Economic growth and polluting resources: Market equilibrium and optimal policies

This paper develops an endogenous growth model to study the decentralized equilibrium and the optimum conditions in an economy which uses polluting resources. The model includes two policy instruments, a subsidy to final consumption and an emissions tax. It also considers two forms of endogenous technical change, pollution-reducing knowledge and horizontal innovation. We show that, if the efficiency of knowledge to reduce emissions is sufficiently high, a higher output is compatible with lower emissions in both levels and growth rates. Additionally, if the two instruments are used together the economy may achieve a higher output and lower emissions since the subsidy may offset, at least partially, the negative tax effects.

► We include resource consumption and pollution in our model. ► Pollution-reducing knowledge and horizontal innovation are considered. ► We study the decentralized market equilibrium and the optimum. ► Under certain conditions a growing economy and cleaner environment are compatible. ► Negative effects of a higher emission tax may be offset by a demand subsidy.