterion for structuring environmental taxes is the source of their
provision, or the sphere of their application. On the grounds of this criterion, OECD
specifies three main groups of environmental taxes: energy, transport, and pollution/
resource.1 Distinguishing among these taxes is necessary because of the differences in
the individual stages of production—from the production of energy and raw materials
to their use in the process of production and the consumption of the end product.
We assume that the two main indicators—environmental influence (protection)
and generated revenues—should be used to assess the application efficiency of one
or another kind of tax. In my opinion, environmental influence must be of highest
priority, while the generated revenues of a tax must be of secondary importance. This
approach is related to the Pigouvian (1947) environmental tax, named after the great
British economist Arthur Pigou.
I determine that the role of tax receipts should be secondary because the main
goal of applying this specific legislation is to model a particular behavior and
not to merely generate certain budget receipts. It is logical to expect that, after
the introduction or increase of a tax such as the tax on carbon dioxide emissions
polluters will be compelled to take the relevant technological and organizational
measures to reduce or eliminate these emissions. In this sense, the reduction in
receipts from pollution will be a positive outcome. Thus, with all other conditions
being the same, the more these receipts are reduced, the more sustainable the
economic growth will be; and the more sustainable economic growth is, the more
these receipts will be reduced.

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The increase in receipts from environmental taxes would reflect a move toward
sustainability if the increase in receipts is the result of an increased tax rate, expansion
of the tax base, or both, i.e., the tax base of applied rate. Many supporters who believe
in the necessity of environmental tax reform argue that an increase in the rate and
scope of environmental taxes would result in the “double dividend hypothesis”. The
double dividend is a simultaneous increase in environmental taxes and environmental
quality. Some economists like Bovenberg and de Mooij (1994), however, disagree
with the “double dividend” theory and argue that we need to compare the effects of
possible improvement of the environmental quality with the distortion effect on the
whole tax system caused by the introduction or increase of the existing environmental
taxes. This idea is shared by Metcalf (2002), who also believes that there is no positive
relationship between the so-called optimal Pigouvian tax rate and improvement of
environmental quality. In his general equilibrium model, Metcalf substantiates that
the optimal environmental tax rate is not as important as some economists believe;
instead, he argues it is possible to achieve higher environmental quality at diminishing
optimal tax rates.
In contrast to Metcalf’s argument, I suggest that the theory for inverse relationship
between the tax rate and a possible distortion effect on the whole tax system is visible
only when the introduction or increase of environmental taxes does not take place as
part of an overall reform of the tax system. The above relationship between optimal
tax rates and environmental quality would be positive if the tax changes were based on
tax neutrality—in other words, if the increase in environmental taxes is compensated
by a decrease in other taxes (income, corporate, social, etc). This relationship will be
further analyzed a little later in this chapter.
Ligthart (1998) justifiably argues that the possible economic distortion effect
must be compared with related change in public spending (more tax revenues equals
more available public funds), with the quality of the produced public goods and
services and the induced change in the level and structure of employment. I definitely
agree with such a broader approach that takes into consideration all possible effects on
the economy caused by environmental fiscal policy in general and environmental taxes
in particular. Let’s see now how environmental tax reform in different countries and
groups of countries (developed, developing or in transition toward market economy)
is mirrored in some key economic and environmental indicators.
According to data from Eurostat (2004), receipts of the EU from environmental
taxes amounted to EUR 238 billion in 2001, which constitutes 6.5 percent of the
EU’s total tax receipts and social contributions and 2.7 percent of its GDP. The main

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share of these receipts—77 percent—comes from energy taxes, which amount to EUR
182 billion.2 Transport charges come second at 21 percent of the environmental tax
receipts, providing budget receipts amounting to EUR 49 billion. Receipts from the
two most recent kinds of environmental taxes, pollution taxes and resource taxes are
rather symbolic at EUR 4.4 billion and 1.7 billion (Eurostat, 2004a).

Fig.5.1. Environmental Tax Revenues in the European Union (in Euro), 1980–2001

Legend: Total–total environmental tax revenues, En–energy taxes, Tr–transport taxes.

Source: Data from Eurostat. (2003). Environmental taxes in the European Union
1980-2001. Environment and energy. Theme 8-9/2003. Statistics in focus. Retrieved
5 January 2005 from [Link]
In Figure 5.1, the tendency toward an increase in environmental tax receipts is
clearly seen in the period after 1990 and especially in the late 1990s. This was because
of (1) the public’s heightened sensitivity toward environmental problems because of
wider awareness of these problems and (2) the increased pace and scale of environmental
pollution. Peculiar to the EU is the strengthening of the political positions of parties
and coalitions identifying themselves with protecting the environment. The “green”
parties and movements have gained parliamentary representation or increased the
number of their members of parliament. For many of the countries of the EU,
especially those in northern Europe, the inclusion of the “green” in the executive
power was an inevitable condition for the formation of governing coalitions; thus,
the coalition partners were compelled to accept the preliminary conditions of the
“green” for initiation or expansion of a number of legislative initiatives, including

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environmental taxation. In this way, after 1993–1994, the implementation of green

tax reforms, which encompassed all EU members to a certain extent, commenced.
This helps explain the increase in the volume of receipts caused by higher
environmental taxes, especially those on energy consumption and, to a lesser extent,
property and motor vehicle taxes. This provides us with the grounds to assume that
the transport sector occupies one of the priority positions (next to the power industry)
in the sector structure of EU environmental fiscal policy. In the past several years,
the share of these taxes remained at a level of about 6.3–6.7 percent of the EU’s total
tax receipts and has even decreased a bit. This is understandable if we consider that
this share results from changes in the rates and proceeds from the other two main tax
sources, labor and capital revenue. In the majority of industrialized and emerging
economies, taxes on capital revenue are growing, which leads also to an increase in
these taxes’ share in the overall tax receipts in these countries.
Also important is that the environmental tax rate for individual countries is constant
or has some dependency on the level of revenue of those countries. With such dependence
between the tax and revenue, as is the case with capital revenue, each change in GDP
causes absolute and share changes in the structure of tax receipts. This explains why,
with the improvement of energy efficiency in the EU by some 10 percent for the period
1991–2001, the total receipts from environmental taxes marked 335–percent growth.
Obviously, the growth of rates and the broadening of the taxation base compensates in
advance for this increase in the energy efficiency of production.
In the previous chapter, we traced tendencies in the energy intensity of GDP and
concluded that energy intensity is decreasing because of new energy-saving technologies.
Conditions for gradual “passing of one another” are thus created between the tendencies
for growth of GDP and the growth of receipts from the main energy tax. According to
data of the European Communities (2004), the environmental taxes of EU-15 in 2002
constituted 2.7 percent of GDP. After a tendency toward increase in this share in the
second half of the 1990s, a tendency for stabilization and even a slight decrease has resulted
in this indicator (Eurostat, 2004b). Despite higher environmental taxes, the share of
environmental taxes decreases because of two positive and interrelated tendencies—the
decrease in the energy and resource intensity per a unit of GDP and the resulting shrinkage
of the taxable base. Another important factor is the movement of the price of power sources
and natural resources; any increase in prices, as is the case with the leap of oil prices in the
end of 2004, automatically brings greater receipts from ecotaxes. Depending on the degree
of this increase, the absolute value of these receipts also increases, which leads to a change
in the shares of tax receipts without changing the tax rate.

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Fig.5.2. Environmental Tax Revenues for Selected EU Countries in

Percentage of GDP, 2002

Legend: EU-15–fifteen member states of the European Union as of 2002.

Source: Data from Eurostat. (2003). Environmental taxes in the European Union
1980-2001. Environment and energy. Theme 8-9/2003. Statistics in focus. Retrieved
5 January 2005 from [Link]
In Figure 5.2, I chose for illustration purposes the three countries having the
highest (Denmark, Netherlands, and Portugal) and lowest (France, Spain, and Ireland)
shares of the receipts from ecotaxes compared to GDP. Denmark is a marked leader
in this legislation since the share of receipts from ecotaxes has reached 4.58 percent
of GDP and 9.54 percent of overall tax receipts. For comparison, in 1980 these two
indicators were 3.5 percent and 7.68 percent. Since 1980, and especially after the
launch of the ETR in 1994, the Danish Ministry of Environment has led a consistent
policy of expanding the tax base and increasing existing tax rates. In the period 1980–
2002, the tax receipts from import customs duties thus grew almost 5 times; from the
consumption of electric power, about 7 times; oil, 2.5 times; carbon dioxide, 4 times;
and pesticides, 60 times. Only for the period 1998–2002, energy taxes on domestic
consumption of oil were increased by 15–25 percent. Since 1994, new taxes on the
emissions of sulfur, natural gas, chlorinated solvents, NiCad batteries, waste water,
nitrogen, and even the consumption of pipe water have been introduced (Ministry of
Taxation, 2002).

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The above figures show different dynamics of the absolute and relative values of
environmental tax revenues and environmental tax percentage compared to other tax
revenues such as the revenues from customs duties. Because of this, no immediate
conclusions should be made about the scope and efficiency of the ecofiscal policy
of the individual countries. Still, the comparison between the different national
environmental tax scopes and tax levels and the weighted average percentage for the
EU as a whole shows that the “green legislation” is best developed in the Northern
European countries.
In these countries, the tax instruments are used more actively and generate
comparatively high budget receipts compared to the US and Japan. This is not
grounds for excessive optimism, however, for at least two reasons. First, a great part
of the lion’s share of receipts from energy consumption taxation is still being “washed
away” in overall budgetary outlays. Under various arguments, the governments use
these financial resources for solving problems that are not directly related to the
dimensions of sustainable development. Often in such cases, the true motives for
use of the financial resources are political rather than social or ecological. Second,
returning these receipts completely or partially, to the polluting companies through
tax credits is an almost-universally established practice.
The Swedish ecofiscal policy is among the most sophisticated policies in the
European Union. Total environmental tax receipts in the decade from 1993 to 2003
increased by 34 percent from 47,700 million Swedish Krona (SEK) to SEK 71,900
million (see Figure 5.3). This growth of tax receipts is not high, considering inflation,
but it shows that the tendency for growth in these receipts is constant. Considering
that in the mentioned period, the share of environmentally expedient technologies
and end products has grown in Sweden, we can conclude that the increase is the result
of an expanded tax base and the increased pressure of taxation.

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Fig.5.3. Environmental Tax revenues in Sweden, 1993–2003

(Current Prices, SEK Million)

Legend: Entax–energy tax; Substax–tax on certain substances including sulphur,

insecticides, fertilizers, waste, and domestic air transport; Trtax–tax on transportation;
Nrtax–tax on natural resources.
Source: Statistics Sweden. (2003). Environmental tax revenues. Retrieved 30
November 2004 from [Link]
Sweden’s experience in internal structuring of ecotaxes, among both the various
types of taxes and the particular objects of taxation, is interesting. In the group of
energy taxes, tax receipts from used fuel taxes have remained almost unchanged—from
SEK 20200 million in 1993 to SEK 20800 million in 2003, which is a very slight
increase of some SEK 600 million (in 2004, USD 1 equaled SEK 7.36). At the same
time, a sharp increase occurred in receipts from taxation of electricity consumption
(274 percent) and of carbon dioxide emissions (226 percent).
Tax receipts from the Swedish nuclear power industry are growing sharply—
from only SEK 100 million in 1993 to SEK 1.8 billion in 2003, or an eighteen-
fold increase. The turning point to a substantial increase was in 1996 when these
tax receipts increased more than eight times from the previous year. Since 1997,
Sweden has not levied energy tax on hydropower plants because they use renewable
and environmentally clean natural energy resources. As shown in Figure 5.3 above,
receipts from taxation on synthetic fertilizer use have almost doubled (from SEK 185

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million to SEK 340 million). Budget receipts from taxes on used insecticides increased
approximately five times—from SEK 13 million to SEK 67 million.
The change in the taxation of natural resource consumption (natural gravel tax, for
example) is significant. In 2003, it brought SEK 193 million to the budget receipts—
275 percent more than in 1993. Using the “traditional argument” for preserving the
competitive capacity of its economy, Sweden does not carry out an aggressive tax
policy for the transport section of its economy, which is generally among the main
producers of pollutants with carbon dioxide, sulfur, heavy metals, and other toxic
substances. In any case, based on the volume and structure of receipts under ecotax
legislation, we can judge the priorities of a particular country in the implementation
of such a policy and the country’s decisiveness to limit emission of a particular kind
or group of pollutants.
In general, the fiscal and monetary policies are the two main pillars of economic
policy under the conditions of market economy, but fiscal policy is likely more strongly
influenced by political factors than is monetary policy. As a rule, the budgets and the
policy for their realization are adopted by an Act of Parliament. The political fate of
each ruling majority depends on the public assessment of the efficiency of the budget
policy. The level and structure of taxes are among the most discussed issues during
and after elections. When we speak of increasing ecotaxes, the question that comes to
mind is how this increase is reflected in the general tax level and how it influences the
income of companies and households.
The most common tendency in a tax rate change is for it to decrease. The reason
for this lies not only in political motives, which we have already discussed, but also in
some purely economic considerations. The latter pertain to an increase in consumer
demand, the release of more investment resources, and the improvement of conditions
for raising capital profitability. The degree of tax lowering and the particularization
of tax for the various business activities and kinds of consumption depend on the
government’s chosen economic policy. The country’s chosen model of market economy
also considerably influences the tax structure and receipts. The countries of Northern
Europe (Sweden, Denmark, Finland, and Norway), Canada, and, to some extent,
Japan have higher tax rates than the US, the UK, Italy, and Portugal.
The higher tax rates are because of the greater budgetary commitments of
these countries to social provision and maintenance of social nets for low-income
families and the unemployed, as well as for cofunding of things such as healthcare
and education. In the period of 1993–2003, then, the share of ecotaxes in the total
tax receipts in Sweden is 5.4 percent, which is 3 percent below the level of the same

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tax in Portugal. In this way, a country such as Sweden, which is among the leaders in
the application of environmental taxation, appears to be behind Portugal in terms of
shares of these taxes. At the same time, the comparative shares of ecotaxes in Denmark
and the Netherlands (both at 9.4 percent) exceed the analogous share in Portugal,
which implies that the protection of the environment is indeed of high priority in
these two countries.

Fig.5.4. Revenues from Environmentally Relevant Taxes as a Percentage of

Total Tax Revenues in Selected OECD Countries, 1994, 2002.

Legend: OECD*—weighted average.

Source: Data from European Environment Agency (2005). OECD/EEA database
on instruments used for environmental policy and natural resources management. Retrieved
30 June 2005 from [Link]
The interpretation of the data in Figure 5.4 supposes good knowledge of the
particular economic conditions and the share of environmental tax revenues in various
countries. The US, for example, is among the countries with the lowest environmental
tax revenues as a percentage of GDP, although it is the largest consumer (in relative
and absolute terms) of natural resources and of energy in particular. This implies that

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the tax legislation of the country falls behind in collecting environmental taxes when
compared to the developed countries of the EU. It should be taken into consideration
that this is the country with the most developed capital markets and with a greater
share and absolute value of capital tax revenues. Also, the unemployment level is, on
average, two times lower than that of the EU and OECD, which, coupled with the
higher income per employed person, contributes to bigger income of households and
greater tax revenues from this income.
The volume and share of income from ecotaxes depend also on the structure of
economy and the energy intensity of production. Turkey reports a very high share of
revenues from ecotaxes—more than 10 percent—but these revenues indicate great
energy intensity of their production and consumption rather than well-developed
legislation for environmental protection. This makes some people wonder if applying tax
pressure to impel a particular environmentally expedient behavior is effective. I believe
the answer is yes, if we judge by the particular results after the start of environmental tax
reform (ETR) in the EU in the middle of the 1990s. The statistical data also shows some
negative correlations between tax levels and energy consumption (Figure 5.5).

Fig.5.5. Correlations (in Percentage) between the Trends of Taxation Levels on

Final Energy Consumption and the Final Energy Consumption per Unit of
GDP (1995 = 100)

* 2005 value is forecast.

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Legend: Ent–energy taxes/final energy consumption, Enc–final energy

consumption/real GDP.
Source: Data from Eurostat. (2004). Environmental taxes in the European Union
1980-2001. Environment and energy. Theme 8-9/2003. Statistics in focus. Retrieved
5 January 2005 from [Link]
I expect that an even more clearly expressed negative correlation between the
two indicators will appear after 2005, considering that after six years of negotiations,
the EU countries agreed on the introduction of a unified minimal tax on energy
consumption, which should influence the processes examined from 2005 onward.
Fulfilling the commitments to limit the emissions of carbon dioxide compulsorily
requires a more substantial decrease in these emissions, and tax pressure on energy
consumption will undoubtedly be among the actively used economic incentives.
The tax base since the initiation of ETR in the Netherlands in 1996 comprises
energy, landfill waste, ground water, drinking water, aviation noise, and manure. This
expansion of the tax base is accompanied by a proportional reduction of taxes on
household income. The country chose the introduction of energy environmental tax
after it became clear that the EU as a whole could reach a consensus on this tax.
Pointing out the classical argument for mitigating the expected effect of a lower price
competitiveness of its manufacturers, especially of the energy intensive branches of
industry, the Dutch applied the degressive approach, meaning that the household (the
smaller energy users) pays higher taxes per unit of energy used than the huge consumers
do. As a result, the main burden of reform in this case is placed on households.
In this system, businesses will be granted tax credits, energy investment
allowance, accelerated fiscal depreciation and cheaper credits (lower interest rates),
and environmentally friendly investments. Consumers will get tax rebates for motor
vehicles with lower harmful emission rates and greater distance run per unit of fuel.
In addition, every household or company receives a tax credit of EUR 142 annually
as compensation for additional taxes on electricity consumption. In other words, such
tax credits represent tax recycling, which benefits both businesses and households.
Another feature of the Dutch green tax reform is the stage-by-stage principle of tax
increase from 1996 to 2001, which provided a chance for companies and households
to adapt to the new tax structure and take the relevant measures to reduce energy
consumption by improving technologies, switching between energy sources, improving
thermal insulation, and so on.
According to data from OECD (2004) the revenues in the Dutch budget from
energy tax reached EUR 3 billion in 2002. Some 2.4 billion of these receipts are used

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for offsetting the reduced taxation of income and labor, whereas the remaining EUR
600 million is recycled for environmental protection programs. The latter includes
subsidies to the use of renewable energy, to consumers more fully using the energy
produced (for heating and electrical energy at the same time), to the use of energy-
efficient household appliances, and so on. The results of ecotax introduction are more
than encouraging. For instance, the number of households buying “green electric
power” grew from 100 thousand in 2000 to 2 million in the beginning of 2003, marking
a growth of 2000 percent in only three years. The economic advantages of “green
energy” would be even more enhanced if the next step in the ETR were internalization
of the externalities—formation of a real, complete price of nonrenewable fossil fuels,
taking into consideration also the harmful consequences for people’s health as a result
of using these energy sources.
Understandably, the ecotax policy has its peculiarities in various countries.
The different economic structure, the availability or absence of energy and raw
material sources, the market orientation, the level of legislation development for
environmental protection, and the model of social economic policy are among the
factors preconditioning these differences. I will illustrate some of these differences and
peculiarities, taking as an example the application of a tax rate in the use of energy
sources. In countries such as the Netherlands and Finland, the tax is based on carbon
and energy content for a unit of production, whereas the US administration prefers to
apply the tax only on energy content. Norway, Sweden, and Denmark determine their
tax rates based only on carbon content. These countries are distinguished from the
other two EU countries that initiated the ETR by another peculiarity, as well: Their
tax rate is lower, but they include a considerably smaller number of tax exemptions
compared to the Netherlands and Finland.
The five EU countries mentioned stand out because their economies are
characterized by comparatively low energy intensity, which means that the introduced
tax burden on the consumption of energy carriers is not so great. Despite this common
bond, the five countries have certain differences in the structures of their energy-
related branches of industry, which is reflected in the approaches they choose for
applying the tax at hand. Norway is endowed with sufficient water resources, which
are a chief energy source for production of electric power, but Denmark does not have
at its disposal such water resources and has based its electricity production on the
use of coal—some three-quarters of the total production of electric power. A strong
anti-nuclear lobby exists in the country, and, in all probability, it will not change the
structure of its energy branch.

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Sweden and Finland rely considerably on nuclear power engineering and partially
on coal. According to the World Nuclear Association (2005), about 50 percent of
the electricity in Sweden is produced by nuclear energy plants, while in Finland,
only 27 percent of the electricity consumption is based on nuclear energy. In Sweden
and Norway, respectively 2 percent and 23 percent of the production of electricity is
based on coal energy sources. Despite some doubts, especially after the incident at
Chernobyl (Ukraine), the nuclear power industry remains an energy source that these
two countries cannot and will not replace with fossil fuels yet. This is, first, because
replacing nuclear power with fossil fuels would make their task of decreasing carbon
dioxide emissions more complex, and second, because it would require enormous
capital investment for restructuring of the power industry.
A clearly expressed dependency exists between the structure of the power
industry, the principles of taxation (carbon based, energy based, or compound based),
and the amount of the tax. The countries that have power industry characterized by
low levels of carbon emissions (hydropower, nuclear energy) apply higher taxes. In
Norway and Sweden, the taxes are up to USD 172 and USD 148 per ton of carbon
dioxide emissions. In Denmark, the taxes are up to USD 55, and in Australia, where
the energy sector relies mainly on coal as an energy source, taxes are only USD 3 per
ton (IEA,2004); OECD( 2004).
The Clinton administration’s project for green fiscal reforms (1996) included, rather
successfully, the environmental and social dimensions of sustainable development. The
idea was promoted to introduce broad-based taxes based on energy content with emphasis
on petroleum fuels, coal, and natural gas. The plan also covered nuclear energy and huge
hydroelectric plants. The project has several interrelated goals: increasing tax revenues
and contracting the budget deficit; increasing social expenses in favor of low-income
households; reducing environmental pollution because of the expected decrease in fossil
fuel use; and reducing the country’s dependency on oil imports. The US’s preference
for using a tax system based on energy content instead of carbon emissions can be
explained by the expectation that the choice of energy content would be more politically
acceptable and would gain support by Congress and the Senate. Unfortunately, even
this “maneuver” turned out to be insufficient to overcome the powerful energy lobby in
both institutions, which did not allow infringement of the narrow economic interests of
corporations in the branch. Eventually, the project did not gain the necessary legislative
support and was put off for “better times.” Probably in the form of delayed PR effect, the
Senate came out of the awkward situation with a cosmetic increase in the petrol tax.

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Fiscal Mechanisms for the Protection and Maintenance of Forests

I choose to discuss the forest sector here for two reasons. First, it is impossible to
investigate the application of ecofiscal mechanisms in the whole spectrum of public
production of goods and services. This makes it necessary to choose particular sectors
of the economy that would be representative enough of the mechanism and results of
the application of the general tax principles. Second, at this stage most scientists define
global warming as a priority because of its scope of consequences and the dynamics
with which processes in this sphere take place. The conservation and expansion of
forests are among the key factors that could help solve this serious environmental
problem. To conserve forests, a combination of fiscal instruments is needed, including
concession fees; annual fees; fees per unit of forests cut (per cubic meter or some other
specified area); and different taxes, charges, and so on. The revenues thus received are
directed, directly or indirectly, back to the same sector, where they are used for target
environmental programs or for social support to the local population in those regions
where the exploitation of forests takes place. The manner and rate of this redistribution
of tax receipts vary by country and are issues of specific fiscal policy.
Experience has shown that applying budgetary funding—in the form of either
subsidies (negative tax) or direct funding of programs aimed at maintaining and
expanding forest areas, including forestation—is a successful policy tool. The gathered
experience confirms the efficiency of and need for a combination of purely environmental
goals and achievement of positive social effects. The conservation of a forest can and
must be bound to the improvement of the standard of living of the local population and
its economic motivation for implementation of environmental programs.
China’s Forest Ecological Compensation Fund is an excellent example of production-
environmental fiscal policy being applied in developing economies. Initiated in 1996 in
the mountain province of Sichuan, this Compensation Fund was approved by the State
Council in 2000, and its pilot implementation was launched in 10 Chinese provinces
at the same time. The basic idea is to bind the revenues from entry fees for using the
services of natural parks and reserves to the regeneration and maintenance of forests.
The funds are redistributed in favor of the owners of these forests (private, corporate,
and state-owned forestry farms, nongovernmental agencies, and organizations) chiefly
by the central state budget with additional funding from the provincial and municipal
budgets, meaning the compensatory funds are from two sources. Support is provided in
the form of money or in funding the supply of planting material and plant protection
preparations. This financial scheme also comprises programs for forestation along borders
with desert and semidesert areas for stopping the desertification process.

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China’s active fiscal policy for developing such target programs has a future, and the
basis of its application will probably be expanded. The large-scale industrialization of
the country and decades of underestimating industrialization’s negative environmental
effects have already inflicted serious damages on the size and condition of China’s
forests. The processes of soil erosion, landslides, microclimate changes, desertification,
and other unfavorable consequences have gone beyond critical limits, and the fiscal
measures adopted are imperative. Using this policy is one way for China to realize its
international commitments for partial neutralization of the huge emissions of carbon
dioxide caused by a coal-based power industry.
Not surprisingly, the problem with the new fiscal policy is that the amount of
compensatory funds provided is insufficient. According to an assessment by experts from
the China Council for International Cooperation on Environment and Development
(2002), the present amount of compensations per unit of forests is seven to eight times
below the sufficient minimum to ensure effective operation of these fiscal incentives.
The insufficient funds restrict the program’s scope of application, and in 2002, only
32 percent of the total forest areas in one of the chosen provinces (Guandzou) were
included in the scheme for compensations (subsidies). Despite these problems, the
very initiation of the program and its practical application is a definitely positive step.
The encouraging results of the program’s first years of application will help the stage-
by-stage increase of these subsidies. I expect that the share of participation of local
budgets will gradually grow at the expense of the central budget. This will be related
also to the general tendency for decentralization of budgeting. Also, the application of
the program is a successful example of successful international cooperation with US,
Canadian, and Australian institutions and NGOs in the search for the best solutions
to environmental problems.3
Fiscal mechanisms turn out to be the basic instruments for implementing the
Kyoto Protocol. Experts believe that 20–30 percent of the increased amount of carbon
dioxide in the atmosphere is because of the decrease of forest areas, which shrinks the
natural process of absorption and degradation of this pollutant. Aside from the greater
commitment of central and local budgets, a tendency also exists to strengthen the
fiscal cooperation between those companies whose activities are directly or indirectly
related to the conservation and reproduction of forests. For instance, one hydropower
plant in Costa Rica voluntarily provides monetary funds for subsidizing private forest
owners in the region of the power plant in return for the owners’ maintenance of
the forests. In Paraguay, Hydroelectricity International Company (AES) also provides
more than USD 2 million in similar funds because the conservation of tropical forests

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in Central and South America is a natural condition for retaining groundwater, which,
in turn, is a condition for providing water resources for the generation of hydropower
(for more information, see Powel et al., 2002).
Today, more than 30 percent of Costa Rica’s forests are protected by the Conservation
Act, which means that their conservation is provided by financial means from the state
budget, the local budgets, and the voluntary investments of interested local companies.
Many other examples can be given in which companies from various sectors of the local
economy show general interest in the conservation of nature. The successful development
of mountain tourism in Austria, Switzerland, and Bulgaria presupposes such a harmony
of interests, as the conservation and expansion of forests is a condition for the prosperity
of tourism. The owners of forests in these countries, then, receive direct compensation
from specialized funds, the amount of which generally varies around levels that make
this kind of service sufficiently attractive for the owners.
The Brazilian fiscal policy for conservation of tropical forests in the Amazon valley
has a specificity of its own. In this policy, a part of the budget receipts is redistributed to
fund environmental programs in the region. The main source of these receipts is taxes
on sales (VAT), and some 25 percent of tax receipts are returned to the local budgets
for environmental funding. This specific tax rebate is mandatory, especially for the
extensive tropical forests in a territory with no industrial or hydropower companies
to financially support these specialized funds. Costa Rica has chosen another source
of tax redistribution—the revenues from excise taxes on fossil fuels are used as a main
source, but revenues are generated also from the hydropower plants and voluntary
carbon emissions mitigation purchases by foreign countries such as the Netherlands
and Norway (Workshop on Payment Schemes, 2002). The mechanism of revenue
generation from selling emission permits will be analyzed in detail in the last chapter.
Ecotax policy regarding the tropical forests in Cameroon, Africa, is a typical
case for fiscal decentralization. Since its introduction in 1994, Cameroon’s policy has
proven its advantages over the decades of centralized management and budgeting of
the 22 million hectares of forests that represent the third largest forest in Africa. The
country’s forestry is the national economy’s third largest sector, following oil mining
and agricultural production, and it brings about one-third of the country’s export
revenues. In this sense, the results of the fiscal decentralization should be viewed in
the context not only of tropical forest conservation but also of the tax reform’s effect
on the whole economy. In analyzing the decentralized ecotax system, Logo (2003)
points out that the tax has two components: regular and irregular. The regular fee is
the forestry fee, which changes and is collected annually. The annual fee is determined

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by two individual components: The first component is determined by the annual base
rate, whereas the second is determined on a competitive bidding basis, meaning that
an element of competition is introduced among the companies applying to receive
the right to log in particular forest areas. The irregular component of the annual tax is
defined as a kind of “parafiscal tax,” which is levied per cubic meter of timber logged
(for more detail, see Logo, 2003, pp. 5–7).
The law envisages that 40 percent of forestry fees are distributed to the rural
councils in the forest areas being logged. Another 10 percent of the receipts are provided
to the local authorities from the neighboring villages, which are located outside the
forest areas. The remaining 50 percent of tax revenues is left to the state budget and
used to fund various environmental or social programs. This decentralized approach
helps to achieve better harmonization of interests among local communities, logging
companies, and the state. It creates important incentives for the local population to
conserve and maintain the forests that give the population a living and usually provide
the people’s only source of income.
With the balancing of economic interests of all parties involved, conditions are
created for achieving specific social and environmental goals. To achieve a higher
target effect regarding poverty-related problems, in 2001–2002, Cameroon created an
equalization fund. The ministries of finance and forests manage the fund jointly and
distribute the collected tax receipts (50 percent of receipts mentioned earlier) among
the local communities. These receipts are distributed according to criteria specified
in advance and under the supervision of the representatives of these communities.
The five criteria for equalization include the size (number of people in) of each
community; the concrete area of logging titles; equal distribution; and distribution of
funds proportional to population after payment of a minimum sum per local council
(Logo, 2003, pp. 11–12).
The change in relative prices is one of the objectives of fiscal policy. Tax level
modification, direct and indirect subsidy use, tax exemptions, priority access to credits,
and other tools cause the desired modifications in the market environment and the
change in behavior of various stakeholders. The result should make environmental
services more lucrative, or at least as lucrative as the use of land for alternative
services. Market incentives play a crucial role in fulfilling the objectives of sustainable
development. The US has well-established traditions in the use of this approach,
which is applied in the implementation of the Conservation Reserve Program (CRP).
CRP was launched in 1930 after the crisis in agriculture in the Southern States, which
was caused by the erosion of soil and a long drought at the end of the 1920s.

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According to data from the US Department of Agriculture (2004), the CRP

comprises approximately 10 percent of all crop land, and the annual compensations
for land owners cost the federal budget almost 1.5 billion dollars. The rent per hectare
of land, which is essentially rented by the government under this program, is 121
dollars on average. In the Midwestern states, which are centers of grain production,
the average rent is considerably higher, at $210. Some states contributing to this higher
average include Illinois ($160), Indiana ($147), and Ohio ($144). According to the
rent contracts signed, 60 percent of this land is covered in grass, 15 to 16 percent is
forested, and 5 to 6 percent is wetland restoration.
Unfortunately, the countries in the tropics do not have such financial capacity for
conservation of their forests, which play such a vital role in the production of oxygen
and the absorption of carbon dioxide. The limited budgets of these governments
make it almost impossible to influence the relative prices mentioned above. The vital
functions of forests do not bring any income to their owners, which is the reason for
the destruction of hundreds of thousands of acres of forests to create pastures and
develop stock breeding. In some regions, alternative uses exist for forests, including
production of natural rubber or collection of herbs, but these alternatives do not
play substantial economic roles. Of course, with proper circumstances, such activities
could be the object of direct or indirect subsidizing if the people involved in them
would take the role of conserving these forests, as is the practice in Brazil.

Some Alternative Sources for Ecofinancing

Sufficient funding for environmental programs cannot be ensured through only
equivalent transformation of tax liabilities into budget outlays. Using other budgetary
sources is also necessary. A number of authoritative economists have resurrected the
idea of introducing a tax on foreign exchange transactions. I use the term “resurrect”
because John Keynes used it in his famous work The General Theory of Employment,
Interest, and Money (1936), in which the proposes the tax on foreign exchange
transactions as a step toward stabilizing the American foreign exchange market. In
his analysis of factors leading to the emergence and aggravation of America’s severe
economic crisis from 1929 to 1933, Keynes points out that the nonregulated
speculative foreign exchange transactions played a destabilizing role.
The same is true today. In the financial crises in Asia (1997–1998) and Latin
America (1994, 1999), the speculative movement of monetary capital led to an abrupt
aggravation in the financial crises. It caused financial losses of hundreds of billions of
dollars. The processes of globalization increase the interdependency between various

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economic sectors and national economies; thus, regional financial or economic crises
can easily be transferred to opposite sides of the world, drawing into their orbit
countries that may have been in comparatively stable economic equilibriums until
then. Subject to these macroeconomic dependencies, the financial destabilization in
Asia and Latin America caused a sharp shrinking of foreign exchange demand in these
regions, which shrank the demand for imported products.
Such a collapse in the troubled countries’ demand of imported goods and services
led to economic problems for the exporting countries. The production facilities of
these exporting countries were not fully loaded, unemployment increased, return
on investments deteriorated; these effects further caused recession impulses, reduced
budgetary receipts, budget misbalances, subsequent problems for the banking and
financial system, and so on. Considering that financial stability is one of the conditions
for sustainable economic development, restricting speculative capital’s excessive
freedom of movement would lead to the minimization of this negative effect. A tax
within 0.10–0.25 percent on the value of the capital and foreign exchange market
transactions would restrict the speculative trade of foreign currency.
Keynes compares foreign exchange markets with casinos and believes that such
markets should be made sufficiently expensive and difficult to access. In his opinion,
“government transfer tax on all transactions might prove the most serviceable reform
available, with a view to mitigating the predominance of speculation over enterprise in
the United States.” This idea was further developed in recent years by the Nobel Prize
laureate in economics, James Tobin (1978), who claims that the development level
reached by the foreign exchange market and its destabilization makes the introduction
of such a government transfer tax more necessary than ever.
Such a tax as that proposed by Keynes and Tobin has been levied in the past and is
now levied in some countries. The tax, however, is not levied systematically, and the tax
rate is rather low. In addition, the tax receipts are not used for sustainable development
programs; thus, the tax on the transfer of stock sales is symbolic—only 0.0034 percent
in some countries. In Belgium, this rate is 0.34 percent, and in Portugal 0.1 percent.
Finland abolished this tax in 1992, hoping that this would facilitate the stock exchange
trade and stimulate the investment process. Everywhere, differentiation of the tax in
question is done for various types of securities, and the rates levied on stock trade are
usually higher than the transaction taxes on government bonds.
Baker (2000) justly questions the possibility of introducing a uniform, sufficiently
high tax rate on the transactions of all foreign exchange and securities markets. This
is indeed extremely difficult to achieve, considering the mutually exclusive policies

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(application of Policy A excludes the application of policy B or vice versa), in this

respect, in the various countries. It is more realistic to expect that a breakthrough in
introducing a uniform tax rate can be achieved, to begin with, in a particular country.
The best scenario would be if the implementation of such uniform tax begins in
countries where the exchange and capital markets represent substantial share of the
World capital and exchange market. The US and UK are the most suitable countries
for that purpose. The proposed additional tax is so low, compared to the other fees
and taxes, that it could not cause transfer of transactions to other markets, like Tokyo,
Hong Kong or Frankfurt.
I doubt, however, that Baker’s expectations for a sufficiently high tax rate to
be implemented in the US are realistic. This is the country where the last several
governments, led by both Republicans and Democrats, carried out a consistent policy
of deregulation of foreign exchange and securities markets. The fiscal restrictions on
their development were insignificant. The US’s approach, with a few exceptions, favors
the US, but not global sustainability objectives; the recent sequence of collapses on the
American stock exchanges makes the effectiveness of the US policy doubtful.
The arguments supporting a tax like the one Baker proposes are convincing.
The objections to this tax’s implementation are political or express narrow lobbyist
interests; this is understandable, considering the extremely high speculative profit of
foreign exchange markets. This is the largest market sector in the world economy.
According to estimations of the Bank for International Settlements (2005), the
average daily volume of foreign exchange transactions exceeds USD 1.9 trillion. This
is 130 times more than the daily turnover of the US stock exchange—including the
NYSE, AMEX, and NASDAQ stock exchanges—and 110 times more than the daily
turnover of the transactions of goods and services worldwide. The latter amount to
approximately USD 5 trillion per annum or USD 13.7 billion per day. In fact, only
2 percent of the foreign exchange transactions serve the international merchandise
trade; 17–18 percent is used in the securities trade, and more than 80 percent moves
along the speculative spiral between the fluctuations of currency exchange rates.
I share the view that these speculative operations are parasitic to the world economy.
A part of the value added, created by the producers of goods and services, is redistributed
in favor of the speculators, whose rate of profit turns out to be higher than for those who
create the value. No proof exists to support the claims that these speculative operations
help the formation of currency market value and fine-tuning of this specific market. The
economic development and facts show that the truth is just the opposite: The greater the
share of these operations and the freer the movement of monetary capital, the broader in

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scope and the more serious the financial crises occurring at certain intervals. The “fine-
tuning,” then, appears as a “fine destabilizing” factor.
Consequently, the proposed worldwide tax on foreign exchange and securities
transactions would have a twofold effect: stabilization of the world financial system
and provision of additional budget receipts, which could be used entirely for
implementing the transition to sustainable development. The transition could involve
target programs for improving the quality of and facilitating access to education and
healthcare and for providing preferential housing credits, stabilizing social and pension
funds, stimulating the export of environmentally clean products manufactured by
means of environmentally friendly technologies, improving forestation or land
conservation, and so on.
Even a tax of 0.25 percent on foreign exchange and securities transactions would
ensure additional budget receipts amounting to approximately USD 140 billion. This
amount is 14 times higher than the current annual budget of the United Nations
and more than 1800 times higher than the annual budget of the UN Environmental
Program Agency. The sum would be enough to achieve a revolutionary leap in the
scale and intensity of environmental and social programs worldwide through which
sustainable development can be achieved.
Palley (2000) makes an interesting proposal for using the Tobin tax to establish
a new Global Marshal Plan for sustainable global economic development. Following
Palley’s proposal, I believe the distribution of receipts from the Tobin tax should be done
by international organizations. Considering that the world foreign exchange market
is territorially concentrated and that the greatest share of operations is performed in
London and New York, it would be unjust for the world foreign exchange trade to
favor the national budgets of only the UK and the US. Transactions are performed on
the foreign-exchange and capital markets, which are mainly in the US, EU, and Japan,
but these markets provide the whole world trade with goods, services, and securities,
so it would be only fair to redistribute any tax receipts to all nations.
Individual countries’ shares should not be determined based on only their
proportionate participation in foreign exchange markets because the dominating
share belongs to the most developed countries. Because of this, after expenditures
for the tax collection have been covered, the receipts should be distributed according
to a mutually acceptable principle. The best situation would be if the authorized
international institutions implementing sustainable development programs managed
these funds. It is also logical for developing countries to be granted a priority in
receiving these funds. In this way, the previously made commitment of the seven most

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developed countries (the G-7 group) to provide economic assistance at the rate of 0.7
percent of their GDP (the current rate is only 0.15 percent) will be easily fulfilled.
Enough funds will remain for expanding the scientific and applied research work with
environmental effects in these same developed countries.
Taxes on pollutants and resources provide rather modest tax receipts because
the level of of these taxes is comparatively low and the tax base is limited. Obviously,
the Environmental Tax Reform requires perfection of this policy, but, in general, the
fiscal incentives in this case are aimed chiefly at the reduction of harmful emissions,
the restriction of natural resource consumption, or both. The correlation in the price
of alternative, environmentally friendly behavior of polluter companies depends on
adequate determination of the level of taxes, charges, or fines. These companies
always compare the penal payments with the required expenditures for eliminating
emissions of harmful substances through closing the production cycle or installing
treatment facilities.
The fiscal policy in this sphere could bring about the desired effects of
environmental protection only if the price incentives for environmentally expedient
solutions are strong enough. The application of such fiscal incentives does not preclude
the use of technical standards and norms, which can be referred to as command-and-
control policies. These policies are not an alternative, but a complementary mechanism
that poses physical restrictions on pollutions. The advantage of taxing pollutants and
resources is that economic incentives are created for constant reduction, or even
elimination, of harmful emissions.
Taxing polluters turns out to be difficult and comparatively expensive for
administration, mainly because the degree of harmfulness—and therefore the rate of
taxation-depends on the geographic location of pollution. A quantity of pollutants
would have a radically different effect on the natural environment and human
health depending on where harmful waste from production and consumption is
discharged—whether near, in, or far from settlements, rivers, seas and oceans, water
wells, or groundwater or in various microclimatic conditions (humidity and ambient
temperature, winds, seasons).
The environmental consequences from the emission of one million tons of
carbon dioxide in immediate proximity to a large settlement would be many times
higher than for the same emissions in a semi-mountainous or mountainous area with
sufficient forest areas nearby. The piling of toxic waste on the bank of a river or lake
would spread the negative effects to tens or hundreds of kilometers from the place of
contamination. The same waste would be localized if stored under suitable conditions,

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preventing contamination of nearby areas. In both cases, the quantitative parameters

of the pollutant are the same, but the degree of harmful effect is different.
The tax rate for such emissions discussed above should differ, insofar as the place
and the conditions of release—free in the natural environment or stored under certain
conditions—have different effects on the environment and human health. To date, a
lot of experience has been gathered in applying similar taxes in most developed and
some developing countries. Probably the most successful instance of limiting water
pollution is in the Netherlands, where the government levies charges on direct and
indirect sources of heavy metals and biochemical oxygen demand (Boyd, 2003).
A possible solution to the problem with the too-big differences in the
environmental conditions in various geographic locations, even within the territory
of the same municipality, is to account for tax differentiation at a local level. In other
words, taxes and charges should be controlled and collected at the municipal and
settlement levels. Using tax receipts at the same level would also be expedient because
it would offset the administrative expenses for implementing this tax policy and, at the
same time, solve part of the environmental challenges facing the settlements involved.
Some of these challenges include creating laboratories (stationary and mobile) for
monitoring the quality of water, air, and soil; processing and recycling industrial and
household waste; and constructing and improving sewage systems.
Downsizing world military expenditures must be a main step toward sustainable
development. The world’s military sector consumes tremendous amounts of financial
and human capital and priceless nonrenewable and renewable natural resources. This
sector enjoys favorable conditions for research and development and is therefore at
the edge of the most modern technologies. The great military powers argue that the
armament is a necessity for national defense or even that the military production
plays a catalytic role for economic development when, in fact, the opposite is true.
The great powers, as always in human history, use military strength to redistribute
natural and economic resources or to prevent such redistribution. The vast quantities
of weapons of mass destruction, capable of destroying the earth thousands of times,
are beyond rationality.
Obviously, the scale of militarization is far beyond the understanding for sufficient
national security. The continuing arms race is one of the main obstacles to achieving
sustainability. It not only wastes highly valuable resources but also destabilizes the
international economic and political environment. Produced weapons continue to
be used for mass destruction and killing in the Middle East, Chechnya, Africa, other
countries. Military production is known for its extremely high profit margins based

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on pseudo-market conditions and extremely favorable government procurement

policies. In most cases, the governments buy military goods only or predominantly
from national companies, even if these companies have a monopoly position and
therefore charge above market prices. Stockholm International Peace Research
Institute (SIPRI, 2005) estimates that in 2002, the annual profits of the leading arms
producers (Computer Sciences Corporation, USA; Boeing, USA; Lockheed Martin,
USA; United Technologies, USA) were in the range of 400–500 million dollars and as
high as 14 billion dollars (General Electric, USA).
The arguments used to defend such a wasting military machine are rather
cynical. The assertion that the military sector is accelerating the development of the
civil sector is as irrational as the assertion that it is better to heat the building from
outside through the external walls rather than from the inside—of course there will
be some heating, but at what price? The major arms producers control a powerful
lobbying force that plays a decisive role in policy formulation at the highest national
and international levels. Hundreds of billions of dollars and mountains of weapons
of mass destruction represent the worst use of production capital. The production
and use of weapons are among the factors most destructive for both the environment
and human society. Clearly, achieving sustainable development is possible only if the
lion’s share of resources used by the military sector is transferred to economic, social,
and environmental programs. This transfer would also ease the preservation of scarce
nonrenewable resources and limit environmental degradation.
Unfortunately, reality is quite different from such desirable developments. As
shown in Figure 5.7, military spending continues to rise—from a total of USD 742
billion in 1994 to USD 879 billion in 2003. This is an increase of 18 percent in only
10 years. I expect that the trend will remain for at least the next five years and that
the level of military spending will cross the mark of one trillion dollars by the end of
2010. Only Europe shows encouraging signs of stabilizing current military budget
levels; a 2 percent decrease—from USD 200 billion in 1994 to USD 195 billion in
2003—has even become apparent. I expect, however, that the region’s expenditures
may rise again if Europe takes further steps toward creating its own defense system as
an alternative to NATO.

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Fig.5.6. Military Expenditures (Constant 2000 USD and

Constant Exchange Rates)

*2010 value is forecast.

Legend: As & Oc–Asia and Oceania, ME–Middle East.

Source: Stockholm International Peace Research Institute (SIPRI). (2004). SIPRI
yearbook 2004. Retrieved 7 January 2005 from [Link]
Military spending sends destabilizing impulses to the economies of less-
developed countries. It is indicative of such destabilization that the increase of
military expenditures (1994–2003) in less-developed countries is higher than the
average increase. For example, in the Middle East, Southeast Asia, and Northern
Africa, percentage increases were 48 percent, 41 percent, and 24 percent, while the
increase of world military expenditures was only 18 percent. I would like to stress
that equal military expenditures have different effects on the economies of developed
countries than on developing countries. The economic and social burdens on the latter
are much bigger and cause much deeper destabilization of their economic systems.
Instead of investing in poverty eradication, job creation, technologies improvement,
environmental protection and recovery, and so on, developing countries use their
scarce budget resources in the wrong direction.
Certainly, the sellers of military goods and services collect an impressive profit,
which explains why these sellers and their representatives do everything they can to
maintain political instability in certain regions of the world. For these sellers, this is

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the best way to secure the collection of revenues for future periods. Not accidentally,
many regions of conflict are in areas with vast deposits of energy sources, or where
transportation of these resources (pipelines, ports) takes place. In most cases, local
governments borrow money from developed countries to buy weapons from the same
or other developed countries.
This practice creates a vicious circle that leads to few clear results, including more
profits for the arm sellers and higher deficits and debts for the buyers, easily manageable
and more-dependent developing countries, formal excuses for developed countries’
military presence in developing regions, direct control by developed countries of
developing regions’ natural resources, increasing technological gaps between rich and
poor countries, and others. The list of negative effects is endless. At the same time, the
profits generated from arms sales do not cover substantially the losses that developing
countries incur from military spending; profits are negligibly low when compared
to all military spending. As I mentioned earlier, however, the picture is completely
different for the producers and sellers of military commodities.

Fig.5.7. Military Expenditures and Pollution Abatement and Control

Expenditures by the Public Sector in Selected Developed Countries
(Percentage of GDP)

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Legend: PAC–pollution abatement and control expenditures, MIL–military

expenditures.
Sources: Stockholm International Peace Research Institute (SIPRI). (2004). SIPRI
yearbook 2004. Retrieved 7 January 2005 from [Link] Organization for
Economic Cooperation and development OECD. (2003). Pollution abatement and
control expenditures in OECD countries. Retrieved 22 December 2004 from http://
[Link]/searchResult/0,2665,en_2825_293564_1_1_1_1_1,[Link]
As shown in Figure 5.7, military spending is much higher than spending for
pollution abatement and control4 as a percentage of GDP. The disproportions are very
high for countries like the US and the UK because of their key roles in NATO and
their fiscal priorities, which favor their strategic military and foreign policy objectives.
Budget spending for PAC in the US is annually about USD 150 billion, which is two-
and-a-half to three times less than the country’s military budget. The situation is a little
different in Greece, where the high percentage of military spending can be explained
by the relatively lower GDP per capita. It supposes higher GDP share for the same
military products or services necessary for the fulfillment of Greece’s responsibilities
as a member of NATO.
Among the selected countries in Figure 5.7, only Japan is not a member of NATO;
Japanese PAC expenditures are nearly twice as low as the country’s military spending,
although, in accordance with the constitution, the latter must be a maximum of 1
percent of GDP. For some NATO members such as Austria, Spain, Luxemburg, and
Finland, military expenditures are lower, about 1 percent of GDP. At the same time,
their budget investments in education and healthcare are in the range of 4–6 percent
of GDP (SIPRI, 2004). This shows that membership in a military organization does
not predetermine a country’s system of fiscal priorities.
It is interesting to see the economic outcome of fiscal stimulus for armament
export versus environmental technologies export. The world market for environmental
technologies is twice the size of the market for military products—USD 200 billion
compared to USD 400 billion. The United States export covers nearly half the world
market for environmental technologies. Although this market is often more profitable
compared to military export, with clear moral and political advantages, the US
government continues to support arms export. Fiscal priorities favor arms production
and export; for example, the export premiums are 12 times higher for the export of
military goods and services than for environmental technologies export. In other words,
the money from American taxpayers is directed in an economically less-efficient and
politically dangerous direction. A recent study by Pemberton (1998) shows that budget

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spending on promotion of environmental technologies export has an investment return

25 times higher than the return for promotion of military export.
No doubt, the one trillion dollars that the world spends on military programs
each year could make a dramatic difference if invested in socioeconomic development
and environmental protection. A gradual transfer of budget spending from military
programs toward programs for sustainable development is the most suitable and most
realistic potential opportunity for resource generation, necessary for the realization
of UN Agenda 21.5 Such transfer is possible if the international community finds
the appropriate mechanisms and instruments for neutralizing corporate interests
committed to the military sector. Fiscal policies need their priorities rearranged
for sustainable development; transfer of public spending from the military toward
environmental and social programs could generate higher economic outcome and
substantially aid the achievement of sustainable development.

Pros and Cons for the Policy of Subsidization

Subsidies, also called “negative tax,” are often used in contradiction with the
objectives of sustainable development. Today, the total amount of subsidies throughout
the world exceeds USD 600 billion per year. The main beneficiaries are agriculture,
extraction industries (mining), and the energy sector. The problem is that, through these
subsidies, taxpayers’ money changes the market environment so as to stimulate both
producers and consumers to use more natural resources. For example, the subsidies for
mining industries cover a substantial share of the production costs, thus allowing lower
sales prices. In such cases, taxpayer money is used for cheap delivery of nonrenewable
resources. Further, the cheaper the resources, the weaker the incentives for their efficient
utilization. The excuse that such policy protects jobs in this mining sector is not
acceptable; the negative outcome of such policy substantially exceeds the positive.
The techniques used for direct and indirect subsidization are diverse. Farmers, for
example, are subsidized directly. The subsidies are based on unit of exploited area. In other
cases, the subsidies are in the form of export premiums (OECD and, to a lesser extent,
some medium-developed countries) and reach indirect financing such as subsidization of
the production of fishing ships (Norway) or the aircraft industry (EU). Frequently used
techniques of indirect subsidization are the tax holiday (tax exemptions) or tax recycling.
Tax recycling is still widely used in favor of the energy sectors, even by the Northern
European countries that have a pioneering role in improving environmental tax legislation.
Unfortunately, quite often, tax recycling is applied so as to create preconditions to delay
structural and technological reforms toward sustainable development.

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Current forms and sectors of subsidization have another negative effect on

sustainability of development. This effect is expressed in the distortion of economic
conditions for free international trade and the placement of developing countries in
extremely unfavorable positions, especially with regard to the agricultural production
market, where the deformation is the greatest. Any subsidies in developed countries
increase their price competitiveness, which lowers the competitiveness of developing
countries. The loss of export potential of developing countries is reflected in the lower
production profitability in these countries and leads to lower levels of employment,
problems with the balances of payment and trade, heavier servicing of foreign debts,
and, eventually, aggravation of serious social problems.
Recent developments in the North American corn market are typical examples
of some negative effects of subsidization on liberalizing foreign trade. Since the
establishment of NAFTA in 1995, the US corn export to Mexico has tripled and now
accounts for about 30 percent of the domestic market. Heavy government subsidies
are one of the decisive factors for this development. Oxfam (2003) estimates that
American corn producers receive about USD 10 billion in subsidies per annum, which
enables them to sell at lower prices on the world marketplace. The level of dumping
in Mexico is in the range of USD 105–145 million per year. Such restructuring of
the corn market in Mexico has socioeconomic and ecological effects that are quite
different in each country.
In Mexico, the fortune of three million corn producers is in jeopardy. The price
received for Mexican corn fell by nearly 70 percent, pushing millions of farm families
out of business. Mexico’s economic burden is doubled because additional spending on
corn imports has to be added to the loss of domestically generated income. It creates
additional problems for the budget and therefore limits Mexico’s available resources
for social and environmental programs. A worsened balance-of-payments is another
concern because of the increased trade deficits and stronger pressure on the hard
currency reserves. The US is gaining from this situation. Annual export to Mexico
(more than 5 million metric tons) brings the US about USD 500 million revenues.
The United States’ widening market niche in Mexico can be viewed as a kind of
compensation for its lost market share in Europe, Japan, and other regions of the world.
Many countries applied restrictions on genetically modified American corn, arguing
that such products could damage the environment and have unpredictable risks for
human health. Although Mexico does not allow production of genetically modified
corn, it still allows the import of such corn. In other words, American exporters take
the revenue, and Mexicans take the risks. At the same time, the American taxpayers

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are financing such economic irrationality. Although mostly American’s are profiting,
some Mexican businesses enjoy some economic advantages from this situation: Trade
liberalization and increased import brought prices down, meaning that the final cost
of their food products is now lower.
Such market restructuring has contradictive environmental results. On one hand,
lower corn production volume in Mexico means less chemical (fertilizers, herbicides,
and insecticides) use, and the chemical intensity of American corn production is lower
than that of Mexican corn production; therefore, increased production in the US has
its environmental advantages. On the other hand, American corn production is more
dependent on irrigation, which means more intensive use of scarce water resources. One
must take into account that the accumulated level of pollution in the United States is
much higher than in Mexico. Keeney and Muller (2000) argue that various chemicals,
including nitrogen, coming from corn-growing areas and carried by the Mississippi
River are responsible for the enlarging “dead zone” in the Gulf of Mexico.
The European Union has a policy of subsidization similar to that of the US.
EU farmers enjoy up to 100 billion Euros of subsidies. This results in much higher
supply, higher food surpluses, and lower prices on the world marketplace. At the same
time, the EU market is heavily protected against import of agricultural products from
developing countries. The latter face two interrelated problems in this case: restricted
market potential and lower revenues of hard currency. No doubt, both restricted
potential and lower revenues directly reflect the global socioeconomic system and make
implementing environmental principles in the agrarian sector much more difficult.
This status quo also affects the countries in transition toward market economies.
During the EU debate (June 2005) on the budget policy, the UK Prime Minister
T. Blair stressed that the EU subsidies per caw are two Euros daily—more than the
daily pension in most Eastern European countries and more than the daily income
for more than nearly three billion people in developing countries. The comparison
speaks for itself.
Most of the countries in transition report increasing trade deficits. For example,
Eastern European countries were converted from net exporters to net importers of
agrarian products. The policy of subsidization is a crucial factor in this result; it is
a perfect example of how fiscal policy can cause deterioration of the conditions for
sustainable development. Developed countries do not appear ready and willing to
start real fiscal reforms and to begin a gradual phase-out of their economically perverse
policies. Similar to the motives for support of the military sector, political interests
appear stronger than economic and social rationality.

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The above examples confirm the necessity for thorough general and structural
changes in the fiscal policies’ mechanisms and objectives. The first step is the
restructuring of subsidies or, more precisely, the transfer of subsidies from activities
giving rise to nonsustainability to more activities that are sustainable. For instance,
the shrinking and stage-by-stage elimination of price subsidies in agriculture can be
used for such things as (1) broadening the fundamental and applied research for new
environmentally expedient technologies in agriculture, (2) expanding land conservation
programs, (3) stopping desertification processes, and (4) creating fiscal stimulation.
Analogously, budgetary funds would be more expediently used if they were directed
toward the use of renewable, instead of nonrenewable, resources and energy; to the
elaboration and implementation of energy- and resource-saving technologies; to the
recycling of solid waste and neutralizing of toxic, radioactive, and other pollutants
hazardous for people and for nature; and so on.
The implementation of such reforms is not an easy task at all, as it involves
restructuring toward a new balance of economic and political interests that has
been forming for decades. The political power of lobbyist groups in legislative
institutions still holds the decisive levers in the process of decision making,
yet a number of positive developments in this direction give us hope that the
situation must and can be changed. For example, the European Commission
pursues a budgetary policy that is more and more bound, directly or indirectly,
with environmentally expedient programs. Such is the case with the subsidized
sales price of materials used for thermo-isolation of homes, office buildings
and industrial facilities. Such thermo-isolation improves the energy efficiency
and therefore lowers the consumption of energy sources. The difference in
price between thermo-isolation nonrenewable materials (mineral wool, glass, or
expanded polystyrene) and renewable materials is from 50 percent to 300 percent.
The pure market criteria are therefore positively in favor of the production and
use of insulating materials made from nonrenewables.
With the commitment of the EU budget and of the individual member countries
in covering the differences in prices, the necessary price incentives for priority use of
building insulation made from renewable materials is created. The application of this
fiscal mechanism in Germany and some other countries yields encouraging results. The
consumption of nonrenewable resources is reduced; at the same time, the emission of
pollutants into the air is avoided. The renewable materials are basically carbon dioxide-
neutral, which helps to fulfill the targets for lowering carbon dioxide emissions into
the atmosphere. Some analogous price subsidizing is used for financing the use of

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renewable sources of energy, especially for purchasing equipment for generation of

wind- and solar-based electricity.
In other cases in Europe, indirect subsidization, or negative taxes,” are used.
Bulgaria, which is an associated member of the EU, will introduce in 2005 an
amendment in its tax legislation that will exempt households and companies that
insulate their residences and work premises from building taxes for 5–10 years. For
this purpose, independent, private, and licensed–by-the-state expert evaluators will
issue the respective certificates against which tax exemptions will be granted. The aim
is to improve the return on investment and shorten the term for repayment insulation
costs. Better thermal insulation guarantees reduction of energy consumption per unit
of area, which contributes to reduced consumption of natural resources and restriction
of environmental pollution from the burning of fossil fuels.
Subsidization of energy-intensive branches and agricultural production inflicts
more harm than help on their development. By placing these sectors in preferential
fiscal conditions (tax credits, tax recycling, tax exemptions, direct or indirect
subsidization), governments create preconditions for behavior that is in sharp contrast
to the objectives of sustainable development. Energy-intensive and agricultural sectors
are characterized with high energy- and material intensity of production. In the case of
agriculture, subsidies actually make pesticides, synthetic fertilizers, and other chemicals
cheaper and therefore encourage their extensive use. Such absolutely inappropriate
budgetary support not only hastens the degradation of soil but also constitutes a direct
hazard for human health.
Two more highly negative effects of subsidies are the violation of market
principles of competition and the distortion of conditions for forming absolute and
relative advantages in international trade. Because considerable budgetary resources
are needed for subsidization, it is applied mostly by developed market economies.
From this viewpoint, subsidization has another negative effect—ousting developing
countries from international markets and, hence, aggravating their economic and
technological backwardness. This twofold negative effect can be avoided by eliminating
nonexpedient subsidies and redirecting them to activities that would help achieve the
objectives of sustainable development.
The analyses made in this chapter confirm that current fiscal policies need
thorough reforms if the objectives of sustainable development are to be fulfilled.
Sustainable development supposes reforms in a few key directions, including a broader
environmental tax base; higher environmental taxes under the principle of “tax
neutrality”; better dependence between the scope and level of taxation on renewable

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and nonrenewable natural resources; direct and indirect stimuli for environmentally
friendly production and consumption; thorough restructuring of the current policy
of subsidization, which is a rather larger barrier to sustainable development better
coordination between government spending and companies’ investment policies
in sectors of the economy which play decisive roles for appropriate economic
restructuring, and so on.
I would like to stress the necessity of harmonizing the environmental fiscal policies
of different countries or group of countries with one another. Unfortunately, the
success of those reforms in one country often provides fewer positive results compared
to the outcomes from the delayed reforms in other countries. In other words, the
greening economy in Denmark, for example, cannot compensate for the deepening
environmental problems in China, India, or the US. Also, different environmental
standards and different fiscal policies, including those concerning export and import,
result in unequal conditions for market competition. Such inequality leads to
redistribution of income from the countries with “green economies” toward countries
that continue to increase emission of pollutants. This particular problem will be
discussed in the next chapter.

References
Baker, D. (2000). The feasibility of a unilateral speculation tax in the United States. Center for Economic
and Policy Research Global Policy Forum. Retrieved 27 July 2004 from [Link]
socecon/glotax/currtax/[Link]

Bank for International Settlements. (2005). Central bank survey of foreign exchange and derivatives market
activities in 2004. Retrieved 13 June 2005 from [Link]

Bovenberg, L., & de Mooji, R. (1994). Environmental levies and distortionary taxation. American
Economic review, 94, 1085–1089.

Boyd, J. (2003). Water pollution taxes: A good idea doomed to failure? (Discussion Paper 03-20). Washington,
D.C.: Resources for the Future. Retrieved 7 November 2004 from [Link]
[Link]#search=’Water%20pollution%20taxes:%20A%20good%20idea%20doomed%20to%20
failure?’ (pp. 6–7).

China Council for International Cooperation on Environment and Development (CCICED). (2002).
In pursuit of a sustainable green west. Newsletter of the CCICED Western China Forest Grasslands Task
Force, pp. 7–9. Retrieved 24 May 2004 from [Link]
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European Statistics (Eurostat). (2004a). Statistics in focus: Environment and energy, Theme 8-9/2003.
Luxemburg: European Union.

European Statistics (Eurostat). (2004b). Structures of the taxation systems in the European Union. Data
1995–2002. Luxembourg: Office for European Publications of the European Union.

International Energy Agency (IEA). (2004). Retrieved 4 October 2004 from [Link]

Organization for Economic Cooperation and development (OECD). (2004). Retrieved 4 October 2005
from [Link]

Keeney, D., & Muller, M. (2000, September). Nitrogen and the upper Mississippi River. (Working paper).
Minneapolis, MN: Institute for Agriculture and Trade Policy. Retrieved 2 November 2004 from http://
[Link]

Keynes, J. (1936). The general theory of employment, interest, and money. Amherst, NY: Prometheus.

Ligthart, J. (1998). Optimal fiscal policy and the environment. (IMF Working Paper WP/98/146).
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Logo, P. (2003, January). The decentralized forestry taxation system in Cameroon: Local management and
state logic. Environmental governance in Africa. (Working paper No. 10). Washington, D.C.: World
Resource Institute, pp. 5–7.

Metcalf, G. (2002). Journal of Public Economics, 87, 313–322.

Ministry of Taxation, Denmark. (2002). Retrieved 17 August 2004 from [Link]

publikationer/udgivelser/1754/2anvendelseafafgiftsregulering/#id3032345

Oxfam. (2003). Dumping without borders: How US agricultural policies are destroying the livelihoods of
Mexican corn farmers. Retrieved 4 April 2004 from [Link]
[Link]

Palley, T. (2000). Destabilizing speculation and the case for an international currency transactions tax. Global
Policy Forum—Social and Economic Policy. Retrieved 5 December 2004 from [Link]
org/socecon/glotax/currtax/[Link]

Pemberton, M. (1998, October). Arms & environmental technologies. Foreign Policy in Focus, 3(31),
17-24. Retrieved 16 November 2004 from [Link]

Pigou, A. (1947). A study (3rd Ed.). London: Macmillan.

Powel, I., White, A., & Mills, N. (2002). Developing markets for the ecosystem services of forests.
Washington, D.C.: Forest Trends. Retrieved 7 April 2004 from [Link]
pdf/powellwhite_ecoservices.pdf

Sjolin, M. (1998). Environmental taxes in Sweden-Environmental taxes as a part of environmental accounts.

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Stockholm International Peace Research Institute (SIPRI). (2005). SIPRI yearbook 2004. Oxford
University Press. Retrieved 10 June 2005 from [Link]

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Notes
1
Energy taxes include taxes on carbon dioxide emissions and on energy products used for both transport
and stationary purposes. The latter consist of consumption of coal, electricity, fuel oils, and natural
gas; the transport taxes cover taxation on ownership and use of motor vehicles; and pollution/resource
taxes include taxes emissions that pollute air and water and taxes for the management of solid waste
and noise.
2
See footnote i.
3
Participating in the elaboration of the Forest Ecological Compensation Fund are the Canadian
International Development Agency (CIDA); the Australia Center for International Agricultural
Research (ACIAR); Ford Foundation; the World Bank; NGO Forest trends in Washington, DC;
and the Chinese Academy of Sciences.
4
PAC activities are defined by OECD as purposeful activities aimed directly at the prevention, reduction,
and elimination of pollution or nuisances arising as a result of production processes or the consumption
of goods and services. This definition excludes expenditures on natural resource management and
prevention of natural disasters and hazards, on nature protection (such as the protection of endangered
species or the establishment of natural parks and green belts), and on exploitation and mobilization of
natural resources (such as the supply of drinking water).
5
Agenda 21 is a comprehensive plan of action to be taken globally, nationally and locally by organizations
of the United Nations System, governments, and major groups in every area in which humans impact the
environment. This plan was adopted by more than 178 governments at the United Nations Conference
on Environment and Development (UNCED) held in Rio de Janerio, Brazil, 3–14 June 1992.

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C H A P T E R 6.
EFFECTIVENESS OF
E N V I RO N M E N TA L F I S C A L P O L I C Y

Fiscal policy ensuring sustainable development is subject to an intensifying

discussion among economists, environmentalists, and politicians. Understandably,
any change in the system of public spending, taxation, or subsidization (called also
“negative taxation”) causes modification of the economic and social environment and
may result in substantial redistribution of wealth among businesses and social groups.
In general, environmental fiscal policy around the world has few interrelated objectives:
(a)environmentally friendly behavior of producers and consumers; (b)transfer of
funds from polluters to environmentally friendly producers and consumers; (c)
appropriate restructuring of the economy and/or companies (use of nonpolluting
and energy saving technologies, introduction of technologies and products that
suggest use predominantly of renewable energy sources and renewable raw materials,
recycling, and so on); (d) generation of budget revenues necessary for financing social
and environmental government or municipal programs; and (e) fulfillment of the
environmental standards of the domestic and world markets.
Unfortunately, in most countries, fiscal policy does not yet support sustainable
development. One of the main reasons for the present poor condition of the environment
and social conflicts is the delayed placement of fiscal barriers to environmental
pollution. In one form or another, polluting companies realized additional profits for
subsidized energy and raw materials, and they transferred the negative effects to the
whole of society. The application of economically significant (and not symbolic) fiscal
charges on the polluters started only in recent years. The first results are encouraging
because they prove the inverse proportionality between the rate of these charges
and the quantity of the emitted pollutants. The fiscal disincentives prove to be an
exceptionally powerful tool having positive effects even in the short run. The problems
now are how to make this policy a universal practice for all countries and how to
combine private business interests and public interest in the short- and long runs.

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Widely used policy of subsidization continues to be one of the key factors in

market distortions, deterioration of the principles of fair competition and real support
of environmentally dangerous production technologies, production of environmentally
risky goods and services, or any combination of these factors. Currently, the total
annual amount of subsidies worldwide is estimated at some 800 billion dollars.
Besides industry, a lion’s share of these huge budgetary funds goes toward subsidizing
agriculture, including the use of such things as synthetic fertilizers and pesticides and
fuel and lubrication materials. Mainly through indirect subsidies, transport—one of
the chief pollutants of the environment—also achieves such budgetary injections.
Besides subsidies, transport vehicle manufacturers also receive additional incentives in
the form of tax concessions.
With the achievement of certain positive effects (increase in production volume,
higher price competitiveness, foreign currency receipts from exports, more jobs, and
so on), such fiscal policy, in its essence, stimulates nonsustainable development. This
negative influence has three interrelated dimensions. First, market principles are
violated, and conditions for ineffective distribution and use of capital are created.
The positive effects in the short run are, by far, smaller than the losses for society in
the long run, as a result of the incentive application. Second, the higher energy and
material intensity in the manufacturing of a unit of production is stimulated, which
automatically means greater consumption of nonrenewable and renewable natural
resources and more intensive emission of soil, water, and air pollutants.
Such incentives slow down the process of technological and product renovation
because part of the production costs is covered at the expense of the state budget. Third,
the blocking of such huge amounts of budgetary outlays causes a “crowding-out effect”
for alternative budgetary investment for the purposes of sustainable development,
including applied research; incentives to the application of environmentally clean
technologies and the production of environmentally friendly products; change in
consumer behavior; regeneration of the environment; construction of efficient social
nets; facilitation of access to and improvement of the quality of public healthcare,
education, and social provision, and so on.

Policy Instruments for Achieving Sustainable Development:

Mechanisms and Results
Sufficient proof shows that fiscal instruments—taxes, charges, and fines—lead to
positive changes in the behavior of manufacturers and consumers when the instruments’
levels and the organization of their collection are adequate to the conditions at hand.

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More effective is not the higher but rather the sufficient tax. In other words, achieving
the desired change in behavior with the lowest possible tax burden is what should be
strived for because when this behavior leads the system of fiscal priorities, the amount
of tax receipts is of secondary importance.
Such is the case with taxes and fines in the use of batteries, including for motor
vehicles, which are a part of the ecotax system of the European Union. These taxes
are applied together with technical standards and norms banning the production
of a particular type of battery (alkaline-manganese batteries containing more than
0.025 percent of their weight in mercury). The products meeting the standards are
fiscally stimulated to reduce the content of these heavy and toxic metals—mainly
cadmium, lead, and mercury—in batteries to a minimum; thus, precious metal
consumption is reduced and the emissions of toxic substances in the soil and waters
are limited. That in a number of cases the producer companies would rather enter
into voluntary agreements with governments for improving the ecological parameters
of their products instead of coming within the provisions of the taxation system is
positive. Consequently, we are witnessing such situations as the one in Belgium, where
some developed, but not applied, taxes indirectly bring about alternative solutions to
problems, with the same final effect.
Thanks to the voluntary agreement between the EU countries in 1997, the
exemption from ecotaxes is given on the condition that the seller of batteries shall
organize his or her collection and recycling upon expiration of his or her service life.
To harmonize the interests of producers (sellers) and buyers (consumers), the latter get
back up to 50 percent of the tax generally included in the selling price when recycling
used batteries. This is a strong enough stimulus to make consumers not treat batteries
as solid waste but to take them to collection points for some compensation. (This
practice involves chiefly automobile batteries.) Another positive effect of these tax
instruments is the increased production and consumption of rechargeable batteries,
which have extended life cycles.
Here we have a combination of economic and environmental effects that has
become possible with the introduction of fiscal incentives changing relative prices of
the various battery types. According to a study by ECOTEC et al. (2001), because of
the comparatively low price of batteries, the higher price of batteries resulting from
the inclusion of the ecotax in the supply price (weighted 20 to 30 percent) has not
changed the elasticity of demand. Of importance is that the relative price of batteries
compared to the devices wherein they are used is important; the cost of motor vehicles,
and even of CD players or toys, is many times higher than that of batteries. With few

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exceptions, batteries do not have alternatives in the use of these devices—they are
interrelated goods.
In the period 1990–2000, the Italian nonprofit consortium COBAT collected for
recycling a total of more than 1.5 million tons of batteries that contain highly toxic
metals and chemical compounds. COBAT’s activity is funded by the receipts from
the selling price tax increase. The physical recycling of the product coincides with the
financial recycling of tax receipts into economic incentives for environmentally clean
production and nonpermission for the product to turn into toxic waste.
The fundamental problem with symmetry in the placement of tax burden on
those manufacturers and consumers that cause the greatest harm to the environment
has not been solved yet. Comparative analysis shows that the tax burden is still on the
shoulders of households. This is because they usually pay a greater relative share of
taxes compared to the share of households in the total amount of air, water, and soil
pollution with various harmful emissions. Even in Sweden in the 1990s, the processing
industry’s share in the provision of ecotax receipts was only 7 percent although this
sector of the economy generates almost 30 percent of the country’s carbon dioxide
emissions. The transport sector accounts for 20 percent of these emissions but covers
only 11 percent of tax receipts.
At the same time, households pay ecotaxes included in the end-consumer prices
on energy carriers, the share of which is considerably higher than their “contribution”
to the pollution of the environment. In Sweden, Norway, and Denmark, whole
economic sub branches characterized by high energy intensity are practically exempt
from ecotaxes because the tax receipts are returned to the companies in the sector,
meaning that tax receipts are recycled and their role as tools for changing manufacturers’
short-run behavior is eliminated.
This approach has gained wider application in the EU. In 2003, the UK activated
its ecotax policy by introducing the Climate Change Levy as an attempt to reach a
turning point in global warming tendencies. The Climate Change Levy is an energy
tax that, depending on the type of energy used, is differentiated as 0.43 pence per
kWh for electricity, 0.15 pence for coal and natural gas, and 0.07 pence per KWh for
liquid petroleum. This tax is 80 percent lower than in the energy intensive branches,
which are placed in a privileged position. Here, too, as in the Scandinavian countries,
the motive for tax privileges is the preservation of the “national competitive capacity.”
Although the tax on the use of coal and natural gas is the same, the difference in the
volume of pollution from use of the two energy sources is dramatically different. This
is because England is rich in coal deposits, and coal’s relative price is considerably

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lower than the price of most other alternative energy sources. Despite this, exempting
the use of renewable energy sources (solar and wind energy) from energy tax can be
considered positive.
Tax privilege is granted to electricity companies burning fossil fuels to produce
heat and electric power at the same time, which creates an increase in utilizing energy
source efficiency from about 20 percent to more than 60 percent. The realized budget
receipts from applying this energy tax reach one billion British pounds (GBP) per
annum, which is used for funding various environmental programs and reducing
social security payments of employers; thus, polluters pay principle, and the principles
of tax neutrality are combined.
These tax exemptions and tax recycling erode the basis of the ecotax mechanism
and strongly dampen its influence on the behaviors of companies and consumers.
Apprehensions about possible damages to the competitive capacity of the production
of the sectors concerned has always been pointed to as a main reason for the rather big
compromises of the producers of products with markedly high energy and material
intensity. This argument can and must be eliminated if the World Trade Organization
makes more efforts and succeeds in regulating the conditions and methods of ecotax
application by all member countries, including in those sectors with markedly high
energy and material intensity. As is the case with the stage-by-stage approaches for
lowering the overall level of import customs duties and other nontariff restrictions on
trade, mutually acceptable periods of time can be agreed on in which the level of these
taxes should increase gradually, until the taxes become equal to the level applied to all
other sectors of the economy.
The general application of these taxes will preclude the possibility to further use
the argument of damaged competitive capacity. I do not see any problems, in those
cases where various countries apply tax weights differently, with applying the Border
Tax Adjustments1, yet enough reliable and well-known mechanisms exist that would
guarantee the preservation of sufficient profitability for producers and would create real
economic incentives for the reduction of energy and resource consumption—especially
of nonrenewable natural energy and other material resources—at the same time.
We can conclude that perfecting the differentiation of ecotaxes between businesses
and the households is necessary. The reduction of GHG, for instance, can be achieved
at various economic costs. Considering that this price has been proved to be lower in
the business sector, the present fiscal policy, in which ecotaxes have traditionally been
higher for households, is also subject to reassessment. This approach is not consistent
with the facts that the main polluter is business and not households, and that for the

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national economy, it would be cheaper to apply this tax mechanism more strictly to
industrial enterprises. The government of the UK should ask themselves how long
corporate interests should have priority over public interests and how long the profit
rates for polluters will be more important than the social and economic benefits for
all of society.
Introducing or increasing ecotaxes turns out to be an effective means for changing
the behavior of consumers. In general, price has an informative function with regard
to the quality of the goods or services sold; when all other conditions are equal, the
higher the price, the greater the expectations about the quality level. This is a natural
expectation because the creation of higher quality requires greater production costs.
The dependency between ecotaxes and reliability (quality) of a product is inverse.
As Brown (2001) points out, when an ecotax is levied on a certain product or when
this tax is increased, the change is a signal to consumers that the particular product
is “bad,” because it harms the environment or is risky for human health. This signal
induces less demand for such “bad” goods.
Buyers, especially in developed countries, show a growing sensitivity to the
environmental cleanliness of consumption goods. If the price of a particular good is
heightened because of the product’s additional taxation from an ecotax, this signals a
compromise with the quality of the goods and contributes to the negative elasticity of
demand, and vice versa. Consumers are apt to buy comparatively more expensive goods
if the higher price is because of higher production costs for achieving these quality
parameters. A good example of this is the expanding market for “organic agricultural
products,” for the production of which non-chemical fertilizers are used. The same
applies to meat produced by excluding hormone stimulants or genetic altering for
growth. It is not surprising that a great demand exists for new hybrid automobiles,
despite their comparatively higher market prices.
The application of new ecotaxes provides companies with an opportunity to
choose; they are released of ecotaxes if they undertake voluntary, proactive measures
to improve the technologies, energy and raw material sources, or both, which would
lead to certain reductions of pollution. These “voluntary” measures are induced by
the alternative to pay additional taxes. The companies can avail themselves of the
alternative to invest their revenues in some pro-renovation instead of paying penalty
taxes. In England, for instance, such companies can use up to 80 percent exemptions
from ecotax obligations if they sign voluntary agreements with the government to
reduce particular kinds and quantities of specific pollutants. A similar practice has
been applied in Germany since the 1990s—in 1998, the representatives of businesses

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from the nuclear power industry signed a voluntary agreement with the government
for stage-by-stage decommissioning of nuclear reactors and replacing them with
renewable energy sources.
The advantages and disadvantages applying one or another form of taxation or
the level of taxes remains subject to discussion. Two main assessment criteria are used
in these discussions: (1) the collectibility of taxes and the amount of budget receipts
and (2) the degree of influence on polluters (producers and consumers). According to
the first criterion, fiscal efficiency is considerably higher when ecotaxes are collected
as early as the import or the local mining of natural resources in the form of excise
tax, compared to their being realized by means of an additional increase in the sales
tax or the value added tax (VAT). This is because the collectibility of excise taxes
is considerably higher because, in its essence, collection of the VAT precludes the
possibility to evade tax obligations and is based on a wide enough tax base. Taxation in
the consumption phase generally limits the tax base because intermediate consumers
use tax credit, meaning that the collected VAT is returned to the taxed entities.
An exception exists only with the producers of an end product—the buyers
(the final users. It happens, however, that the burden of taxes against environmental
pollution is transferred from the polluters (producers) to the end consumers, which is
a violation of the “polluter pays” principle. The costs for administering the excise tax
system are considerably lower than other taxes because they are collected at the point
of import. In addition, such a mechanism of tax collection avoids tax evasions and
therefore ensures the implementation of the “polluter pays” principles.
Environmental fiscal efficiency depends on the price elasticity of the consumed
resource subject to taxation. Ramsey (1927) noted that differentiated and high taxes
on those resources, the price elasticity of the demand for which is feebly expressed,
generate considerably higher revenue than does a lower, uniform tax. One example
of high tax revenues is the taxation on energy resources (oil, natural gas, and coal, for
instance) that have comparatively low price elasticity, especially markedly expressed
in the short run; thus, the increase in the price of the end product would not have
as strong an effect on shrinking demand as taxation would have on importation or
mining of the natural resource.
From this viewpoint, applying tax mechanisms “on entering the system” has its
advantages with regard to (1) the changes it can cause in the behaviors of producers and
consumers and (2) budget receipts provided. Of course, increasing the positive effects
and minimizing the negative results of applying one or the other system of taxation
can be achieved by targeting both objectives (high revenues and changed behavior)

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at the same time. Naturally, such a combination presupposes careful balancing of the
ecotax burden within the bounds of general tax obligations. Achieving a particular
environmental effect should not be done by violating other economic incentives on
which investment activity and market equilibrium depend.
Methodological similarity exists between the dilemma of taxation at the entrance
(input) or the exit (output and consumption) of the economic system. The choice
between uniform or differentiated ecotaxes is another dilemma for policy makers. The
differentiation of taxes has undoubted advantages because it enables the placement of
a bigger tax burden on those manufacturers and consumers who are the chief culprits
for pollution by specific physical volume. The differentiation also has the advantage
of stimulating, to a greater extent, the companies implementing environmentally
expedient technologies and production, reorganizing their production to eventually
achieve a substantial decrease of these emissions.
Undoubtedly, this approach is more equitable because the biggest polluters pay higher
tax rates per unit of pollution compared to the companies moving along the trajectory of
sustainable development. It should also be considered that the same emissions of harmful
production waste, in terms of volume, have a different effect on the environment depending
on the already-accumulated concentrations of pollutants. In other words, the utmost effect
of pollution is considerably higher in those regions where pollution has already reached
critical levels and the existence of the ecosystem is threatened or where serious hazards for
the health of people living in the area are created.
The opportunity cost of applying differentiated taxes, however, is rather high.
Large tax administration is necessary, as are permanent measuring and monitoring of
the main pollutants. The greater the number of pollutants—a function of the quantity
parameters set up for taxable levels of pollution—the higher the tax costs will be. In
a number of cases, the administrative costs may be equal to, or even higher than,
the monetary value of the achieved positive environmental effect. Such discrepancy
between costs and benefits, at the expense of the benefits, makes the application of
differentiated approach economically inexpedient, and the application of this approach
makes the discrepancy equally inexpedient. If the benefits (tax revenues, reduced
harmful emissions, regeneration of the ecosystem, improvement of natural conditions
for living, reduction in the budget outlays for reestablishment of environmental
equilibrium) are greater than the costs for administration of a preferential tax system,
the application of a lower, universally valid tax rate would be advantageous.
Consequently, it would not be right to claim a priori which of the two approaches
is more efficient; it is first necessary to clarify the tax policy’s objectives and priorities.

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Different policies may aim at different objectives, including increased budget revenues,
reduced overall pollution, or reduction of the pollution in specific regions where it
has reached critical values. The other point of reference when deciding on the issue
should be determined after a detailed cost-benefit analysis, which could determine the
net economic effect of applying differentiated or uniform tax policy in the particular
circumstances.
The efficacy of tax instruments can be determined on the basis only of comparative
analysis with the other mechanisms for achieving the goals of sustainable development,
including the trade with emission permits; technical and health standards; permissible
volumes of pollution, charges, fees, licensing and license withdrawals; and some others.
Tax instruments have several substantial advantages, including the following.
They leave some freedom for the company to make an adequate decision based on
two monetary assessments, first, of the measures (staff qualification improvement,
production reorganization, transition to alternative sources of raw materials and
energy, replacement or perfection of production technologies, treatment facility
installation, and so on), that should be taken to reduce harmful emissions, and
second, of the due ecotaxes. This freedom of choice is especially important to
companies because it enables them to form their investment policies on a long-
term basis. At the same time, the tax authorities can influence these decisions
through changes in tax rates, depending on the objectives set and according to the
period of time and necessary company costs for avoiding tax sanctions.
I stress that in most cases, the change in the behavior of polluters is more
important than the realization of tax receipts. A proof to this effect is the commonly
applied practice of recycling these tax receipts back, in favor of the producers, with
the express condition that the recycled taxes be used entirely for improving the
environmental parameters of production or consumption. Substantial in this case
is that the total costs for reducing harmful emissions are lower that the total cost
related to compliance with other technical requirements, quantitative restrictions,
or market incentives. Smith (2003) argued that such tax system creates conditions
for the realization of the “static efficiency.”
As a subsystem in the general taxation system, ecotaxes can be used as an active
element of fiscal policy, contributing to the improvement of the overall investment
climate and to the raising of purchasing capacity. The ecotax reform has a twofold
positive effect. Aside from creating incentives for reducing pollution, ecotax reform
creates a more favorable investment climate through the parallel decrease of taxes
on income from labor and capital. This investment climate improves the conditions

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for economic growth. The growth of GDP increases the income levels, enhances
employment, and reduces the need for budget outlays for social compensation
programs. This releases budgetary funds for environmental programs, workforce
prequalification, national infrastructure improvement, and so on.
The uniform tax mechanism is the most markedly advantageous compared to the
other instruments if we consider the costs to administer the other instruments. The
difference in the volume of these costs is especially sensitive when a multitude of
comparatively small companies (in terms of pollution) exists. In such a case, the
total administrative costs for determining permissible levels of pollution (different
for each company because of the difference in the energy sources, feedstock and
materials used, utilized technology, locations, financial standings, and so on)
become rather high. Additionally, in those cases where only the biggest polluters
are monitored, these smaller companies that are not covered by this monitoring and
control often resort to the system of sub-supplies. In this way, evading the imposed
restrictions is done at the expense of the environment and people’s health.
The use of excise taxes is most markedly advantageous when applying the criterion
of administrative cost value for implementing various influencing mechanisms. Tax
administration is done when a resource enters the system (import or local mining),
irrespective of the company, branch, or conditions for production under which
the energy or raw material is used. This process contains one basic disadvantage
of the uniform tax system, however: the impossibility of showing flexibility with
regard to the bigger polluters in those areas where the critical pollution levels have
already been reached or exceeded. This drawback of environmental tax efficiency
can be overcome by using differentiated taxes on the condition that this approach
is cheaper or more efficient compared to a unit of cost of applying the alternative
mechanisms (differentiated taxes) for influence. Bear in mind, however, that
experiences in OECD and non-OECD countries show that tax system simplicity
has clear advantages compared to differentiated taxes that are too complicated and
expensive to manage.
To conclude this analysis, we can say that the determinant criterion for assessing
comparative efficiency should be the correlation between the environmental effect
expressed in monetary terms and overall costs on the alternative mechanisms to achieve this
effect. These overall costs include both costs for companies and administrative costs of the
authorities applying the mechanisms. We will examine some new aspects of this comparative
analysis after further analyzing the other two main mechanisms for influencing ecotax
application—trade with emission permits and subsidization of ecological programs.

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Using a wide spectrum of fiscal instruments proves its reliability and efficiency
as a tool for achieving a particular model of social and economic development,
meeting the criteria and purposes for public development. Using suitable economic
incentives makes possible the change in the behavior of market subjects. In some
cases, this can give rise to problems with short-term profitability; in such cases, the
state can render direct or indirect fiscal support, which should neutralize, or at least
limit, any possible losses for producers. It is entirely possible for governments to
balance the environmental, social, and business goals in the medium- and, especially,
long run. We can assume that the efficiency of fiscal mechanisms is enhanced when
the mechanisms are well coordinated and applied jointly or consecutively with other
mechanisms and approaches. An example of this is the binding of ecotaxes, charges,
and fees with technical standards or other administrative restrictions. Because the
latter are, and should be, a variable value reflecting the development of science and
technology, the fiscal instruments should also presuppose sufficient flexibility in
their application.
The main challenges facing fiscal policy for sustainable development are its
coordination on an international level and its placement on the basis of generally
accepted principles. Acceptance of common principles does not mean that certain
national differences and approaches cannot be preserved, however. In the same way
that one universal macroeconomic policy does not and cannot exist, fiscal policy—
one of macroeconomic policy’s chief mechanisms—should not be universalized.
Differences among individual countries are many, including in economic structures;
in the extent and localization of environmental pollution, peculiarities of the national
policies for social protection; and in budgetary possibilities for the realization or
support of environmental and social programs. These differences should be examined
as grounds for looking for national solutions within the framework of the generally
accepted principles, however, and not as excuses for not applying these principles.
I believe two main reasons require the acceptance of common principles for fiscal
policy toward sustainable development. The first is that, as we discussed in an earlier
chapter, environmental pollution has a cross-boundary nature, and some of its forms
encompass the whole planet. It would not be acceptable for one or more countries
to suffer from the environmental consequences of the insufficiently active or wrong
fiscal policy of a particular polluting country. It is hardly feasible that the taxpayers of
Country X would agree to fund the achievement of environmentally clean production
and consumption if its neighboring countries, like Country Y, continue to pollute the
whole region. The fact that such islands of environmental cleanliness are unachievable

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presupposes common fiscal policy, taking into consideration the capacity and condition
of the countries from a particular region.
The second main reason for accepting common principles is contained in the
international division of labor and world trade. When we consider that all fiscal
instruments directly or indirectly influence the price of production, the preservation
of the principles of competitiveness and equality of producers requires a particular
harmonization of national and fiscal policies, including tax policy. In fact, the
violation of this principle of nondistorted competitiveness gives an advantage to the
polluters of the environment and to the consumption (both production and personal)
of nonrenewable natural resources, but, a substantial difference exists in the export/
import environmental tax policies among countries or group of countries.
These differences still exist, despite the WTO’s attempt to harmonize these taxes
through a Board Tax Adjustment (BTA) mechanism and despite the call for trade
liberalization and globalization. The North American Free Trade Agreement (NAFTA)
exempts government subsidies for oil and gas exploration and development from trade
challenges (article 608.2). In this way, country-members of NAFTA may continue to
subsidize this exploration in contradiction with the criteria for sustainable development.
This agreement prohibits the imposition of export taxes that exceeds those applied to
domestic consumption (Article 605). In addition, NAFTA agreement allows the US to
a proportional share of Canadian energy resources in perpetuity or until the Canadian
resources are fully exhausted (Article 605). With good reason, the WTO (1999) argues
that such tax exemptions and one-sided preferences are in contradiction with the WTO
rules—particularly Articles II, 2(a) and III, 2 of its agreement. Similar violations of the
basic principles for fair competition on the domestic, regional, or world marketplace,
unfortunately, are still not exclusive. That is why WTO must continue its efforts for
gradual phaseout of such distorting subsidies. From this perspective, the implementation
of effective BTA would have a double effect: establishment of justified principles for
international trade competition and better opportunities for implementing export/
import fiscal stimulus for sustainable development.
Understandably, an attempt at better coordination and harmonization of fiscal
and other policies for sustainable development does not exclude certain national
or regional specifics. Each country has the right to decide which fiscal or other
instruments it will use to achieve its standards of environmental effect and pollution
level, to what extent, in what relation, at what scope, and so on. Naturally, determining
the standards at an international level is a complex process, requiring efforts and
certain mutual compromises. The experience of the European Union shows that the

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acceptance of common bans, standards, and norms or quotas for the kinds and the
admissible quantity of pollution is often more difficult than the coordination of fiscal
policy. From this point of view, fiscal tools are easier to apply and can be put into effect
more quickly than are environmental standards.
Fiscal policy, from the aspect of the social dimension of sustainable development,
should be determined by both the governmental institutions of the respective country
and the model of social and economic development chosen by the government.
The dependency between the poverty factor and the environmental balance has
been proved; consequently, poverty eradication cannot be realized by less-developed
countries. Obviously, these countries need international financial, technological and
institutional support from the developed countries and international organizations.
Solving environmental problems helps solve the problems of poverty, and vice versa.
In this sense, the social and environmental aspects of fiscal policy are interrelated.

Environmental Fiscal Policy and Competitiveness

What can be the external sources of funding for ecofiscal policy? First and
foremost, the expectations for such funding should have their logical grounds. The
oxygen produced and carbon dioxide absorbed by tropical forests are global benefits,
expressed in the provision of 25 to 30 percent of the planet’s oxygen. This benefit is
available to all and is not subject to sale or purchase. The conservation, maintenance,
and expansion of forests, however, are within this economic system; hence arises the
need to search for sources of such funding as well as the principles and institutions
through which the funding can be realized. Several potential sources for this funding
exist. These include
1. redistribution of a part of receipts from energy and transport taxes. The countries
with the greatest consumption of energy resources are among the chief polluters
of nature, and especially of the air. The reference criterion for the manner of this
budget restructuring should be “the environmental return per unit of budget
expenditures.”
2. the introduction of new taxes on highly profitable business activities that have,
until now, been beyond the scope of fiscal liabilities, as were, for instance, the
speculative foreign exchange transactions.
3. restructuring of the budgetary outlays in favor of environmental programs, the
greatest potential being in the reduction of military expenses, which vary from 2 to
7 percent of GDP in developed countries (excluding Japan, where a constitutional
restriction controls the share of these outlays to 1 percent).

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4. introduction of ecotax by the countries that, because of economic and political

considerations, still do not apply such an instrument.
Japan is still in the process of discussing such a law of environmental taxation,
although, despite its economy’s high technological level, carbon dioxide emissions
continue to grow. Preliminary assessments show that if a tax of Japanese Yen (JPY) 1
per liter is introduced, which means JPY 3,400 per ton of carbon dioxide emissions,
emissions will be reduced by approximately 10 percent. Recycling receipts from this
tax for direct subsidizing or for tax credit (indirect subsidizing) of the companies
using energy saving and clean technologies, as well as for increasing the areas of forest,
would make possible a reduction of carbon dioxide emissions by 6 percent from 1990.
According to Shimbun (2003), in this way, Japan would fulfill its commitments under
the Kyoto Protocol.
To be just, I should point out that levying a new ecotax on oil and other fossil
fuels would complicate Japan’s administration, considering that oil already has seven
other taxes (including a road tax, import tax, tax for funding overseas investments in
oil projects, and consumer tax) levied on it. The total budget receipts from these taxes
in the fiscal year 2003 amount to approximately USD 4.2 billion.
Miura (2004) estimates that the introduction of the new tax could increase the
country’s receipts by JPY 1 trillion (approximately USD 840 million). Considering
that the discussed ecotax concerns all consumers of fossil fuels, we can logically
presume that it will have a short-term negative effect on the production costs of
companies in heavy industry. The expected increase of costs for the steel industry
reaches JPY 150 billion (USD 1.26 million). The targeted use of receipts from oil taxes
is also interesting; of a total JPY 3 trillion (USD 2.5 billion) receipts from these taxes,
only JPY 76 billion (USD 639 million), or 25 percent, is used for direct funding of
environmental programs. The rest of the funds are used for repair and maintenance of
the country’s road network.
This data implies that the efficiency of the ecotax policy depends not only on the
level and structure optimization of various taxes but also on the use of the raised funds.
Governments often divert these funds for activities that bring them political dividends, as
is the case with road maintenance in Japan. In fact, this is a common practice, which only
proves that environmental taxes are still low; their tax base is limited; their management
is often in discrepancy with the main objective of their application; and the condition
of the ecotax system is rather disheartening, considering that even highly developed
countries like Japan and the US have not yet introduced such a general ecotax.

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Other developed and developing countries also argue the negative effect on price
competitiveness for not implementing an ecotax. The US firmly refuses to introduce
such ecotaxes, which is related to the country’s unwillingness to subscribe to the Kyoto
agreement. Such is also the position of Ireland, where the idea of introducing such a
tax was sharply met by the business organizations in the country; through the lobbies
of these organizations in the parliament and the government, the introduction of
the tax was blocked at its very conception. The argument was that taxation of the
fossil fuel consumption will increase the end price by too much and that the result,
expressed in a reduction of emissions by only 0.5 million tons per year, does not justify
such a price increase. Clearly, the planning and assessments of the Irish government
differ radically from those of the EU member countries, and even from those of the
UK. The US generally accepts the goals to reduce harmful emissions in the air, water,
and soils and share intentions to reduce the emissions of greenhouse gases (GHG), but
they defend the thesis that this goal can be achieved by means other than ecotaxes.
As we have already discussed, because of purely political motives, the US does not
wish to introduce any new tax rates and mechanisms even if the mechanisms are based
on the principle of tax neutrality. The US administration would rather use other tools
such as technical standards, the national carbon emissions trading system, voluntary
agreements between producers and environmental government agencies, and budget
support for developing environmentally expedient technologies. In other words, it
relies chiefly on other market mechanisms, the legislative basis for which was laid
with the passing of the Clean Air Act amendments as early as 1990. This position is
unacceptable because no one contests and excludes the use of market tools for solving
the environmental and resource-related problems. The same market tools are used in
many countries around the world. The issue here refers to expanding the system of
tools used and, eventually, optimizing the economic policy in accordance with the
criteria for sustainable development.
The counterarguments presented by the US government constitute an attempt to
use pseudo-scientific arguments for protection of obvious lobbyist interests. Thus, the
implementation of the “polluter pays” principle is restricted, with all resultant effects
not only for the country’s ecosystem but also for the environmental equilibrium in
global terms. In any case, the US produces one fourth of the world’s carbon dioxide
emissions, and its per capita annual waste is 720 kg, which is nearly twice as high as
in Germany and Japan and four to five times higher than in developing countries.
Approximately the same proportion is valid for the ratio between GDP per capita and
the “ecological footprint” (see Rees and Wackernagel, 1996).

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Grounds exist to support the claim that the ecological footprint can be used to
determine the fiscal responsibilities of various countries. With all other conditions
equal, higher levels of this ecological footprint presuppose, on one hand, a wider
basis for applying an adequate system of environmental taxes, and, on the other
hand, adequate mechanisms for redistributing part of these tax receipts in favor of
countries that have a positive “environmental trade balance.” The latter is expressed
in the fact that, in reality, the land and natural resources of developing countries
are used for the provision of many times greater demand in industrially developed
countries, so this greater demand is to be blamed for the accelerated extraction and
export of nonrenewable resources. It would be absolutely justified for a certain share
of the environmental taxes collected in developed countries is transferred back to the
developing (exporting) countries.
The ecological footprint shows how much ecologically productive land and water
a defined population unit needs to support its current consumption and take care of
its wastes. According to estimates by Venetoulis, Chazan, and Gaudet (2004), the US’s
ecological footprint is the equivalent of 9.57 hectares per person, whereas in the countries
with analogous technological and economic development, this indicator is far lower:
Germany (4.26 hectares), the Netherlands (3.81 hectares), Italy (3.26 hectares), and Japan
(3.91 hectares). The ecological footprint is an excellent point of reference for binding the
stress placed on the environmental system with specific fiscal responsibilities.
For nearly a decade, international efforts have been in search of common approaches
for solving environmental problems so as to place countries on an equal basis. The only
hope comes from the fact that, after some doubts, Japan accepted the EU position.
Russia ratified the Kyoto Protocol in October 2004 and cleared the way for adoption
of the treaty. I expect that, although at a later stage, the US will also subscribe to the
set of fiscal tools recommended for all countries that have signed and ratified the Kyoto
agreement. The United States’ support is of crucial importance because this country
accounts for 35 percent of the world emissions of greenhouse gases.
Hoerner and Muller (1996) propose a system of criteria that can be used for assessing
measures for overcoming any possible unfavorable consequences for the competitive
capacity that may result from the introduction of broad-based environmental taxes.
These five criteria include effectiveness, environmental incentive, administrability,
fairness, and revenue loss. The authors convincingly defend these criteria, but I
believe that the criteria should be more closely bound to the end environmental and
social effects. For instance, to precisely assess the environmental effect, we need to
measure not only lost tax revenues but also budget expenditures saved as a result of

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the achieved lower pollution level. With a specific policy achieving a greater reduction
in budget expenditures for regeneration of the environment compared to the reduced
tax receipts is entirely possible. In such a case, the net effect on the budget would be
positive; thus, funds would be freed for expanding the environmental programs or for
additional funding of programs with social purposes.
In fact, it would be expedient to add one more criterion—the social effect of
the chosen compensatory mechanisms. The greater price for taxpayers for supporting
the required administration, for instance, could be offset by opening new jobs from
levying the ecotaxes. Because restructuring the economy is sought in the direction
of energy- and material-saving productions, such a restructuring involves changes in
employment, including greater demand for labor. Another social effect of reducing
environmental pollution is better health of people and lower healthcare expenditures.
The basic approach of tax neutrality means that the ecotaxes will be offset by lower
taxes on labor and capital. The latter implies more investments and greater demand
for the labor force in addition to increasing income for households. Consequently, the
additional criteria that I have proposed would allow for a more complex assessment of
environmental tax and its influence on market competitiveness.
The arguments that the possible introduction of ecotax will have a negative effect
on business and the purchasing power of households are not justified. Foremost, a
change in tax environmental legislation is generally accepted as neutral with regard
to overall tax level. In other words, introduction of a new ecotax will be accompanied
by an adequate reduction of the tax on the other two production factors—capital and
labor. The goal, through the restructuring of the whole taxation system, is to achieve
a concrete target effect without increasing the overall tax burden; thus, the “twofold
effect” can be interpreted as a simultaneous reduction of both pollution and the total
cost for the tax policy’s implementation.
The European Commission (2004) published a study on the economic and
environmental impacts of environmental taxes and charges. The study concludes
that the implementation of new or higher taxes and charges on energy, nitrogen
oxides, water abstraction, waste water, pesticides, mineral surpluses and fertilizers,
landfill, aggregates, packaging, and batteries would have zero or negligible effect
on the EU’s economic competitiveness. The reason for such encouraging “trade-
off ” between environmental quality and competitiveness is the tax neutrality
approach: Lower taxes on corporate profit and household income and lower social
security contributions compensate for higher environmental taxes. For example,
if the EU’s minimum tax rate level is increased to 15 Euro per ton of carbon

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dioxide emissions, coal prices would rise but macroeconomic impacts would
remain negligible.
In other words, new or increased environmental taxes would cause price increases,
which would be limited to particular sector or companies. In addition, such a price
effect would have short-term effects when viewed through the analyses of relative
prices between economic sectors. The main conclusion is that, if well-balanced and
gradually implemented, environmental taxes and charges lead to better environmental
quality at a low, fully acceptable economic price. Furthermore, in many cases, such
environmentally friendly tax policy leads to higher economic efficiency in the long run
because of the fiscal stimuli for implementing environmentally friendly technologies,
products, or both.
Parry and Bento (1999) proved, through an econometric analysis, that the
optimal ecotaxes can actually generate additional social and economic effects when
the reduction of taxes on labor is in productions where taxes on labor distort the
relative prices of the groups of consumer goods. The elimination or, at least, reduction
of these distortions can help achieve a more rational choice of goods and consumer
behavior. It is an acceptable thesis that the effect is markedly strong when we discuss
correlations between relative prices of consumer goods and services, the production of
which is related to different intensities of environmental pollution.
As with any tool of economic policy, ecotaxes may cause short-term problems
in some sectors of the economy or for a particular group of companies. Particular
attention should be paid to those companies, which at the moment of introduction
of the new taxes are in poor financial situations. I support the consideration given by
Sterner (1994) that the Pigouvian tax discussed earlier in this chapter presupposes a
tax level that will make possible the reduction of maximum costs to the permitted
level of pollution. This level may turn out to be below the level of the expenditures
of the companies facing difficulties, meaning that the new tax may contribute to
these companies’ bankruptcies. The application of the Pigouvian tax, then, would
be politically unacceptable. For this reason, particular companies under specific
conditions prefer to use the tradable emission permits system, which would not have
such a direct influence on the financial standing of these companies.
Thanks to the neutral nature of the ecotax reform, the companies’ returns on
investment or rates of profit will not be reduced if the companies start paying such a
tax, but the rate of their payments for their workers’ social security or their own tax
on profit is reduced at the same time. The same approach is used for balancing the
tax burden that is transferred onto the consumers in the form of increased market

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prices as a result of the introduction or increase of ecotaxes on consumer products.

The combination of lower taxes on capital and household income and the reduction
of other direct and indirect taxes can neutralize this undesirable effect; hence, the
perfection of the ecotax legislation known as the Environmental Tax Reform
mentioned earlier, which is generally defined as a neutral tax reform. Without any
changes in the tax burden, a targeted effect is achieved and expressed in the changed
behavior of entrepreneurs and consumers, making both production and consumption
environmentally friendly.
The results of environmental tax reform carried out in some European countries
such as Norway, Denmark, and Sweden positively prove these expectations of
environmental friendliness. Undoubtedly, tax neutrality is a precondition for wide
political support from the electorate and business because tax policy has always been at
the heart of the election process. In any case, a particular change in tax legislation when
EU member countries are concerned can be made only by the country’s parliament,
the EU Parliament, or both.
The political dimensions of ecotax reform were the source of both controversies
among various countries and the unwillingness of some countries to initiate this reform.
It is true even for the EU, which has reached a high degree of economic, monetary,
and political integration. Fiscal policy is among the limited range of spheres where
the coordination and harmonization of national policies is still far from the desired
level, however. This “environmental fiscal disharmony” strengthens the apprehensions
of countries that have already begun the implementation of ecotax reforms that their
market competitive capacity may suffer should their example not be followed by the
other EU member countries and their main competitors in the international market.
At this point I would like to emphasize that, when analyzing the advantages
and risks involved in implementing the ETR, the double effect should be borne in
mind. The first effect is expressed in the reduction of environmental distortions,
and the second in the introduction of environmentally clean technologies, which,
as a rule, are more productive because their lower energy and material levels increase
market competitiveness. The effect at the national level would be similar—the fiscal
commitments of the country for payment of any possible international charges and
fees would be lower because of the more environmentally friendly production. Cleaner
production is saving environmental fees, fines and taxes and therefore decreases the
production cost, which in return increases price competitiveness. In addition, the
cleaner production and cleaner products are better accepted by importing countries
and by consumers from domestic markets.

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Achieving the double effect is aided by active fiscal policy through direct and indirect
subsidization of introducing environmentally friendly technologies and products. The
tools and fiscal techniques used may vary, including: the recycling of receipts (partially
or completely) from energy and other ecotaxes in favor of the companies taxed;
budget funding of national or corporate scientific research studies with environmental
effects; payment of export premiums for exporting environmentally clean products
or products manufactured by means of environmentally friendly technologies; and
subsidizing producers that revert to the use of alternative energy sources, restructuring
the feedstock basis from nonrenewable to renewable resources, or both subsidizing
and restructuring.
The data in Figure 6.1 illustrates two chief peculiarities—different retail prices
in various countries and the considerable oscillations in short-run prices. Both
peculiarities help illustrate the need for ecotax introduction on a global scale. If the
same tax rate is applied to all countries, the absolute value of tax will be quite different
for each country. The prices of unleaded petrol in Sweden were almost three times
higher—EUR 1.12 and EUR 0.42—than those in the US in January 2004. The
prices in the US are, on average, two or three times lower than those in the EU and
their other trade partners that are non-producers of oil. We will not dwell here on
the complexities of why gasoline is so cheap in the US, but the decisive factor is,
undoubtedly, the effect of economies of scale.

[Link] Petrol Price Fluctuations (in Euro), January–June 2004

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Source: Data from AA Roadwatch. (2004). Latest petrol prices. Retrieved 3

January 2005 from [Link]
The US is the largest consumer of oil products in the world, but in any case, the
application of a universal rate will have different tax effects, in terms of both tax burden
on companies and the value of budget receipts. In both cases, application of a universal
rate will reflect on the effects of the tax policy. For instance, a 1 percent additional
tax on unleaded gasoline, with all other conditions equal, means that gas will be more
expensive by 3.5 cents in the US but only by about 1 cent in the European countries
because of the difference in the absolute prices per gallon of gasoline. Eventually, the
relative prices will remain the same. We can assume that the application of this tax
should not change, generally, the relative prices of the product because this would
result in additional difficulties in reaching international agreements.
A possible solution to the contradiction between the uniform rate and the
preservation of relative prices could be applying the ecotax as an absolute value—1 or 2
cents per liter, for example. Although the percentage price increase will be different with
a different price basis for taxation, the absolute amount of the additional price burden
will be equal for all countries; the amount of the additional tax bears a relation to price
competitiveness. The above example also shows that the introduction of such a minimal
additional tax of 1/2 or 1 percent, or one cent, in EU countries has an unsubstantial
effect on the price compared to the other price factors. Within only six months, the price
of unleaded gasoline on the American market has grown by seven cents (20 percent),
in Poland by 12 cents (15 percent), and so on. For the period 1998–2004, the price
of crude oil fluctuated from about USD 10 per barrel to USD 50 per barrel; the price
fluctuations are within the bounds of 500 percent! Consequently, the argument that 1
percent of additional tax would make the price of oil products too high is absolutely
unacceptable against the background of these fluctuations.
The combined overall taxes on gasoline consumption gasoline (mainly in the form
of excise tax) are the main cause for the gasoline price differences among countries.
Figure 6.2. illustrates a dramatic difference in this tax among OECD member states.

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Fig.6.2. Tax rates for Unleaded Gasoline (in Euro Cents per Liter),
Selected OECD Countries, January 2005

Source: European Environment Agency (2005). Tax rates for unleaded petrol.
Retrieved 1 July 2005 from [Link]
In the US, the tax on gasoline is rather symbolic compared to other OECD
members. The tax ratio between the UK and the US is nearly 18:1! A similar ratio
exists between the US and the Netherlands or between the US and the Northern
European countries. Even the Eastern European countries in transition (Poland,
Hungary) have petrol taxes that are eight times higher than the US taxes. Obviously,
such tax differences not only favor the American economy and US export but also
supports the extremely high consumption of gasoline per capita in this country. The
latter directly affects the environmental quality in the US and all over the world,
causing global warming and an alarming increase of polluting emissions—carbon
dioxide, lead, sulfur and many other health-risky metals and chemicals—in the air.
What is even more alarming is that the US government has decreased this tax
from 5.3 Euro cents per liter in 2000 to only 3.9 Euro cents per liter in 2005. Such
a tax policy fully contradicts the attempts of the world community to further restrict
the consumption of nonrenewable energy sources and to limit the emissions of various
pollutants. The US government tries to explain such an environmentally unfriendly

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tax policy by claiming an attempt to soften the effects of higher prices on crude oil and
keep inflation under control I share the understanding, however, that the key problem
is not in crude oil prices but is obviously in the inefficient organization of transport
causing this price increase. In fact, the higher and unjustified increase in demand for
gasoline, not the volume of petrol production, causes the gasoline price escalation.
Such irresponsible tax policy would lead to environmental disaster if followed by the
rest of the world.
The above ratio analyses on gasoline price differentiation argue convincingly for
the necessity of a tax increase on oil consumption in the US. Although the price of
gasoline in the US is from 2 to 3 times lower than in the EU, Japan, and China, the
US trade balance with these countries is chronically negative. This implies that the
price differences of gasoline having a direct effect on the whole price system plays a
secondary role compared to other price factors such as supply and demand, consumer
preferences, or the prices of related goods. Consequently, the objections of the US to
implementing the Environmental Tax Reform and its apprehensions that the reform
would harm its economic interest do not rest on any convincing proof. We can expect
that such an insignificant price (1 percent) change will only slightly influence the
behavior of the producers and consumers, meaning that the elasticity of these products’
supply and the demand for them will not change considerably. The application of this
tax, however, will provide considerable budgetary resources for funding environmental
programs and reducing the taxation of companies and households.
Usually, the resistance against applying this new tax comes from countries that
implement a neoconservative economic policy; for them, each increase of taxes is
unacceptable and contradicts the principle of “less state” in market economy. Despite
this resistance, the problem of harmonizing environmental legislation cannot be
avoided. This problem is exceptionally complex and obviously needs stage-by-stage
solving that considers the specificity of individual countries. That only a portion of
the member countries of the EU, which is at a high level of internal integration,
decided to make such a step, implies that there is a long way to go toward widespread
acceptance of the new environmental tax policy. A country’s apprehension about loss
of competitiveness can be dissolved by attendant fiscal and commercial measures
that will make the process acceptable for all countries. We see possibilities for solving
apprehension in the mechanisms of the WTO, which regulates the conditions for
international trade implementation.
I propose an option with which each importing country will be given the right to
impose a targeted environmental tax on imported products at the rate of any possible

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difference between the analogous tax in the importing country and in the exporting
country. Reliable estimates show that the degree of change in products from various
sectors of goods and services production is a result of a unit of change in the price of oil
or other natural resources. Hoerner (1998) calls this leveling price mechanism Border
Tax Adjustment in Environmental Taxation (BTA) and determines the subject of
taxation (producer or consumer) based on where taxes are collected—at the producer
or at the consumer. If taxes are collected at the producer, this BTA is necessary on the
consumption side of taxes, and if collected at the consumer, the BTA is necessary on
the production side taxes.
Some peculiarities in the manner of international transaction realization should
be borne in mind. The most simplified is the bilateral trade, in which the BTA
mechanism is most easily introduced. Considerable parts of this international trade
are realized through mediators and re-export. It would not be acceptable if leveling
taxes were collected by the intermediary countries in these transactions. This issue is
especially delicate when commercial turnover occurs in a regional customs union or
an integration group, as is the case with the EU, NAFTA, ASEAN, and others. The
product may be imported into a member country, where the distributor center is
located, before being redistributed.
Tax receipts favoring only the country into which the product is imported would
not be acceptable because the whole—or at least the greater quantity of—import could
possibly be redistributed to the partner countries. These substantial differences in the
very mechanism of realization of commerce necessitate the search for an adequate
solution of the problem that, on the one hand, would support making the burden of
environmental taxes equal and, on the other, would harmonize the budgetary interests
of the producers and the end consumers. In other words, organizing collection of this
tax is necessary on not only a bilateral basis but also on regional and international bases.
The regional mechanism (EU or NAFTA, for example) can be applied comparatively
easily because these customs and integration groups already have established fiscal
structures that service the import and export trade arrangements. More efforts,
however, will be needed to establish such a mechanism at the level of the WTO.
The WTO and the individual member countries have sufficient experience and
qualified personnel to methodologically and factually solve the problem who and how
to tax properly. Using such a leveling tax mechanism would neutralize the problem
through the effect caused by any ecotax on competitiveness. Leveling fiscal mechanisms
have long been used as countermeasures to differentiated taxation by the importing
country when the exporting country subsidizes particular groups of goods directly or

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indirectly. Thus, the subsidized export is viewed as an unfair competitive tool against
producers in the importing country. Most often these leveling mechanisms cover some
agricultural goods and metallurgical products.
Various options exist for distributing and using the receipts from this
“offsetting” rate on the imported goods and services that are not subject to an ecotax
in the exporting country. This eliminates the problem with possible unfavorable
competitive advantages based on government subsidies or low environmental taxes,
even absence of such taxes. The importing country is interested in applying this
mechanism because it not only defends the country’s producers but also provides
additional budget receipts. The administrative costs for implementing such a system
would usually be within 4 to 6 percent of these receipts annually. In this way,
the exporting country will be under the influence of these economic incentives
to organize ecotaxation within its jurisdiction instead of transferring the budget
benefits to its commercial partners.
What should be the procedure if neither country (exporter and importer) has an
effective ecotax? Two practical solutions exist for this situation: the compensating tax is
applied (1) irrespective of the status of the countries or (2) by redistributing a specific
percentage of the receipts to a specialized fund of the WTO or another international
agency to be managed. I presume that using existing international institutions would
be more expedient than creating new administrations, which would take more time
and more expenses. Redistributing receipts to a special organization would invalidate
any attempts to make the national producers benefit from ecotax receipts recycled in
their favor. It is possible to eliminate that possibility by introducing international legal
restrictions on the application of such recycling fiscal mechanisms.
I believe that applying such a mechanism of redistribution of environmental
tax revenues or creation of such revenues, based on induced environmental taxes by
an international institution, would render groundless the present objections from
such countries as the US, the UK, Ireland, and Japan. These countries argue that the
introduction of universal and comprehensive environmental taxes, including those
on energy consumption and carbon dioxide emissions, would erode the countries’
competitiveness. We can logically assume that some countries may reduce some of
their other taxes, at the expense of the newly introduced environmental taxes, to
preserve their export prices, but this can hardly be done automatically because these
tax receipts will already have been bound to other budgetary commitments. In the
worst scenario, specialized funds will be established that can be used for only target
environmental programs.

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An alternative exists for solving the possible negative effect of ecotaxes on national
competitiveness. It is possible to use the price difference that occurs as a result of
the imposed tax to reduce harmful emissions in developed and developing countries.
We assume that a country’s commitments to reduce its harmful emissions—of
carbon dioxide, for instance—to a certain volume of physical units (in thousands or
millions of tons) can be performed through emission reductions in both this country
and another country. This is on the condition, however, that the first country has
contributed directly the second country toward reduction of carbon dioxide (or any
other pollutant) emissions through funding, technology transfer and facility provision,
and the sharing of knowledge and managerial experience.
There should not be any problem regarding the support from the better
developed country if this help is in the form of maintenance and expansion of forests
or for implementation of more environmentally friendly technologies or both. The
expansion of forests increases the capacity for absorption of carbon dioxide emissions
while the better technologies minimize or eliminate these emissions. Of course, the
determination of the country recipients of budgetary stimuli should be done subject
to international coordination. This is necessary because the extent of present pollution
is different in different individual geographic regions. Other things being equal, the
financial and technological support for regions with higher current emissions of
pollutants should be given a priority.
The economic evaluation of activities and the determination of prices for the goods
and services must be done mainly through the market mechanism. The determination
of prices is facilitated by the presence of the groups of goods and services on the
international market, which makes their prices easily known. Thus, for instance,
it can turn out that it is more economically advantageous for Denmark to finance
the preservation of tropical forests in Brazil than for it to reduce its own emissions
of carbon dioxide from the industrial sector. The costs for the reduction of carbon
dioxide emissions by one million tons in Denmark have to be compared to the costs
for the conservation of the respective forest area that would ensure the absorption of
the same one million tons of carbon dioxide.
Another option, instead of levying new or additional taxes on the pollutants,
would be for the country to discharge its obligations under the Kyoto Protocol by
engaging part of its budget outlays for international environmental programs. This
monetary support, in any case, involves assessment and control by an authorized
international authority or specialized department at the already existing international
organizations. We have already said that the best solution would use the already-

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existing international institutions; in this way, the additional administrative costs will
be minimized, the necessary procedures for registration and legal regulation will be
shortened, and the experience of the organization will be available.
To minimize the problems that introduction of environmentally expedient fiscal
policy causes with competitiveness between countries, the introduction should be
as broad in scope as possible—with the participation of all UN member countries,
for example. It is understandable that the level of the applied fiscal measures, the
concrete tools, and their relative weights will be different for the different countries.
Application of common principles in the approaches of applying ecotaxes does
not preclude certain flexibility in the concrete instruments of their application,
depending on the implementing country’s physical volume of emitted pollutants,
current environmental condition, degree of social polarization, economic structure,
dependency on international markets, structure and volume of export and import,
availability of natural resources, and so on. The opportunity to apply different fiscal
instruments under the common principles would make much easier the introduction
of environmental fiscal reform for all countries.
If industrial countries, including Russia and the other Eastern European countries,
account for three-fifths of greenhouse gas emissions, including carbon dioxide, they
should play the leading parts in applying adequate fiscal policy in their own countries,
which should gradually result in the reduction of the GHG emissions, in terms of
both absolute volume and measured per capita of population. It is admirable that
some of the most developed countries—chiefly within the EU—but this is merely the
beginning of the process.
Some other economic, social, and political discrepancies exist among the
industrial countries, as well as among the industrial and the developing countries.
These discrepancies or differences should be overcome as soon as possible, and the
responsibility for overcoming them lies both with governments of individual countries
and regional communities and with the international business, financial, and political
organizations and institutions. The analysis of these discrepancies shows that the
possible damages to competitiveness are pointed out, at least in the short run, as a
main obstacle to increasing ecotaxes. This makes it necessary to look for mutually
acceptable solutions on a multilateral basis.
In 2005, the Economist published encouraging data about the positive effect of
tax exemptions on the use of alternative energy sources. Special attention is paid to
biofuel in this report: The US federal tax credit is 10.5 Euro cents per liter, with an
extra 8-15 Euro cents per gallon for small producers (up to 30 million gallons per

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year). In addition, some states (Illinois, Missouri and North Dakota) give additional
state tax credits—about 10-15 Euro cents. These tax exemptions per “bioliter” are
much higher in the EU, amounting to 47 Euro cents in Germany, 40 cents in Italy, 33
cents in France, and 29 cents in the UK and Spain. As a result, France is expecting to
triple the output of ethanol and biodiesel by 2007. Germany’s production of biodiesel
is rising by 50 percent annually, while US output of maize-based ethanol rises 30
percent a year. This is an excellent example of appropriate fiscal policy paving the way
toward sustainable development, but these desirable trends cannot compensate at this
stage for the continuing policy of subsidization. The outcome of the appropriate fiscal
policy is negligible compared to the economic, social and environmental damages
from wrongly directed budget spending.
Most experts justly believe that the most suitable and most prepared institution
to offer such solutions is the World Trade Organization. The WTO has proven
that, with goodwill, mutual interest, and creation of both medium- and long-term
objectives, mutual compromises can be reached, facilitating the development of
the world economy. The manifold reduction, and even elimination, of tariffs and
some nontariff restrictions that was achieved in the past few decades proves that such
mutually beneficial agreements concerning international trade can be reached.

References
Arden-Clark. (1994). Environmental taxes and charges and border tax adjustment—GATT rules and energy
taxes. Gland, Switzerland: World Wildlife Fund for Nature. ***There is no reference to this source in
the text. Should it be here?***

Brown, L. (2001). Eco-economy. New York: Earth Policy Institute, W.W. Norton.

ECOTEC [with CESAM, CLM, University of Gothenburg, UCD and IEEP (CR)]. (2001, April). Study
on environmental taxes and charges in the EU. Brussels: ECOTEC Research & Consulting. Retrieved 7
May 2004 from [Link]

European Commission. (2004). Study on the economic and environmental implications of the use of
environmental taxes and charges in the European Union and its member states (DG TAXUD C5). Retrieved
3 February 2005 from [Link]
htm

Hoerner, A. (1998, March 19). The role of border tax adjustment in environmental taxation: Theory and
U.S. Experiencee. (Working Paper). Washington, DC: Center for a Sustainable Economy. Presented

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at the International Workshop on Market Based Instruments and International Trade, Institute
of Environmental Studies, Amsterdam. Retrieved 17 May 2005 from [Link]
newprograms/sustEcon/[Link]

Hoerner, J., & Muller, F. (1996). Carbon taxes for climate protection in a competitive world. Environmental
Tax Program of the Center for Global Change. College Park: University of Maryland. Paper prepared for
the Swiss Federal Office for Foreign Economic Affairs. Retrieved 27 February 2004 from [Link]
[Link]/[Link]

Keeney, D., & Muller, M. (2000, September). Nitrogen and the upper Mississippi River. (Working paper).
Minneapolis, MN: Institute for Agriculture and Trade Policy. Retrieved 2 November 2004 from http://
[Link]

Miura, J. (2004, September 10). Japan: New gas tax ineffective. Yomiuri Shinbun, p. 3. Retrieved 5
January 2005 from [Link]

Oxfam. (2003). Dumping without borders: How US agricultural policies are destroying the livelihoods of
Mexican corn farmers. Retrieved 4 April 2004 from [Link]
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Parry, I., & Bento, A. (1999, February). Tax deductible spending, environmental policy, and the “double
dividend” hypothesis (Discussion Paper 99-24). Washington, D.C.: Resources for the Future. Retrieved
16 September 2004 from [Link] (pp. 3–7).

Ramsey, F. (1927). A contribution to the theory of taxation. Economics Journal 37, 47–61.

Rees, W., & Wackernagel, M. (1996). Our ecological footprint—Reducing human impact on the earth.
Gabriola, Canada: New Society Publishers.

Shimbun, A. (2003). Japan needs an ecotax. Forest Conservation Archives. Retrieved 11 February 2005
from [Link]

Smith, S. (2003, June). Energy taxation and environmental policy. Conference paper presented before
the South African Conference on Excise Taxation, (pp. 11-13). Retrieved 1 July 2005 from [Link]
[Link]/030707-Presentation_Smith.pdf

The Economist. Special report: Biofuels. (2005, May 14), pp. 71–73.

Sterner, T. (1994). Policy instruments for a sustainable economy. In T. Sterner (Ed.), Economic policies for
sustainable development (1-19). Dordrecht, The Netherlands: Kluwer Academic.

The World Trade Organization (WTO). (1999). A guide for environmentalists. Retrieved 1 July 2005 from
[Link]

Venetoulis, J., Chazan, D., & Gaudet, C. (2004). Ecological footprint of nations, 2000 update. Sustainability
Indicators Program (p. 9). Oakland, US: Redefining progress. Retrieved 9 May 2004 from [Link]
Redefi[Link]/publications/[Link]

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Notes
1
Boarder Tax Adjustment is an instrument for equalizing tax burden, including environmental taxes, if
there is a difference in the appropriate tax level between the country exporter and country importer. Fo r
example, if the environmental tax in the country exporter is 5 percent and the same tax is 10 percent in
the country importer, then the importing country may apply an additional 5 percent import tax. In this
way, the local producers would have the same tax burden as the producers from the exporting country.

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C H A P T E R 7.
MECHANISM OF EMISSIONS
T R A D A B L E PE R M I TS

Trading in emissions tradable permits (ETP) is among the prospective market

based instruments (MBIs) for obtaining ecologically clean production. Although
fiscal policy is relevant to price-based measures, ETP trading is based on instruments
related to rights-based measures. ETP trading, occurring mostly in the United States,
proves its potential to achieve environmental objectives. Binding these objectives with
specific economic interests has proved to be possible based on economic incentive
and more favorable positions for companies whose productions are less hazardous
regarding environmental pollution.

Nature of the Mechanism for Trading in Emissions Permits

Trading in emissions permits combines administrative and economic approaches
for achievement of sustainable development. With this system, a government sets the
country’s maximum admissible volume of tradable emissions permits based on several
criteria, including (1) the level of current emissions; (2) the country’s commitments
to reducing such emissions in compliance with bilateral or international treaties,
as well as by virtue of national programs; (3) the real opportunities for improving
production technologies assessed from a technical and economic point of view; (4)
the expected effects of ETP on market competitive power and on trade balance and
the balance of payments; (5) the expected volume of ETP demand at different price
levels, and so on.
The basic principle of this mechanism is that the admissible volume of ETP
should be under the current level of pollution. This principle—also known as the cap-
and-trade approach—is basic and obligatory because it is the only way to guarantee
the reduction of the general level of harmful emissions from the industrial sector. The
key element of this approach includes the allocation of permits among producers and
the improvement of industry’s ecological parameters. The allocation of ETP among

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producers also stimulates technological and product renovation and brings additional
revenues to those market subjects that succeed in implementing program objectives.
Salmons (2002) states four preliminary conditions for the functioning of the
tradable permits system, including (1) expressing the final environmental goal in
quantitative measures (for example, reduction of harmful emissions by tons and cubic
meters); (2) determining the place and time for achieving this goal; (3) establishing
a monitoring and control system and, if necessary, administrative constraint; and (4)
distinguishing clearly between assignment of environmental obligations and initial
allocation of tradable permits.
Quantitative determination of parameters according to these four conditions has
a major importance for the size and character of the market, including for the price
and the purchase—sale terms and conditions. The complex process of determining
quantitative parameters becomes even more complicated when it concerns not only
the national but also international market: The policies of different governments
may reveal undisguised aspirations to receive unilateral national advantages on this
international market. Such aspirations may be expressed by national governments in
the determination of a bigger number of permits and/or extension of the ETP period
of use. These possible aspirations lead to degradation of environmental programs and
unacceptable compromises with national and international environmental standards.
This risk is higher for countries in transition to a market economy that are still in a
more unfavorable economic position in relation to the performance of environmental
obligations resulting from international treaties or unilateral commitments. Actual
opportunities for seeking unilateral benefits are likely restricted, however. Countries’
participation in regional or global ETP markets will not be unconditional; countries
and companies shall be admitted to these markets only if they comply with the general
rules and principles of the markets. For example, eight of the Eastern European
countries are now members of the EU, and two more, Bulgaria and Romania, are to
be admitted in January 2007. Their legislations, including environmental legislations,
harmonize with those of the EU. ETP trading in the EU is strictly regulated, and
these regulations apply to all participants. Through the formation of a uniform and
sufficiently big ETP market, favorable conditions are created for achieving Pareto
optimality, which results in an increase of net benefit1.
The use of ETP shall not be considered only as an alternative to either environmental
tax legislation or the use of national standards for production and consumption. The
issue is rather of using ETPs as a specific instrument for influencing implementation
of sustainable development policies. From this point of view, the taxes, standards,

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and trading in ETP are mutually complementing instruments. Different approaches

enable better flexibility in implementing certain policies complying with standards
set for environmental conditions. Mutual complementation does not exclude the
alternative use of one or another mechanism (taxes, standards, and trading).
The United States, for example, prefers trading in ETP rather than using the fiscal
instruments. In fact, as stated by Svendsen (1999), businesses prefer tradable permits
than environmental taxes, because it gives companies’ management more flexibility
and better incentives. The reason for this is that they prefer to have more flexibility
in choosing the least costly method for pollution control. Until the end of the 1990s,
the EU was defending the opposite position. The Union gave exclusive priority to
ecotaxes and dissent to ETP, believing that the use of ETP mechanism might lead to
the legalization of harmful emissions. Since the beginning of the twenty-first century,
however, the EU’s position has shifted for two major reasons. The first is the EU’s
aspiration to overcome its differences with the US and to facilitate the US joining the
Kyoto Agreement.
The second reason is related to economic expedience and the desire to use some new
market instruments to achieve environmental objectives. Using market instruments to
achieve objectives became possible when the political influence of the “green” parties
in the EU was reduced, which in turn provided for the corporate lobby to implement
its views on the programs for environmental improvement. Similar processes can be
noted in Japan, Australia, and a few other regions, as well. The trend for expanding
the scope of the ETP trading market has won recognition as a result of the shift
in political influences. At this stage, the ETP trading market has an extremely local
character, but it is highly probable that the market will become global. In any case, we
can expect increased use of this instrument for influencing producers’ behaviors and,
subsequently, improvement of the energy and resource efficiency of production, thus
reducing the negative effects on environmental equilibrium to the minimum.
The program of the US Environmental Protection Agency (EPA) for protection
from acid rains is a wonderful example of the efficiency of the ETP approach. First
implemented in the early 1990s as the Clean Air Act Amendments, this program
helped reduce harmful industrial emissions in the US by four million tons of sulfur
dioxide per year, which in turn reduced the acidity of the rains in the US and nearby
countries by approximately 25 percent. The second phase of the program was launched
in 2001, and preliminary assessments promise even more encouraging results.
In addition to environmental benefits, the agency also reports high economic
expediency and efficiency of the program, bearing in mind that the annual costs for

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its organization, including monitoring and control, amount to only two billion USD.
This amount is almost half of the projected cost and is, of course, rather smaller than
the ensured additional economic effect measured in money from the improvement
of conditions for agriculture, protection of forest ranges, reduction water source
pollution, reduction of negative effects on people’s health, protection of biodiversity,
and so on.
The mechanism ETP mechanism was implemented in various states and includes
pollution with sulfur dioxide, nitrous oxides, sodium oxides, and other harmful
emissions. Dekkers (1999) and Hoibye (1999) give convincing examples of successful
implementation of trading emission mechanism for NOx and SO2, respectively in
the Netherlands and Norway. Thanks to this trading mechanism, implementing the
Montreal Protocol—for termination of chlorofluorocarbon (CFC) production and
import—was successfully completed, and at a lower economic price compared to the
other economic influence instruments (taxes, fines, subsidies, or standards).
According to the information provided by the United States EPA Environmental
Center for Environmental Economics (2001), potential savings of widespread use of
economic incentives in the US could reach $45 billion annually. This amount includes
$700 million in acid rain trading (ETP) savings annually.
In the uncapped emission or effluent reduction credit (ERC) mechanism, the
volume of permits issued by a government is determined as a percentage of a unit
of product or service, which means that there is no absolute set limit for harmful
emissions. In other words, economic growth will automatically cause an increase in
the emission of harmful substances. The economic incentive in this system makes
it possible to reduce the harmful emissions per production unit. In this case, the
freed polluting quantities could be sold on the market to companies that cannot meet
environmental standards. Thus, companies that have pollution emissions lower than
the environmental standard gain additional revenues at the expense of the companies
with environmentally unfriendly production.
We can assume that the environmental effects are considered secondary in the
ERC system. This approach can be useful only if the accumulation of pollutants in
the air, water, and soil do not exceed critical limits. If the critical limit has already
been reached, the additional growth will have a positive economic value but will be
unstable and, therefore, unacceptable. In this case, the negative environmental and
social effects would be bigger than the economic growth. We can assume that the
advantages or disadvantages of this model of permits trading depend on the specific
conditions under which this model has been and will be applied.

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Another form of ETP application is baseline-and-credit, where target limits of

pollution are fixed for different major polluters, usually large metal works and power,
chemical, and mining companies. The limits set by governments are target limits in the
sense that pollution is expected to decrease for a certain period of time, usually within
one year, to those limits. The permitted quantities of harmful emissions for different
companies with baseline-and-credit conform to the companies’ general, national, or
regional levels of allowed pollution. Because of the way this mechanism works, we can
assume that baseline-and-credit is a specific instrument for implementing the more
general cap-and-trade approach. The baseline of baseline-and-credit corresponds to the
issued license per maximum amount of emitted pollutions. The question is whether
this licensed amount corresponds to the national or international commitments taken
to reduce pollution.
In a number of cases in the United States, the EU, and Australia, differences
between the amount of pollution licensed by the national governments and the
international commitments are being observed. Unfortunately, the observations came
to the conclusion that in many cases the licenses have been issued to major polluters
for quantities higher than these commitments. It is appropriate to note that using the
baseline-and-credit approach would have an environmental effect because the issued
licenses are bound to the common local, regional, or national programs for reducing
emissions; the reduction of emissions achieved through both baseline-and-credit and
cap-and-trade mechanisms will be to required levels. Otherwise, if the reductions
do not lower emissions to required levels, the new and ostensibly “environmental”
approaches must be viewed as propaganda, a disguise of corporate interests.
For example, the limit on the annual emission of greenhouse gases set by a
government for a company producing electricity may be ten thousand tons. If a certain
company succeeds in lowering its emissions below this level, it is granted the right to
sell the difference in the form of emission permits. Furthermore, leading companies
often have a wide range of products. This supposes monitoring of both production
and product environmental qualities. Environmentally clean production does not
make impossible environmentally harmful products, and vice versa. So, the best case
is when the appropriate economic incentives cover both production and products.
Using a process such as that in the example above, motor vehicle producers
offer cars on the market with low fuel consumption, which include sports cars, jeeps,
passenger and cargo trucks, and others. The emission of harmful gases from such
vehicles, measured per unit of run or unit of fuel consumed, is different for each vehicle.
The differences result from the power of the engines and their technical characteristics.

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In these cases, the company-producer may achieve lower weighted average indices of
pollution by improving the parameters of a specific line of products or by maintaining
different quantitative correlations between the types of vehicles it offers on the market.
This approach, characterized by efforts for better weighted average indices for several
groups of products from the same class—such as vehicles—is called bubble policy.
Netting is a variation on trading in emission permits. The principle in netting is
that companies having production of different products in several locations may use
an indicator for average levels of pollution as a starting criterion for determining the
permits left free for trading. It means that company X may still have “free for trade
pollutions” even if some of its divisions do not meet the environmental standards. This
scenario is possible if the saved pollutions from one or more incorporated companies
(or divisions) are higher than the “surplus” pollutions from other(s) divisions. In this
way, the company may open new divisions without changing its commitments for
pollution levels, provided that the aggregate emissions of all units do not exceed the
already-fixed levels.
This is a system based on the offset principle: Certain companies may obtain a
permit to open new production facilities in a given region, provided that at the same
time, they achieve reduction of emissions in the existing capacities—the amount of
emissions after the expansion of production does not exceed the same index prior
to the opening of these capacities. In this way, a reduction of harmful emissions per
production unit is achieved.
A practice similar to netting is used by companies such as British Petroleum (BP)
and Shell that have established an inter-company credit system with trading in carbon
dioxide. A division unit that “spares” carbon dioxide may sell the spared amounts
to another unit of the company that has not yet succeeded in achieving such an
environmental effect. In other cases, the offset principle is applied on a regional basis.
Beder (2001) gives an example in Oklahoma City (US), where the local chamber of
commerce agrees to register and permits General Motors to create a new factory in
the area if other businesses promise to lower their emissions, so that overall regional
hydrocarbon emissions are reduced or at least stay the same.
As a rule, a positive link exists between the reduction of emissions and overall
economic effect. This link is better expressed over medium- and long-term periods.
However, under certain conditions, this link can be negative over a short period.
The cause of this negative relationship is the high original cost for improving the
environmental parameters of (1) production, (2) the final product, or (3) both.
The results of using netting and bubble systems—even together—then, could be

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discouraging over a short period of time. Several studies—among them Denicolo

(1999), Requate (1998), Laffont and Tirole (1996)—bear out the positive relationship
between use of ETP and technological innovation. This relationship is clearly shown
in the long run.
Undoubtedly, the use of netting and bubble systems has a positive effect on
large automotive corporations producing a wide range of final products. Thanks to
this policy, they can afford better flexibility in production policy that can change
depending on the international environmental standards. Smaller companies come to
be in more unfavorable positions, as they cannot maneuver according to the average
indices as easily as the larger companies. It is possible that this will become a problem
in negotiations between countries when a global market for emission permits is
being formed. Companies have an interest in seeking technical and organizational
solutions that enable them to improve their production in advance according to
national or international standards, and to be granted financial premiums. The dual
positive behavioral effect is that the premium shall be paid by the company that buys
the “spared” permits, meaning that polluters pay leading companies for instituting
innovative and environmentally appropriate policies.
Another motive for companies to trade with ETP is when the buyer of ETPs
estimates that buying permits is cheaper than making technological improvements,
reorganizing production, purchasing licenses and equipment, improving manpower
qualification, and so on. Because of this, the seller receives additional cash revenues
that may help production innovation processes. The buyer wins time and at the same
time facilitates the innovation process economically. He also receives better economic
conditions for adequate depreciation of disposable production capacities.
Trading permits offers two alternative approaches to primary allocation of permits.
The first is the grandfathered approach. An authorized governmental institution
allocates quotas of permits among the major polluters where the quota’s size depends
directly on the polluters’ emissions during recent years (the specific period varies in
different countries but is usually three to five years). The bigger the emissions were, the
bigger the number of permits issued. Because of the considerable administrative costs
in identifying polluting companies and determining the exact emissions in previous
periods, this approach applies only to the largest companies. The positive effect here
is that the largest polluters are included, but this approach has obvious flaws. One of
these flaws is that it is possible for the total amount of pollution from a large number of
medium and small companies to be greater than the pollution caused by one or several
large producers. Consequently, this approach causes segregation among producers.

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The original allocation of permits is carried out by the administration while

their resale on the secondary market is based entirely on a market principle. Another
disadvantage of this administrative approach where the permits are distributed by
the government is that polluters may exercise a lobby influence on environmental
protection policy and legislation. Those large producers are capable of avoiding the
socioeconomic and environmental criteria for sustainable development. These lobby
interests often differ, and possible preferences (higher volume of pollution permits)
for certain producers may be to the detriment of public interest.
Determining ETP quotas is difficult for administrations when such quotas must be
allocated to different economic sectors (metallurgy, chemical industry, transportation,
and so on). Undoubtedly, determining the same quota for different sectors seems to be a
fair approach, but it would be extremely economically inefficient because of the entirely
different prices of their quotas assigned to different economic sectors: Companies
from different economic sectors pay different costs for achieving higher environmental
standards. Achievement of such high environmental standards and the related costs are
the basis for substantial variation of the tradable permit’s price. Hung and Sartzetakis
(1998) argue that cross-industry permits trading helps equalize the ETP’s price. They
have good reason for this assertion; however, different volumes of ETPs given to
different sectors of the economy give varying market power to those different sectors.
Other instruments could therefore be used for appropriate compensation of the sectors
with lower volumes of assigned tradable permits. Such compensating mechanisms could
include differentiated taxes and export stimuli or direct or indirect subsidies for research
and development of environmentally friendly technologies and [Link] goal of
any company in a market economy is to achieve an explicit environmental objective
with the lowest costs possible. The last principle excludes, or rather makes economically
inefficient, allocating permit quotas equally. The allocation should rather be based on
the criteria for the highest economic efficiency from the permits’ use, all other things
being equal. This is possible with the use of the auction principle.
The auction principle is the second (the first being the grandfathered approach)
alternative for the primary allocation of permits and is also called allowance trading.
In this approach, no difference exists between the primary and secondary allocations
of tradable permits. The amount of permits set by the government is offered at an
auction, and the producers offering the best price get them. The auction method was
first applied in 1993 in the US, when only 2.24 percent of the total permits issued by
the Environmental Protection Agency (EPA) were sold at an auction. Selling prices
ranged from 120 to 450 USD.

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According to Tietenberg (1997), the prices paid in the auction for sulfur pollution
permits were comparatively lower than the estimated costs that buyers (electric power
producers in this instance) would have incurred from installing sulfur purification
equipment. He demonstrates the same interdependence between alternative costs
(buying permits or installing sulfur purifying devices) and useful (economic and
environmental) effects of using emission permits for use of unleaded fuels and ceasing
production of ozone-depleting chemicals. Nussbaum (1992) estimated that the savings
of US refineries in 1993 were estimated at 36 million USD, but the banking effect
(permit saving)2 by some refineries reached 200 million USD for a period of three years
(1989-1991). For the same period, the monetary equivalent of the positive effect on
people’s health from the reduction of lead emissions was estimated at 2.6 billion USD.
Buyers are free to resell the permits they bought, which automatically means
that two independent subject-buyers are created: producers and intermediaries. As
with securities in general, the purchase sale of permits is driven by a speculation
motive—to buy cheaper and sell more expensively. In other cases, the buyer is an
intermediary who completes the transaction on behalf of the seller or the buyer
against a commission. The roles of and effects from the participation of intermediaries
on the ETP market are similar to those of intermediaries on capital markets; thus,
purchasing of permits means additional production costs (including commissions fees
for the intermediaries)for producers but is a means for gaining profits from speculative
operations for intermediaries.
The risk of speculation is calculated in the price of the service and is included in
the resale price. As with any other group of goods, ETP transaction intermediaries
eliminate or minimize the risk by means of contracting parallel transactions, meaning
they sign preliminary purchase-sale contracts with buyers and sellers. This enables
them to buy and sell at prices they already know; however, this does not exclude the
risk, because the “known” price could be higher or lower than the actual market spot
(current) price in future periods. In fact, this is a risk for all stakeholders: buyers,
sellers and intermediaries.
In general, the natural place for trade of emission permits is the already-
established market institution for trading in securities. Thus, transaction-related
costs are minimized because there is no need for establishment of new institutions
specialized in ETP trade. At the same time, the involvement of ETP in capital market
flows contributes to the enlargement of capital markets and to the increase of the
economic efficiency of capital market functioning. Another positive result from the
establishment of such a homogenous market—involving ETP in securities markets—

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is the reduction of transaction cost. The International Petroleum Exchange (IPE) in

London has proposed to establish a secondary market in carbon dioxide permits. This
market is expected to operate on a spot-and-forward basis3, which would be based on
up to a three-year period; this secondary market would have trade principles similar to
those for petroleum products. The idea is that the market would begin its services on
a national basis with the intention of becoming a widely open European market. The
Paris stock exchange has already taken similar steps toward this end.
I believe that environmental effects from trading emission permits should be
used as main indices, whereas some authors emphasize the market character of the
approach. Although it is true that the market character of trading permits must not be
underestimated, the basic objective using environmental policy’s instruments is not to
expand production’s market base, but rather to improve production’s environmental
expediency. The approach that ensures the best environmental effect per cost unit
should have absolute priority, regardless of whether this approach relates to the market
or to the administrative instruments. For this reason, I give priority to the achievement
of specific sustainable development goals. For comparative analysis at this stage, I will
restrict discussion of the scope of only ETP regarding GHG emissions.
For example, regulatory governmental authorities may set top limits on particular,
in this case, air pollution. These limits may be influenced by factors including pollution’s
actual level; pollution trends, state of production technologies, and possibilities for
improving technologies, prices, terms, effect on competitive power; the economic and
social costs of closing polluters, or of restricting the volume of their production; the
capacity of the environment system to absorb pollutants and the limits to which such
a system can bear pollution (the system’s stress level); the government’s obligations
under international treaties or in relation to implementing governmental programs;
the power of environmental protection NGOs; the government’s bargaining power
versus the political power of the relevant companies, and so on.
The national budget is not directly related to the trading of permits, meaning that
this mechanism does not generate budget revenues or need budget spending. Because
of this, some countries such as the US cannot find the necessary political support
for implementing the permit trading system. In the US, introducing new taxes is an
unacceptable risk for election arithmetic and is repeatedly rejected by the country’s
business elite, especially by corporations whose interests are directly concerned.
However, we can assume that the positive effect from the use of new taxes is related
to the national budget on a long-term scale. A lower level of pollution means lower
budget expenses for restoring and protecting the environment.

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A significant advantage of trading permits is that the economic stimuli for the
most environmentally law-abiding producers are at the expense of the polluters—
through collected taxes, fees, charges, etc., which are transferred in the form of various
stimuli to the companies with environmentally friendly production of goods and
services. From that perspective, the stimuli are on the expense of the polluters and
not at the expense of the national budget. The government has the only obligation
to cover (totally or partially) some administrative costs, including environmental
assessment, control, monitoring, and others.
Direct investment stimuli for improving production’s environmental parameters
are created by governments. The lower the company’s parameters are below fixed
pollution restrictions, the more “free” emission permits available that may be converted
into cash revenues. Cash revenues strengthen the company’s financial balance, ensure
fresh financial resources, increase the price competitiveness, improve the company’s
image, and thus make its stocks more attractive. With a fixed “limit” of pollution,
the established stimuli system generates prerequisites to apply economic pressure
for technological innovation and improvement of production organization; in other
words, it converts polluters into active participants of minimizing such pollution. The
lower the designated pollution limits than polluter’s current level, the stronger this
economic pressure.
Another positive effect of ETP is fixing the price per unit (ton, kilogram, liter,
and so on) for each permit, which automatically means development of monetary
criterion for assessing return on investments of innovations aiming to decrease a
certain number of polluting emissions units. The advantage of the ETP instrument is
that it is widely used for both diminishing carbon dioxide and other GHG emissions
and restricting global warming trends.4
ETP trading has some advantages over ecotax use. I share Sterner’s (1994) belief
that the Pigouvian ecotax model assumes a tax level that sets the marginal abatement
cost at the allowed level of pollution and may cause bankruptcy of companies that
are financially stressed, or for which the tax base would be too high because of the
large amount of emitted pollutants. Using the Pigouvian tax is therefore politically
unacceptable. For certain companies under certain conditions, using tradable emission
permits is better because the systems of trading would not have such a direct effect on
$16.95
companies’ financial conditions.
The tradable permit, or dilemma tax, approach is rather serious when it involves
companies that have a key role in some basic economic sectors, such as electric power
generation, chemistry, and metallurgy. A certain proof of the impossibility to settle

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the contradiction between environmental and socioeconomic interests at a public and

company level is that some of the Northern European countries use tax exemption
policy in the above-mentioned economic sectors. These exemptions practically
invalidate the fiscal pressure on the companies from these economic sectors for a
faster- and larger-scale decrease in harmful emissions. The problem is that it is hard to
distinguish between the actual effect on short-term competitive power and the open
defense of corporate interests.
Many large corporations in the industrial sector manipulate their real net incomes
or use established tax havens in offshore zones to avoid paying taxes. Naturally, these
companies will disagree with any form of taxation, including green taxation. Christensen
and Murphy (2004) give an interesting example of this concerning the US energy
giant Enron, which is heavily criticized by pro-environmental organizations. For the
period 1996–2000, the corporation made an overall profit of 1.8 billion dollars and
paid nothing in federal taxes, including environmental taxes. It was possible because of
the grants from the US government ETPs. Unfortunately, Enron is not an exception
in world economic practices.
The Enron case shows some disadvantages of the ETP mechanism. The
subjectivism of this process is rather high when the primary allocation of permits is
made on the grandfathered principle. As we noted earlier, the grandfathered approach
focuses attention on large polluters and minimizes the administrative costs for process
management. This would be the case if the number of medium and small companies
were limited and their aggregate contribution to pollution negligible. For example, if
large companies are responsible for less than 50 percent of the overall pollution, the
small companies would remain outside the grandfathered ETP mechanism. In such
a case, the main polluters (the small companies) would remain outside the scope of
government regulation on pollution.
The proportion between positive and negative effects of the grandfathered
approach will depend on the structure of the industrial sector and the technological
level of companies with a different production potential and share in general
production. Depending on the production structure, the bigger or significant part
of GHG emissions or other pollutants in some countries may continue to grow
because of a lack of government regulation. That is why the offset principle should
not be used for smaller companies—it would infringe the principle of equality and
disturb the competition terms and conditions. The selective grandfathered approach
makes sense, therefore, only if the small companies emit relatively low volumes of
polluting emissions.

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The grandfathered principle of allocating permits creates conditions for conflict of

lobby interests related to different economic sectors and between the companies in these
sectors. Each sector or company is interested in receiving as many permits as possible,
for three economic reasons. The first reason is that the life cycle of used technologies
is prolonged—it ensures sufficient return on investments or, similarly, postpones the
technologies’ eventual write-off because of “environmental depreciation.” As far as
the company has emission permits for pollution, it does not need to improve its used
technologies. The second reason is that these permits relieve companies from paying
ecotax, fees, or charges within the frameworks of the pollution volume permitted,
which prevents the increase of the product’s final price. The third reason is that, when
companies have improved the environmental parameters of the production process,
they may sell saved permits on the market to gain additional cash revenues.
Possible ETP mechanism differences between the participating countries are of
another concern. Varming et. al. (2000) are right that the grandfathered approach
could generate serious distortions of market competition, which could be the case
if a company from country X is awarded free ETP from the government while a
company in the same industry in country Y has to buy these ETP at an auction.
Undoubtedly, this opportunity must be eliminated or at least minimized through
appropriate harmonization of the rules at an international level.
Nevertheless, the advantages of this ETP mechanism supposedly outweigh the
disadvantages. The advantages may be monetarily expressed in millions or even billions
of dollars. Because of this, the political pressure for getting unilateral priorities over other
market participants grows stronger. Using the auction principle, however—which would
eliminate the lobbying danger—would lead to the elimination of the possibility to apply
national or regional priorities (EU, NAFTA) and aim at the use of permits as stimuli
for structural reforms, in correspondence with bilateral and multilateral agreements, for
better access to the world marketplace or for solving local environmental programs.
I think that in some cases the possibility of correlating the tradable permits
market to resolving concrete local or regional environmental problems is very difficult
if not impossible. This is because the heavy industry has reached high territorial
concentration because of a number of economic, social, and technical reasons. The
auction mechanism does not consider territorial concentration of pollution, which
means that a situation may occur in which lower pollution is achieved at places with
the weakest disturbance of the environmental equilibrium; thus, the lower overall
polluting emissions do not exclude the possibility of continuing heavy environmental
problems at the municipality level.

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Global warming, in fact, does not depend on the place of pollution, nor yet on the
territorial concentration of polluters. In most cases, however, emission of greenhouse
gases is accompanied by the emission of several pollutants, including heavy metals and
toxic substances. In this context, the effects of territorial concentration of pollution
sources should not be underestimated. Economic optimization as a result of using
the auction principle for distribution of permits, then, may not coincide with the
territorial optimization that is determined by essentially different criteria such as
employment, access to ports or to the necessary raw materials and energy sources,
available infrastructure, proximity to markets, and so on.
The United States’ experience with ETP also proved that permits trading shall be
considered as only one of the instruments for achievement of certain environmental
aims. In principle, the use of economic mechanisms for modeling producers’ specific
behaviors supposes some classical forms of administration and control. A good example
of these forms is an increase in permitted polluting emission volumes.
The same Clean Air Act that is being used as a legislative basis for implementing
emission permits is also used in signing agreements between the Environmental
Protection Agency and gasoline refineries in the US. CITGO consortium is obliged
to shrink its annual emissions of nitrous oxide by 7,184 tons and those of sulfur
dioxide by 22,250 tons. The same agreement also provides for the reduction of
hard particles emissions that are dangerous to people’s health. To achieve higher
environmental standards, CITGO will invest about 320 million USD in new
production technologies and in monitoring and control equipment. Similar
agreements have been signed with more than 24 refineries in 24 states, and the
overall effect has been the reduction of harmful emissions in the air by more than
200,000 tons per year.
At this stage, the worldwide transportation sector is not involved in the ETP
system. We can expect that in a short time it will be included in the system of ETP
trading for at least two reasons: first, transport is among the major emitters of harmful
gases, and second, market globalization will lead logically to involving this sector.
Unfortunately, economic stimuli and restrictions, as well as most technical standards,
do not refer to the international transport legislation. Furthermore, international air
transport is still excluded from national or international environmental protection
programs. Air transport fuel is exempted from excise taxes, and at the same time,
ecotax practices (energy or taxes on carbon dioxide contents in different fuels) are
frequently used in favor of polluting companies. Their net profits are increasing while
society pays the direct and indirect price of this pollution.

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Governments justify this policy of tax exemptions as protecting competitive

power. This approach is economically and morally unsatisfactory. The result of the
approach is that profits are accumulated by a limited number of large providers
of transport services that do not pay for the enormous damages they cause to the
environment. Profit is monopolized, but the environmental effects are “paid” by
everybody, regardless of whether they use such services or not. The continuation of this
strange policy must not be tolerated. The economic instruments, including the ETP
market, used for sustainable development should also cover the transportation sector,
including international transportation services. Internationalizing this key industry
presupposes the introduction of an economic equivalent (monetary assessed harm on
environment, climate conditions, human health, etc.) of the inflicted environmental
damages. We can expect that the eventual rise in transportation service costs will be
paid by the sector’s suppliers and consumers.
The method of redistributing the additional price burden will depend on the
competition level in the sector. At this stage, the competition in transportation services
is high enough to ensure that the whole, or at least the bigger part, of the price increase
shall not be at the expense of the consumers. In any case, closer interrelation should
be achieved between the volume of harmful emissions and the price of the supplied
product. Considering that international transportation services pollute the world
air and sea space, an authorized international institution should direct permits and
the revenues from their sales. The same revenue effect might be achieved with fiscal
instruments, including taxes, charges, and fees. It is possible to reconsider ETP and
fiscal instruments as not only alternative policies but also mutually complementing.
Keeping in mind the results of using excise duties on fuels, exempting air
transportation companies from excise duties, and recycling revenues from excises and
other taxes, I expect that using ETP mechanisms will have a decidedly better effect
than the current system. We can assume that allocating ETPs with the auction principle
will be more suitable than the current system for several reasons. Using the auction
principle will enable the combination of positive economic and environmental effects;
restriction of physical emission volume will be combined with the (1) price factor and
(2) the optimization of volume of transportation services per unit of harmful emissions.
Companies that cause the least pollution per unit of services shall be given preference.
Choosing a good method of permits allocation requires a comprehensive,
comparative analysis of alternative approaches. One possible option is for allocation
to be based on the grandfathered principle, meaning that all registered transportation
companies will receive permits according to the volume of their harmful emissions

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from previous periods. This task will become more complex if personal consumption
is also considered; governmental costs related to assessing, monitoring, and controlling
will be unacceptably high. The total costs related to implementing ETP transactions
will be further increased if personal consumption is included.
Because of the challenges of including personal consumption, some authors such
as Dobes et al. (1998) reasonably plead for the establishment of market mechanisms
that exclusively include producers (refineries), wholesalers, and, eventually, retailers.
In this way, market organization would undoubtedly be significantly facilitated, and
the mechanism’s efficiency would rise because the economic stimuli for production
and consumption of fuels with a lower content of pollutants would be used in
the production and primary allocation phases. The arguments that using ETPs in
producing and consuming fuels will significantly raise the price and lower demand of
fuels are illogical. Because of the low price elasticity of demand, which I mentioned
earlier, the volume of fuel demand for 1998–2004 has not been reduced, regardless
of crude oil barrel prices increasing fivefold in the same period to exceed 55 USD in
autumn of 2004.
As we can see, it will be economically and socially fair if fuel producers or sellers
buy ETPs according to the auction principle. Providing tradable permits free of charge
would only cause unreasonable increases in producers’, sellers’, or both producers’
and sellers’ profits. We may reasonably expect that whether ETP should be offered to
producers or only to sellers is an issue of expediency. The major principle in this case
should be the avoidance of doubled price on the final product because, in the short
term (in both cases), the introduction of ETP would increase the final price.
National, Regional, and Global ETP Markets
The launching of the tradable permits market in the EU in 2005 resulted in
the formation of international and regional markets for GHG permits. This regional
market includes the countries as set in Annex B (See Appendix 2, end of this chapter)
to the Kyoto Protocol and goes beyond the borders of the European Union. The
formation of the regional market is a logical phase in the formation of a future global
permit market that will also include the United States, Japan, Australia, and other
developed countries which could possibly happen before the end of 2012, when total
worldwide GHG emissions should be reduced from their 1990 level by 5 percent.
The internationalization of this specific market has some positive socioeconomic
and environmental effects that will be analyzed in this section. The process also carries
some risks, however, or implies secondary negative effects. We may expect that some
countries will be interested in issuing a greater number of national permits that can be

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sold on the international market and ensure higher national revenues. This option may
be restricted if the allocation of permits is carried out with the help of a clear and well-
regulated market observed, controlled, and regulated by one or more multinational
institutions. It would be necessary for such an organization to control the number of
permits issued by the relevant country or group of countries and the movement of
these permits on the national and international markets. The major criterion for the
efficiency of operations on this market should be the gradual reduction of harmful
greenhouse gases and other pollutant emissions.
Another potential risk of internationalizing ETPs is the large-scale transfer of
polluting productions from developed countries to countries in transition. Transfer
may be carried out not only by privatization, overseas companies, and joint ventures,
but also by better loading of existing production capacities in Eastern Europe.
A significant part of the chemistry and metallurgy sectors in Eastern Europe are
still not used to full capacity. They might be used in the eventual restructuring of
developed countries’ economies. Should the prices of permits remain comparatively
high compared to the costs for achieving environmentally clean productions,
economic interest may support territorial reallocation of production facilities from
countries with high environmental taxes and/or expensive ETP to countries with
no or lower environmental taxes and respectively cheaper ETP. The consequences
of territorial restructuring will be rather negative if it happens with countries at a
lower technological level and with larger harmful emissions per production unit. The
countries that accept these heavily polluting productions—chemical and metallurgy
industries, for instance—will achieve beneficial financial and social effects, including
additional currency revenues, more jobs, improvement of the trade balance, and the
Balance of Payments. These effects would be felt for only a short time, however, and
their environmental price would be high. The risk of such unacceptable reallocation
of production facilities is higher if it takes place rather in less developed rather than in
Eastern European countries of transition. Simply, in the less developed countries,
the technological development is slower and the emissions per final product unit are
much higher than in transition countries.
Some of the negative effects the risks of trading in permits—occur regardless of
the degree of market internationalization. I do not accept Gupta’s (2002) arguments
against the existence of such negative effects. According to Gupta, everything will be
fine, should the permitted amount of pollution be compensated for by at least the
same amount of “saved pollutions” by another company. In fact, the real advantage
of permit trading is the creation of stimuli for reducing pollution on a long-term

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scale. Permit trading does have a negative effect in the short term, however, because
the pollution “spared” by the seller is transferred as a real pollution to the buyer of
ETP. At the end of the day, society does not care who pollutes; the problem is in the
pollution itself.
The resale of these permits changes only the emitter of pollution: No positive
environmental effect occurs in a short period of time. As I noticed already, transition
toward environmentally friendly technologies is an expensive and time consuming
process, there fore, it can be accomplished only in the long run. This is also the case
when permits are sold to companies in other countries. A kind of positive effect
occurs only on the condition that the emissions are transferred to a region where the
accumulated pollution from previous periods is lower than in the seller’s country. In this
case, the buyer’s country will be able to absorb these pollutants at lower environmental
cost. Obviously, such trade-off is relevant only for non-GHG pollutants.
The beneficial differences in the final net effect come about because of the
specificity of the conditions in the regions where the emission permits market is
implemented. The efficiency rate of this policy, then, should be analyzed separately
for each region, as different local conditions cause different final results. Finally, it
doesn’t matter whether global warming is caused by greenhouse gases emitted in
Northern Europe or in South America. It would be inadmissible to enable the transfer
of environmental burdens from higher-developed to less-developed countries with the
help of proclaimed market-based instruments for environmental protection.
I believe that alternatives exist in using permits. One option is to use permits
in the form of tax credits. The permits obtained from the authorized environmental
agency or other institution could be used as legal tender for paying taxes, as a tax
credit. Bearing in mind that most municipalities have problems with cash liquidity, a
tax credit is, preferably, not meant to cover liabilities in the form of municipal taxes. If
using permits as tax credits is applied in parallel with the existing practice of reselling
permits, then the tax credit amount assigned to each permit can be determined on
the basis of the permits’ market price. Each government will be able to use price
instruments to carry out a policy that best serves national or local interests.
A price premium may be added to the market price to stimulate the use of
permits as payments of tax liabilities instead of selling ETP to another company.
The government and the company would thus jointly take part in environmental
protection. The missed cash revenues for the governmental finances could be considered
indirect budget costs with environmental purposes. The higher the premiums over
the permits’ market price, the greater the increase of the market price—because the

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price in alternative transactions on the market represents the opportunity cost of

the tax credit, and vice versa. This price premium would make more attractive the
technological and other organizational measures intended to conform production to
environmental standards.
Another possible solution is for the system of tax credit for reduced harmful emissions
to entirely replace the present securities trading system. I believe this option has a far
more “green character” because it excludes the possibility of transferring pollution from
one company to another and doesn’t change the amount of emissions over a short time.
The disadvantage here is that the tax credit is at the expense of the national budget—
it financially binds the government, depriving it of certain revenues. This may be a
problem for countries with unstable governmental finance, such as most developing
countries. This disadvantage cannot be considered a convincing argument on its own
against the policy because each government, in one form or another, has made national
and international commitments to protecting and restoring the environment.
This financial problem that developing countries face may have another practical
solution in addition to replacing securities trading with tax credits. If these countries
can receive direct or indirect financial aid against the permits they collected from one or
more international organizations, the problem with the forfeited budgetary benefits can
be eliminated or at least softened. This direct or indirect aid may grant financial aid or
credits under favorable conditions (cheaper credits at lower interest rates, longer periods
for credit service), or it may provide an opportunity for countries to pay their debt with
such specific securities instead of cash. Countries can apply additional duties to imports
from countries where the goods are not levied with environmental taxes, or where the
environmental taxes are lower than in the importing country. In the cases where the
importing country doesn’t have a similar product, average world or regional indices can
be used to determine the level of additional duty to be applied to the import.
The special advantage of this scheme in which countries receive financial aid
against emissions permits, in comparison to existing international aid mechanisms,
is that the aid is directly intended for the contractors, i.e., it is based on market
principle. Another advantage is that the government itself may get a better price for the
package of free permits since it will have a stronger negotiating power than individual
companies, regardless of their size and market power. In this case, receiving financial
compensations against the permits package will be carried out at an international
level. Governments would then be compensated for their eventual losses from tax
obligations. Such compensations would be possible if tax monetary payments are
substituted with the “special securities” explained earlier.

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Often, big polluters are in financial troubles, even if those polluters have small or
even no tax obligations. What would their stimulus be to reduce harmful emissions and
get emission permits? If we speak of the system in which the tax credits and the permits
market are complementary, the solution is simple—these permits are offered on the
market. If the tax credit system is an alternative to the emission permits market, then the
emission permits must be bought by the government under the terms and conditions
stated in the previous paragraph. The amount of traded ETP, their type, trade conditions,
and so on, are matter of concrete solutions. These concrete solutions are efficient as far as
such solutions should harmonize the interests of the society and the single company so
as to encourage producers to use environmentally friendly technologies.
The companies to be included in a policy of complementary tax credits and permit
market must be carefully selected. The national environmental, healthcare, and technical
standards in the countries where these companies are situated can set a limit under
which the companies using outdated and environmentally harmful technologies will
not be eligible for direct or indirect budgetary funding. On the contrary, companies
that meet environmental standards must be rewarded with appropriate economic
stimuli. Special attention has to be paid to companies that are of national, local, or
both national and local importance; have demonstrated their desire for and concrete
results of improvement of their production’s environmental parameters; and need the
amount of the aid to realize technological and corporate restructuring. The international
community should assist companies that are able to make a change instead of companies
that have shown weak market vitality and contradict the sustainable development criteria
with their production and market policies.
Comparative analysis of the advantages and disadvantages of alternative or
complementary instruments stimulating sustainable development supposes quantification
of the volume (total face value) of issued ETP. Volume of ETP is of crucial importance
because it determines the ratio between supply and demand and determines the market
price of ETP. Volume determination is necessary regardless of whether ETP is used on
the domestic market only or on the domestic and international markets simultaneously.
No doubt, the mechanism of an international ETP market is much more complicated;
for example, all things being equal, each country would try to declare larger preliminary
volumes of pollution and greater “successes” in their reduction.
In general, this problem must be resolved for each variant of trading permits. Such
methodological problems, even though concerning a different type of commodity
group, have been successfully solved by the World Trade Organization (WTO),
the organization for Economic Cooperation and Development (OECD), the EU,

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and other organizations. Modern statistical methods, techniques for comparative

analysis and as the access to the statistical data are good objective prerequisites for
a comparatively precise determination of both pollution and the quotas for permits
given to different countries and companies.
The establishment of an international system for assessment, trading, or financial
convertibility of permits is a complex process that requires well-coordinated efforts and
active involvement of all parties concerned. The establishment of this system would
probably be carried out regionally, gradually involving new countries and regions.
This international system requires precise definition of some basic characteristics of
the ETP trading mechanism, including the scope (intra-corporate, inter-corporate,
national, regional, global); admissible pollution limits (absolute level or percentage
of the produced product); method of initial permit allocation (through an auction or
the grandfathered approach); conditions under which its allocation is permitted; free
permits to be “spared” for future use, including for resale in future periods; monitoring
system that must have an international character and effective authorization by the
countries participating in the trading; and, last but not least, priority ratio between
the target final environmental and economic effects, keeping in mind that these two
effects might be interrelated and simultaneously existing.

Particularities of the Tradable Permits Mechanism Stipulated

by the Kyoto Protocol
Analysis of the administrative- and market-based instruments shows that the
goals until 2010 of the Kyoto Protocol cannot be achieved without sufficiently wide
use of the mechanisms of trading emissions permits. As stipulated by the Kyoto
Protocol, achievement of the goals stated in the protocol will be based on three market
instruments: emissions trading (Article 17), joint implementation program (JI, Article
6), and the Clean Development Mechanism (CDM, Article 12). To distinguish among
the characteristic features of these instruments, we must consider that the contractual
parties are divided into two groups given in Annexes A and B. (See Appendix 2.)
The first group includes the developing countries, and the second group includes the
developed industrial countries and the countries in transition to market economy in
Eastern Europe, including the Former Soviet Union Countries.
The CDM enables developed industrial countries to receive tradable permits
against green investments made in the developing countries on the condition that
these investments contribute to the quantitative reduction of carbon dioxide and
other GHG emissions. The presumption is that each investment that contributes

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to the overall reduction of harmful emissions, regardless of the reduction’s location,

would be stimulated with economic measures. For example, if a German metallurgical
company invests in China, in either the company’s subsidiary or a local company, and
achieves an annual reduction of emissions from that company by one million tons,
than tradable permits should be issued against these one million tons. The permits
may be used by the German company as pollution permits in the EU, as a reported
positive result in the company’s balance sheet for total gas emissions, or offered on the
market to bring cash revenues to the company.
This approach has been used in the United States. Since the beginning of 1995, in
cooperation with the government of Belize, the US has been implementing a large-scale
program to restore tropical forests in the Mountain Pine Ridge. This program—Rio
Bravo Carbon Sequestration Project—covers an area of 62,000 hectares of deciduous
forests. Direct implementation of the program is carried out by a nongovernmental
organization program in Belize. During the period 1995–2000, 24.5 million trees
were planted by this program. Within four decades, the amount of carbon dioxide
likely to be absorbed by these trees alone will exceed 2.4 million metric tons. The
higher carbon dioxide absorption enables either larger emissions with no harmful
effects or faster achievement of Kyoto objectives. In most cases, such an approach
may turn out to be more economically expedient than its alternatives. A better cost-
benefit ratio could be achieved by enlarging forest areas than by purchasing ETPs
or by additional investments for technological innovations. In other words, market
principles and economic efficiency suppose selection of a mechanism that provides the
highest environmental protection per unit of investment.
The close relation of environmental objectives with the economic interests of
producers enabled some US companies—namely, Wisconsin Electric Power Co.,
Cinergy, Detroit Edison, Nexen, Pacificorp, Suncor, and Utility Tree Carbon Co.—to
take part in the project with Belize. These companies finance the forestation (5.6 million
USD for the first 10 years) to obtain emission permits that can be used to expand
their production or sold on the specific market. The company Evolution Markets
provides intermediary services in the field of emission permits transactions. Winrock
International Institute for Agricultural Development, a private US organization,
monitors and controls the project’s implementation.
Besides the conservation of carbon dioxide from the atmosphere, the Rio Bravo
Carbon Sequestration Project has other direct environmental effects. It helps protect
240 tree, 70 mammal, and 390 bird species by fighting soil erosion and improving the
quality of underground waters. The program has a secondary socioeconomic effect, as

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well: Two hundred new jobs have been created in reforesting and maintaining the new
forest ranges. The improvement of Belize’s microclimate and environmental quality
also creates new tourism possibilities.
Although the described project has a comparatively small scope and amounts
to less than 20 million USD, it illustrates the opportunity to enlarge the scope of
implementing a permits trading mechanism. In such cases, the permits are also called
“carbon credit” granted to companies funding the project. Conditions are created
for optimizing the financial resources assigned for environmental programs. The
advantage of the “carbon credit” approach is that it combines environmental and
economic effects much more effectively than the previously discussed approaches. In
addition, the environmental effects have a wider scope: Improvement of production
technologies influences only harmful substances emissions, but forestation results in
a series of environmental and economic effects such as soil protection, biodiversity
protection, underground water quality improvement, microclimate improvement and
stabilization, tourism development improvements, multipurpose timber production
for the paper mill industry as an energy source, and so on.
Expansion of forest areas means larger supplies of timber that will reduce the
market price of timber. The reduced price could make timber a preferred material in
construction, replacing and/or reducing the use of cement, steel, and plastic materials.
Keeping in mind that timber is a renewable source and that its production does not
require any nonrenewable sources and energy (as do the production of cement and
steel), the environmental and economic advantages of this method of neutralizing
carbon dioxide and other GHG emissions are more than obvious.
More encouraging examples for joint programs to neutralize carbon dioxide in
the atmosphere exist beyond the US and Belize. The Japanese government (MITI—
the Ministry of Economy, Trade and Industry) created a special carbon fund that
is financed simultaneously by MITI and by private companies. “Emission credits”
are issued as a compensation instrument for contributions to the fund. The funds
gathered are used to carry out overseas projects, helping reduce carbon dioxide through
absorption or implementation of environmentally expedient production technologies.
Japan has committed to reduce carbon dioxide emissions by 6 percent from their
amount in 1990, expecting that more than one-fourth of such reduction—including
in other OECD countries—will be achieved through overseas programs.
The Japanese company Cosmo Oil (Environmental report, 2004), which
performs crude oil extraction and transportation operations, petroleum refining, and
fuel supply, is one of the leading participants in this scheme. The company co-finances

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the fund, which bought carbon dioxide emission permits totaling 71,489 metric tons
from an Australian company “Hancock Forests” in the 2002 and 2003 fiscal years. The
carbon credit is against the investments made for protection and renovation of an area
of 5,000 hectares of eucalyptus forest, and the amount of carbon credit corresponds
to the capacity of these forests to absorb carbon dioxide. Approximately one-third of
the carbon credit is used for covering the harmful emissions from internal combustion
engines (petrol and diesel) used in Japan.
Cosmo Oil’s attempt to involve consumers and drivers of automobiles in the
emission neutralization program is very interesting. For this purpose, Cosmo Oil
granted consumers and drivers “Eco” credit cards, which card holders use to buy fuel
from the company’s gas stations. In this way, consumers helped neutralize harmful
carbon dioxide emissions from cars because of the increased ability of Australian
eucalyptus forests, which are co funded by Cosmo Oil—to absorb carbon dioxide.
The manner in which Cosmo Oil issued sequestration certificates against carbon
credits deserves special attention. These certificates are released on the market, and their
price is determined by supply and demand. At the time of the launch of these certificates
in January 2003, their market price was about 500 Yen (about 4–5 USD) per ton of
carbon emission. Other credits were granted free of charge to Formula Nippon, the
company that organizes sports car racing. That’s how the emissions of sports cars were
“neutralized,” while the certificates found a new field of application. Neutralization was
exercised by investing in development of appropriate forest area capable of absorbing the
carbon dioxide emitted by the sports cars. The experience of Cosmo Oil is a wonderful
proof that the principle of issuing and using emission permits (emission credits) may
combine the efforts of several countries, governments, and companies with that of
thousands of consumers. The combination of economic stimuli and environmental
objectives included in a well-balanced motivational mechanism for businesses and
consumers has produced extremely encouraging results.
Despite the success of these joint ventures in neutralizing GHG emissions, a
number of methodological and organizational problems still await solution to make
such approache more reasonable and efficient. We know that carbon is absorbed by
trees and plants through photosynthesis. Taking into account that tree life expectancy
is about 35–40 years, we can assume that this is to be the period of return on
investments expressed in absorbed carbon. The issuance of permits, then, should
be carried out in stages (periods) to comply with real conditions and environmental
results. Thus, the utilization of the permits (for emissions of carbon dioxide) will be
made simultaneously with the absorption of this carbon dioxide.

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According to common practices, such issuing should take place annually. We

must bear in mind that the rate of carbon absorption varies from year to year during
the average 40 years period: In the initial and final phases of forest development, the
amounts of carbon absorbed are lower, and after this period, almost nothing. Because
of these natural peculiarities, planting new forests has a better environmental effect than
maintaining existing forests. The amount of emissions granted by the permits granted
must exactly correspond to absorbed amounts of carbon and not to the areas of planted
forests, keeping in mind that different plants have different absorption capacities.
We need serious international control to maintain the ratio between older and
newly-planted forests. It is possible to have permits issued against the planting of new
forests or other non-tree vegetation on the conditions that old forests are cleared,
and the total area of forests finally decreases. For the past ten years in Mexico, the
cleared forest areas substantially exceeded the areas with newly-planted forests. Such
disproportionalities make the application of this replacement system inadmissible and
meaningless. Stimulation of new forest plantations would make sense only if net forest
area increases or, at the very least, does not decrease.
As discussed earlier, the use of timber from parts of the old forests that have
exhausted their carbon absorption capacities can be compensated for by planting new
forests in the same or adjacent territories. The protection of old forests implies the
responsible use of legal restrictions, governmental control, and economic stimuli.
Specifically, the problems related to timber ownership need a mutually acceptable
solution. Does ownership remain under the jurisdiction of the country where the
project is implemented (regardless of private or public ownership), or does the timber
belong to the investors? The economic effect for the investor will be completely
different in both cases, and this must be considered when determining the amount
emission permits to be offered.
The real quantity of absorbed carbon dioxide and/or other GHGs must be
guaranteed by reliable insurance protections, as long as environmental results for such
a long period are conditional—that is, if the forests preserve their absorbing capacity
over the entire period. Fires, diseases, tornadoes, or other natural disasters could cause
partial or total discrepancy between actual and expected results. For this reason, the
quantity of compensation emission permits for the investor shall be formed on the
basis of current, proved results, and not on forecasts.
The joint implementation mechanism (JI) is similar to the CDM mechanism, but it
applies only to Annex B countries; it is related to green investments made by developed
countries in the former socialist countries (countries in transition). The EU holds the

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predominant share of investments in these countries because of several circumstances,

including geographic proximity, historical contacts and traditions, volume of trade,
economic cooperation, and others. This is understandable if we consider that eight of
the former socialist countries are already full members of the EU, two (Bulgaria and
Romania) are to be accepted in 2007, and other countries in transition are associated
members of the Union. The geographic proximity of the two groups of countries is also
important, as are their strong trade and economic relations.
The use of permits trading in Europe depends on two factors: firstly, the trade
conditions and the specific organization of trade in comparison to the analogical
mechanism applied by the US and other countries and Secondly, the uniqueness of
the transition from a centralized to a market economy in the former member countries
of COMECON,5 which reflects on the current development of these countries and
on the interaction of economic processes with the environment.
The major difference between the US concept of organization of tradable permits
trading and the EU concept is based on the degree of liberalization of the market—the
degree of trading freedom trading. The US defends the position that restrictions must
be brought to a minimum so that a common world market of permits is established.
Each country can buy and sell an unlimited number of permits following the principle
of free movement of capital throughout the securities stock exchanges network. The
total amount of offered volume of securities shall be a total of the authorized national
volume of permits in compliance with the Kyoto Protocol provisions. The expectations
of the US are that internationalizing supply and demand and liberalizing trading will
result in the formation of a uniform world price for permits.
As with capital and other world markets, the uniform world price will be far
lower than the weighted average price formed on alternative, independent national
markets. In the opinion of the US, an optimal price, lower than the weighted average
price, will be achieved and therefore will render the accomplishment of protocol
commitments cheaper. Countries or companies that will achieve the largest “savings”
of harmful emissions will receive the highest remuneration for their efforts to improve
production technologies and organization, optimize energy and material production
resources, or both.
The European mechanism for trading permits involves significant modification
of the functioning principles of the US permits market. The major differences are in
the degree of freedom of trade and the unrestricted volumes traded (the EU does not
allow unrestricted trading), both among companies and among countries. The main
reason for the EU imposing restrictions on traded volumes is that estimates show that

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total harmful substances emissions will continue to increase slowly. The EU does not
consider the worsening of environmental equilibrium admissible, regardless of lower
tradable permits prices and lower company and national costs for implementation of
the Kyoto Protocol.
To avoid an unsatisfactory environmental effect—unsatisfactory reduction
of pollution and non-achievement of the main objective for reducing the absolute
quantity of emissions—the EU imposes specific restrictions on the tradable volumes
of permits. The restrictions on Annex B countries (in accordance with the EU
proposition of 1999) are listed below. (Remember that these restrictions apply only to
Annex B countries, which means that developing countries may participate in permits
trading without any quantitative restrictions.)
Net acquisitions by an Annex B country for all three Kyoto Protocol mechanisms
may not be higher than 5 percent of base-year emissions multiplied by 5 plus the
assigned amount divided by 2, or 50 percent of the difference between the realized
emissions of any year in the period 1994–2002 multiplied by 5 and its assigned
amount.
Net transfers by an Annex B country for all three Kyoto mechanisms must not
exceed 5 percent of base-year emissions multiplied by 5 plus assigned amount
divided by 2.
The above-mentioned ceilings, for both net acquisitions and net transfers, can
be increased only if the Annex B country manages to achieve an emissions reduction
bigger than the one agreed on in the Protocol. The possible difference between
the assigned level of emissions and the actual (lower) emissions can be used for an
additional export of ETP—above the preliminary defined export ceiling.
Let’s make a more detailed analysis of the structural characteristics of the European
ETP market. We assume that this market may be isolated from the world market—that
it operates on only regionally. In this case, two groups of countries are formed. The first is
the group of developed EU countries, which have the ambitious task of reducing carbon
dioxide emissions through 2010 by 8 percent compared to the base year, 1990. In the
first five to six years after the adoption of the Kyoto Protocol, EU experts were convinced
that the instruments used for achieving this objective did not give the expected results,
and emissions continued to increase, though at a slower rate.
Clearly, the more different the actual levels of air pollution are in comparison
with the required levels stipulated in the Protocol, the harder and more expensive the
reduction of actual emissions to those levels will be. In other words, achieving a prompt
change in current unfavorable trends is the key to respecting the Protocol terms at the

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lowest economic price possible. That explains the change in the EU’s position toward
development of a regional ETP market. After ETPs were initially categorically rejected
by the EU because of “ethic considerations,” the EU finally started applying the ETP
mechanism in January 2005.
The European market makes a clear distinction between countries buying and
selling ETPs. Certain EU countries, such as Germany, France, UK, Italy, can be
only buyers of ETP. The high level of developed heavy industry in these countries
presupposes high GHG emissions, despite the countries’ relatively high technological
levels. Additionally, these countries have taken on specific and difficult responsibilities
to significantly reduce emissions until 2012. These two factors—the achieved level
of emissions and the serious responsibilities taken for their reduction—put these
countries in the position of buyers. The countries not only lack “free” volumes of ETP
but may even have a sharp deficit of such permits.
The differences in the Kyoto Protocol’s objectives for the years up to 2010 and
today’s emissions in the EU are approximately 820 million metric of carbon. This
deficit is so large that its coverage by technological innovation is not realistic even in
the event of revolutionary inventions in technologies and products. The only way to
meet this reduction goal is through an internal European restructuring of used permits
in favor of the highly industrialized countries, meaning that the deficit volumes of
permits (in highly industrialized countries) should be bought from the countries with
an excess of such permits (Russia, Ukraine, Poland, Bulgaria, Romania and other former
socialist countries).
Naturally, the reason for the existence of such surpluses is not some kind of
technological superiority or a highly effective environmental policy. Using 1990 as a
comparative base coincides with the initial period of cardinal changes in these countries
and their transition to a market economy. The restructuring of their economies in
compliance with new realities, the formation of market institutions, the necessity for
creating new high quality markets, the disintegration of cooperative production in the
former COMECON, and the transition to a new system of payments in international
trade inevitably lead to deep economic perturbations in a short time.
These disturbances are generally evident in the loss of about 25–30 percent of
these countries’ GDP. The transition most strongly affected the heavy industry that
worked for decades with the help of great subsidies. When the state was unable to or
did not wish to subsidize the industries anymore, they collapsed. The large-scale closing
of companies and the reduction of their production had severely heavy socioeconomic
effects but a positive environmental effect.

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The shrinking of heavy industry—especially of metallurgy, chemical industry, power

engineering, and transport—caused significant reductions in all types of environmental
pollution, including the amount of GHG emissions. In this way, the former socialist
countries were in the position of potential seller of ETP because the current rates of
growth and restoration of production capacities in these countries under the new
conditions cannot make up for the reduction of industrial output since the 1990s.
Slovenia is the only exception in this group of countries; for a number of reasons that
are not important to our discussion here, Slovenia succeeded most rapidly in adapting
its national economy to the new market conditions. This small country’s eventual ETP
surpluses or deficits would not significantly affect the general indices. In any case, the
free ETPs , called also “hot air”, that Eastern Europe and the Former Soviet Union
(FSU) countries can offer to more industrialized EU countries is about 200 to 500
million metric tones of carbon(MtC), depending on the actual economic growth rates
in the region. The assessments of these amounts by US, European, and Russian analysts
differ by 10–50 percent, which is understandable, considering the rather irregular and
difficult-to-forecast growth of Russia even after the 1997–1998 Asian financial crises.
We can, however, assume that even in moderately optimistic scenarios regarding
economic growth, Russia will be able to offer at least 300 million MtC on the market
in 2010. A recent estimation made by Klepper and Peterson (2002) suggests that in
2010, the FSU and Eastern European countries altogether would be able to offer
carbon tradable permits for about 410 million MtC. It is also important to note
that unused ETP in Eastern Europe have an extremely high concentration. Russia
and Ukraine hold about 60 percent of the total volume of ETP, which is crucial to
understanding this specific market structure, its prices and net revenues movement
models, and the eventual balance of interests between buyers and sellers and even
among sellers and among buyers. For comparison, the overall carbon emissions from
the former COMECON block countries used to be nearly 1.4 billion MtC.
Were the formerly socialist countries included by chance in the annex “B”
countries? No. The developed countries’ economic motives for forming this group
in exactly this way are thoroughly clear. The EU has strong interest in such an
internal resource of ETP. In the course of negotiations regarding the Kyoto Protocol,
the levels of emissions and the real possibilities for the most developed countries to
achieve the objectives were obvious. It is absolutely clear that their obligations can be
accomplished only if the countries of Eastern Europe transfer “licenses to pollute” to
the more developed Western European countries. In the event that a world market of
ETP forms, the US will gain also.

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Eastern European countries are willing to take part in this scheme because this is a
good opportunity for them to gain additional foreign currency revenues by transfering
their ETP rights. Without any production costs, they can thus obtain significant
revenues. Depending on the formation of market prices, these revenues can be crucially
important for some countries. According to Victor et al., these annual revenues for
Russia and Ukraine range from USD 4 billion to 34 billion.20 These amounts are equal
to and even exceed annual revenues from the Russian export of natural gas.
In helping Eastern Europe ensure direct currency revenues, Western Europe helps
itself. Three arguments support this thesis. First, in the long run, this is the cheaper
option for Western Europe compared to the higher price that it would pay if tradable
permits were issued and sold in only developed countries. Second, the costs of improving
technology and final production environmental parameters—including products for
personal consumption (electric power, cooling and heating systems, and so on)—would
be higher if permits were issued and sold in only developed countries. Third, in most
cases, it will be more beneficial for Eastern European heavy-industry companies to cash
in the tradable permits granted them rather than use them for additional loading of their
own capacities; thus, these companies are evicted from the competitive world markets,
leaving sufficient market space for more effective western companies.
All European countries gain benefits from participating in the trade of permits,
but the impression is that the biggest positive net effect occurs in the most developed
countries. These countries would not have introduced and implemented the tradable
permits system if it would not help in achieving some of the sustainable development
objectives at the lowest possible prices and with preserved market positions. Eastern
European countries do not have a more beneficial choice because of the technological
delay and high economic price of the transition phase.
Selecting 1990 as a base year for the formation of GHG pollution ceilings
therefore represents a well-assessed balance of interests between Eastern and Western
Europe and, of course, potentially with other OECD member states, including the
US and Japan. These OECD countries have been trying to make up for the delay in
the accomplishment of the Rio’s6 obligations by using market based instruments for
sustainable development.
Western European companies are net buyers, while Eastern European companies
are net sellers, of ETP. Of course, this does not exclude ETP trade among Western
European companies and among Eastern European countries. However, sales still
maintain their major east-to-west direction. At this point of our discussion, I am
not including the developing countries on the Kyoto’s protocol Annex “A” list. The

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countries on this list have no specific obligations relating to the Kyoto Protocol—they
have no emissions ceilings—until 2008–2012. This automatically means that the
countries would not be able to participate as ETP sellers because they have too-high
GHG emissions. They will probably turn out to be net buyers of ETP during the
second phase of this market development (after 2012).
The single net seller, then, is Eastern Europe, and net buyers are Western Europe
and the rest of the OECD countries, especially the US. Significant differences exist
in price formation and ETP tradable volumes under different scenarios and principles
of organization and functioning of the market including (1) total liberalization of the
market, including no quantitative restrictions to the volume of ETP sold or bought
by a certain company or certain country and full integration of the regional markets,
allowing the formation of a common world ETP market; (2) full regional European
integration of the market, meaning that some autonomous regional markets function
without any market relations between them, or with market relations that are sporadic
and limited; and (3) restricted regional or national trading, with the restrictions referring
to both the volume of sales of a certain seller and the volume of purchases of a certain
buyer (country or company). In the long-run, the eventual restrictions for countries as a
whole are of the utmost importance because the Kyoto Protocol commitments refer to
different countries or groups of countries (EU), but not to different companies.

Elasticity and Structure of ETP Markets

At this point I would like to note some significant interrelations within the ETP
mechanisms. A country or company buys ETP only if the price per ton of ETP is lower
than the cost of reducing one ton of emissions. The lower the ETP market price, then, the
more attractive these ETP are for producers. In this regard, the relative, but not absolute,
ETP price is important. As with any other goods, the ETP price will be affected by supply
and demand: The higher the supply, the lower the price, and vice versa. Because of this,
full liberalization of the market means higher supply, which pressures the price to go down.
This interrelation is used as a basic argument in for the idea that the best solution for the
ETP market mechanism is its full liberalization. The US’s pressuring of other countries to
take such a solution is understandable because with this system, the US would gain access
to much cheaper ETP with the lowest possible effect on the price competitiveness of its
production. Any restriction of supply (for quantity, region of realization, and so on) causes an
increase in ETP value and greater economic efficiency for the buyer.
ETP sellers are interested in the highest possible sales price of ETP. The restrictions
in volume of allowed purchases will raise the cost of these ETP, on the condition that

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they cannot be sold on other markets. For example, if Russia can sell a maximum of
100 million MtC in the EU because of the restrictions on the maximum permitted
EU purchases, the price of ETP will be significantly reduced because these 100 million
MtC are far fewer MtC than Eastern Europe’s free quantities. Eastern European sellers
will compete with each other to be included in the quota of 100 million MtC being
approved as a conditional restriction, and in time, these volumes allowed for purchase
will gradually decrease.
In what direction would the ETP price levels change at different levels of restriction
on permit trading? This depends on the answers to several important questions;
including (1) Will Eastern European countries be allowed to sell the remaining ETP
surpluses after completing the EU quotas?; (2) What is the difference between the
GHG emissions and the admissible indices stipulated in the agreement? (What is
the actual demand?); (3) What is the price of reducing one unit (one ton) of GHG
emissions—the marginal abatement cost (MAC)? (The MAC is different for each
country and company, and its change is not linear but variable.); (4) Will the eventual
presence of market power be of the seller (monopoly) or of the buyer (monopsony)?
Bohm and Larsen (1994) made estimations for the potential price of emission permits
at different configurations of the markets. The expectations are that the price per ton of
carbon dioxide emission permits would be USD 240, provided the market is restricted
only within the territory of Western Europe and that such price would be reduced to
USD 33.5 per ton if Eastern Europe and the former USSR, China, and the other OECD
developed countries, including the US, Canada, Australia, and New Zealand, join the
trading. Other economists such as Larsen and Shah (1994) foresee the price correlation on
a restricted market (OECD) and on a world market for carbon dioxide tradable permits
being less dependent, and the prices will range between USD 35 and 181.
Such prognoses as have been made cannot not pretend high reliability because
of the large number of factors influencing market configuration, which could each
drastically change supply and demand conditions and, therefore, price conditions.
For example, the development of negotiations around the Kyoto Protocol ratification
caused a turn in the ETP market structure: As we discussed earlier, the EU categorically
refused to adopt ETP and relied primarily on fiscal instruments. In the end of the
1990s, the EU shifted its position and adopted certain measures in preparation for
using ETP, although with some adjustments to the existing US model, again, as we
have already discussed. Through these steps, the EU began the first regional ETP
market, which is undoubtedly an important step to the market’s future globalization.
In October 2004, the Russian Parliament ratified the Kyoto Protocol, which actually

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helped its enforcement and, thus, the further internationalization of the ETP market. At
this stage, the US stayed away from this internationalization of the market even though
it had been the first country to develop and implement the ETP market. The new
configuration of ETP markets implies a reassessment of the structural price factors, which
is the power of economic stimuli for sellers and buyers of emission permits. Integration
of the US and European ETP markets would establish new conditions for trading and
would change significantly the terms and conditions for price determination.
We can expect that involvement of developing countries in reducing GHG
emissions will follow the end of the first stage of the Kyoto Protocol implementation
in 2012, bringing new opportunities for the involvement of developing countries in
the ETP markets. No doubt, the newly established markets—the developing countries
with high industrialization dynamics and increased GHG emissions (China, India,
Brazil, Malaysia, Indonesia, Mexico, and others)—would be net buyers of permits.
All other things being equal, the participation in the market of these developing
countries would raise market prices and cause changes in the demand elasticity of
permits. As with the other (non-ETP) commodity groups, the price effects on various
country groups (developed, developing, and in transition) will have different effects
on producers’ behaviors.
All price models are prognostic and must therefore be considered with some
reservations. More important in this case are the eventual changes in price trends on which
experts concur. As with the markets for all other groups of goods, the inclusion of a greater
volume of emissions and the expansion of the ETP market will push prices downward.
The question is what the actual supply and demand will be and under what conditions
the trading will be carried out. According to existing conditions, ETP owners have the
option to sell permits or “save” them for future realization (use of the permits by their
owner to expand production or to sell), but the realization of these permits depends on the
correlation between current market price and the expected price in future periods.
Given existing conditions to sell or save permits, we can assume that Russia will
not hurry to sell its tradable permits on the regional European market. The Russians
will probably wait until a world market for ETP is formed because participation of the
US would substantially increase the demand for ETP. Such an increase in the demand
would inflate market prices for ETP and, therefore, would increase sales revenues. The
United States is a great potential net buyer, and its eventual involvement in a world
ETP market would have a significant effect on the equilibrium price. For Russia, the
price difference would be in billions of USD, which is a sufficiently strong reason for
being patient regarding the time and location of the sale of their ETPs.

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In this regard, any change during the period when the issued permits can be used
is of utmost importance. Even now, permits have a limited time of use, but it is an
issue of international agreement how this term will change in the following stages of
globalization of the ETP market. The tendency should be for shortening the time of
action, but this will depend on the balance of interests of big businesses, the political
elite, and society as a whole. Developed countries that are net buyers are interested in
and will likely insist on the shortening of this term because the shorter the terms, the
greater the economic pressure for ETPs fast sale. Fast sales mean comparatively lower
prices, and slow sales mean comparatively higher prices.
Net sellers from Eastern Europe are interested in keeping better time flexibility,
which they need to manipulate supply and achieve optimal price. The actual terms
will surely be a kind of compromise between these opposite interests, but it is not
difficult to guess that the interests of the buyers will be better protected, especially
considering that the ETP market is organized, operated, and controlled by the buyers
(the developed industrial countries).
I assume that the factor of competition among sellers will be intensified and
that the saving of permits for later sale hides certain risks. For example, the terms for
the permits’ use may be changed with any agreement or with a unilateral decision
of each country participating in the market. This type of risk, together with current
competition, will make the sellers sell more under current conditions, especially if
the price guarantees sufficient revenues. For countries like Russia and Ukraine,
any additional hard current revenues are very important to their economies. It will
probably make them strive for a comparatively rapid sale of the permits.
It is logical to expect that volumes of emissions allowed by these permits will
be reduced in time. However, the main objective is to reduce the total volume of
GHG pollution, and not to develop new markets or distribute revenues for the sake
of the market economy. The tendency in the volumes of ETP supply and demand
will depend on the priority of environmental goals over economic interests; the ETP
market seriously depends on the political wills of the participating countries and on
their decisiveness to protect the long-term objectives of sustainable development
against the pressure of their short-term economic interests.
According to the estimations of Baron et al (1999), the former socialist, Eastern
European countries, excluding Slovenia, will be a net seller of tradable permits, and
developed countries will be buyers only. The potential demand of ETP by the EU is
estimated to be approximately 820 million tons, but the current market rules limit the
allowed purchases up to 298 million tons. Of course, it is likely that this ceiling could be

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increased if the EU demand is much higher than expected. As we already mentioned,

this original polarization (net seller net and buyers) of the Annex “B” countries
under the Kyoto Protocol has been intentionally laid in the adopted mechanism for
fulfillment of the set objectives. The undertaken restrictions on the volume of ETP
trade by the European Commission will, first, limit air pollution and, second, reduce
the price of permits because of the restricted volume of demand. Producers from
developed EU countries will be able to provide permits at far lower prices compared
to unrestricted supply and demand. In this way, the current restrictions reduce the
expected incomes of sellers (countries in transition).
Few factors determine the ETP demand. One such factor is the relation between
the marginal product of emissions (MPE) and the price of tradable permits. The
establishment of new environmentally friendly technologies and products or the
reduction of the price of the existing technologies and products will reduce this MPE.
All other things being equal, this reduction of the MPE will make technological
innovation economically beneficial compared to purchasing permits. This process will
shrink demand and, thus, reduce ETP prices.7
We can assume that at the current stage, all models and preliminary estimations
have a methodological character and can only outline some expected trends. It
would not be possible to make precise prognoses for the ETP price movement
because the volumes of worldwide supply and demand in a global ETP market
cannot be defined. This may prove true if, for example, the growth rates in Eastern
European countries are higher than expected and should therefore be more “used
ETP” than the allotted permits—that is, if the available “hot air” is much less than
the preliminary estimated quantities.
The global ETP market situation will be qualitatively and quantitatively different
than current markets when the European and US markets integrate. Because the
United States is a net buyer, the price of the permits in the global market will be higher
if demand exceeds supply. It is also possible for changes to occur in the set ceilings of
volume of trade within the European Union, especially if it appears that these countries
cannot accomplish their obligations for emission reduction until the end of 2012. I
currently have reasonable grounds to believe that EU member countries will have
serious difficulties achieving the goals because of the delayed start in implementing
the agreement, the hesitations to use ETPs, problems with growth and employment,
insufficient rates of competitive power increase, and others.
The comparative advantages of the ETP market may be verified by taking account
of several indices. According to Scheele (1997), these indices to be accounted must

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include (a) optimization of environmental quality, (b) the correlation between the
measures’ place of technical application, (c) the environmental quality of that place,
and (d) the interrelation between the geographic distribution of emissions and the
original allocation and the term of validity of issued permits.
The ETP market should also include some other economic parameters because,
in general, the emission permits trading mechanism supposes the achievement of
environmental objectives with the aid of economic tools and on the basis of economic
motivation. Because of this supposition, the costs for the issuance, transaction, and
realization of the permits are subject to comparison with the costs of using other
market instruments, including fiscal instruments.
The efficiency of the ETP mechanism supposes determination of the monetary
expression of the environmental effect and eventually to the economic effect for
companies, producers, and countries. Because the validity of permits is usually longer
than one year, the costs-benefit effect should be measured for the whole period of
validity instead of just a single year. As the case is for other market instruments, ETP
trading takes various forms, which supposes many variants for comparative analysis.
The trading of emissions permits shows serious advantages that make it one of
the most preferable market instruments for the implementing various environmental
programs. The experience of the US, Japan, Australia, and other countries with ETP
markets is being transferred to Europe. Conditions are being established for gradual
internationalization of the market. The internationalization and globalization of
the process implies the establishment of common principles of management of the
process, including the adoption of specific mechanisms for monitoring and control.
Tendencies may exist for the market to expand to trade in emission permits including
volatile organic compounds (VOC), nitrous oxides, lead compounds, toxic wastes,
and others in addition to GHG (especially carbon dioxide). In practice, many tons of
various air, water, and soil pollutants may be included.
Currently, emission permits trading includes only the developed OECD and
transitioning Eastern European countries. The expected positive effect and the
accumulated experience of the trading will enable geographic expansion of the
market and inclusion of new groups of industrialized and even underdeveloped
countries. These tendencies of market industrialization should include all the
instruments for implementing a sustainable development policy. The international
character of sustainable development implies an international approach for
the establishment of conditions and mechanisms for its realization. It is also
understandable that the emission permits trading creates conflicts of interest in

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some cases, both among developed countries and among countries at different
development stages.
In some cases, ETP trading delays bringing national productions into compliance
with higher environmental standards. In other cases, it enables the generation
of revenues for companies and countries whose environmental legislations and
technological developments stay behind common development trends. We should
not underestimate the obvious contradictions between developing and developed
countries. First, the purchase of great quantities of permits would cause problems
related to developing countries’ competitive power, especially on a short-term scale.
Because of these potential problems, preparation for developing countries joining
with the common rules and mechanisms should be carried out with a high level of
organization and stronger institutional, expert, and financial support by developed
countries. Second, the asymmetric approach used by the World Trade Organization
(WTO) for liberalizing international trading may and should be applied in respect
to underdeveloped countries. Finally, the implementation of comprehensive
environmental standards for tradable goods should also contribute to the achievement
of the relevant sufficient rate of return on investments for improving the environmental
parameters of production and final products.
Emission permits trading is not a panacea for implementing sustainable
development policy. It is free of contradictions and specific risks considered from
an environmental point of view. In the long run, it is a proven mechanism that has
more advantages than disadvantages. In combination with other market instruments,
based on adequate legislation and technical standards, emission permits trading may
help the successful harmonization of environmental and investment efficiencies. This
mechanism helps achieve sustainable economic growth—it allows the invisible hand
of the market to contribute to visible environmental and socially positive results.

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Annex “I” Parties Annex “B” Parties

Country Kyoto protocol emissions limit as
percentage of base year (1990)
Australia 108
Austria 92
Belarus (Annex I only) —
Belgium 92
Bulgaria 92
Canada 94
Croatia (Annex B only) 95
Czech 92
Denmark 92
Estonia 92
European Community 92
Finland 92
France 92
Germany 92
Greece 92
Hungary 94
Iceland 110
Ireland 92
Italy 92
Japan 94
Latvia 92
Liechtenstein 92
Lithuania 92
Luxembourg 92
Monaco (in Annex B only) 92
New Zealand 100
Netherlands 101
Poland 94
Portugal 92
Romania 92
Russia 100
Slovenia (Annex B only) 92
Spain 92
Sweden 92
Switzerland 92
Turkey (Annex I only) —
Ukraine 100
United Kingdom of Great
Britain and Northern Ireland 92
United States of America 93
NOTE: All are both Annex I and Annex B unless otherwise noted.

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B O O K S F RO M T H E
UNIVERSITY OF INDIANAPOLIS PRESS

(1992–2003)

1. Phylis Lan Lin, Winston Y. Chao, Terri L. Johnson, Joan Persell,

and Alfred Tsang, eds. (1992) Families: East and West.
2. Wei Wou (1993) KMT-CCP Paradox: Guiding a Market Economy
in China.
3. John Langdon and Mary McGann. (1993) The Natural History
of Paradigms.
4. Yu-ning Li, ed. (1994) Images of Women in Chinese Literature.
5. Phylis Lan Lin, Ko-Wang Mei, and Huai-chen Peng, eds. (1994) Marriage and
the Family in Chinese Societies: Selected Readings.
6. Phylis Lan Lin and Wen-hui Tsai, eds. (1995) Selected Readings
on Marriage and the Family: A Global Perspective.
7. Charles Guthrie, Dan Briere, and Mary Moore. (1995)
The Indianapolis Hispanic Community.
8. Terry Kent and Marshall Bruce Gentry, eds. (1996) The Practice
and Theory of Ethics.
9. Phylis Lan Lin and Christi Lan Lin. (1996) Stories of Chinese
Children’s Hats: Symbolism and Folklore.
10. Phylis Lan Lin and David Decker, eds. (1997) China in Transition:
Selected Essays.
11. Phylis Lan Lin, ed. (1998) Islam in America: Images and Challenges.
12. Michelle Stoneburner and Billy Catchings. (1999)
The Meaning of Being Human.
13. Frederick D. Hill. (2003) ‘Downright Devotion to the Cause’:
A History of the University of Indianapolis and Its Legacy of Service.

For information on the above titles or to place an order, contact:

University of Indianapolis Press
1400 East Hanna Avenue / Indianapolis, IN 46227 USA
(317) 788-3288 / (317) 788-3480 (fax)
lin@[Link] / [Link]

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 S U S TA I N A B L E D E V E L O P M E N T

N EW T I T L E S F RO M T H E
UNIVERSITY OF INDIANAPOLIS PRESS

(2004–2005)

1. Philip H. Young. In Days of Knights: A Story for Young People.

2. brenda Lin. Wealth Ribbon: Taiwan Bound, America Bound.
3. May-lee Chai. Glamorous Asians: Short Stories and Essays.
4. Chiara Betta. The Other Middle Kingdom: A Brief History of Muslims
in China (in Chinese and English). Translated by Phylis Lan Lin
and Cheng Fang.
5. Phylis Lan Lin and Cheng Fang. Operational Flexibility: A Study of the
Conceptualizations of Aging and Retirement in China (in Chinese and English).
Translated by Phylis Lan Lin and Cheng Fang.
6. Alyia Ma Lynn. Muslims in China (in Chinese and English).
Translated by Phylis Lan Lin and Cheng Fang.
7. James C. Hsiung. Comprehensive Security: Challenge for Pacific Asia.
8. Au Ho-nien. Journey with Art Afar. Catalog for the Au Ho-nien Museum,
University of Indianapolis.
9. Winberg Chai. Saudi Arabia: A Modern Reader.
10. Philip H. Young. Sandbox World.
11. Mac Bellner & John Pomery, Editors. Service-Learning:
Intercommunity & Interdisciplinary Explorations.
12. Rumen Gechev. Sustainable Development: Economic Aspects.

For information on the above titles or to place an order, contact:

University of Indianapolis Press
1400 East Hanna Avenue / Indianapolis, IN 46227 USA
(317) 788-3288 / (317) 788-3480 (fax)
lin@[Link] / [Link]

239
The Rcriteria
U M E NforGsustainable
E C H E V development have become a decisive factor in the formulation and assessment of
economic policy models. By its nature, sustainable development is a multidimensional category; therefore, it requires
an interdisciplinary approach. The problem must be viewed not just as a theoretical challenge but also as a challenge
for our socioeconomic development. The misbalances between economic growth and consumption behavior on
one hand and the environment on the other hand are worsening. Despite the overall improvement of the social
indicators in the developed and the emerging economies, more than one and a half billion people still live on less
than a dollar a day. The bottom line is that sustained economic growth would be possible only if the market model
is seriously modified.
The study is focused on the economic aspects of sustainable development. However, the analysis includes the
interdependences of the noneconomic dimensions, including environmental, social, and institutional. The author
proposes a new definition for sustainable development that incorporates those dimensions. Special attention is paid
to the advantages and disadvantages of the used indicators as well as on acceptability of some universal indicator.
Professor Gechev argues that the GDP-related indicators are not yet properly used and suggests a new “GDP matrix”
that better integrates the quantitative and the qualitative parameters of the economic output, including its effect on
the environmental equilibrium.
The monograph concludes that it is not economic growth but rather its structure, energy, and resource
intensity that needs to be changed. The author argues that the new patterns of production and consumption
could be achieved with appropriate mechanisms for market regulations, including economic incentives, improved
environmental and technical standards, and development of a reliable institutional structure. Among the analyzed
incentives are fiscal policy instruments and the emissions permit markets. The study is based on extensive statistical
data and comparative analyses. It includes countries and companies from all over the world. The very essence of the
sustainable development has a global dimension, and this monograph discusses the possible ways for harmonization
between the national and international instruments and regulative mechanisms.

Professor Rumen Gechev completed his PhD in Economics at the University of National and World Economy
(UNWE) in Bulgaria in 1989. He was awarded a Fulbright scholarship for Illinois State University (1987-88) and later
specialized at the University of Arizona as well as in the UK, Austria, Malta, and Greece. He had been visiting professor
and guest speaker at universities and chambers of commerce in the USA, Japan, EU, Russia, and India. He is currently
a professor at the International University, Sofia, and an associate professor at UNWE in Sofia, Bulgaria.
Dr. Gechev’s teaching and research interests are in the fields of economic policies for sustainable development
and international business. He has published numerous textbooks, articles, and studies in English, Bulgarian, Czech,
and Ukrainian. The main focus in his publications is on the market reforms in Eastern Europe and the economic
incentives for sustainable development. Some of them have been presented before, at international conferences in
Europe, Asia, and North America. At the same time, he has been actively involved in national and international
consulting projects, including the Harvard Institute of International Development in Kiev, Ukraine.
Professor Gechev was deputy prime minister and minister of economic development of Bulgaria (1995-1997).
He served as chairman of the 4th Session (1996-97) of the Commission on Sustainable Development (CSD) of the
United Nations and took an active part in the Session’s work for the development of systems of economic indicators
for sustainable development. Dr. Gechev actively participated in the UN thematic roundtables in India and the
USA, which played an important role in the preparation for the Earth Summit on sustainable development in
Johannesburg in 2002. As a visiting professor at Galen University, Belize, Central America (2003-05), he founded
courses in Sustainable Development for the bachelor’s and MBA programs.
$29.95

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