Optimal health and environmental policies in a pollution-growth nexus

•We study a dynamic overlapping-generations model where pollution worsens risk of future ill health.•The paper shows why policies aimed at insuring health risks and those intended to improve the environment are (and should be) deeply intertwined.•Our model generates a “pollution-growth nexus” in which capital accumulation is attractive from a growth perspective but might hurt welfare.•Private health insurance with pay-as-you-go insurance along with a Pigouvian tax on emissions and a profit tax can replicate the first best.

This paper shows how policies aimed at insuring health risks and those intended to improve the environment are (and should be) deeply intertwined. In the model economy inspired by recent Chinese experience, pollution raises the likelihood of future, poor health prompting households to save more so as to self-insure against anticipated medical expenses. Increased household saving generates more capital while capital use by firms generates more pollution. Along the transition, such a “pollution-growth nexus” may be attractive from a capital-accumulation perspective; however, rising pollution, via the health channel, hurts welfare. Both insurance and environmental policies affect capital accumulation and can have additional dynamic benefits. The availability of private health insurance to top up pay-as-you-go coverage of medical bills along with a Pigouvian tax on emissions and a profit tax can replicate the first best.