Economic growth can be sustainable – only our study accounts for green policies.

This study provides new evidence on time varying scale and technique effects of economic growth on the environment. To do so we examine the dynamic effects of economic growth shocks on environmental quality using panel data from Canadian provinces. We break down the total impact of economic growth into scale and technique effects and estimate how the two individual effects manifest over time. We use a new empirical approach that allows us to move away from the homogeneity of impulse responses derived from standard panel VAR techniques. Instead, we estimate pollution response paths that are heterogeneous and depend on the levels of technique and scale in a region.

Our study yields several important findings. We contribute to the recent literature which conceptualizes the net growth impact on the environment as the sum of scale, technique and composition effects. While previous work has focused on a static accounting of growth effects, we provide empirical evidence that scale and technique effects and, therefore, the net effect of growth on the environment can change over time. For the case of Canada, we find that scale effects typically dominate over technique effects and that the net negative effect on the environment worsens over time. Although, the dynamic effects are short-lived and die out within 3–4 years following a growth shock. Given our estimates of the magnitude of scale effects, it is unsurprising that decision-makers in Canada have been unable to introduce sufficiently stringent measures that would improve environmental quality at the expense of economic growth. Our results also suggest that, compared to less developed and isolated regions, economic growth in developed regions is more decoupled from environmental damage both due to the presence of larger technique effects and smaller scale effects. The bulk of the literature on economic growth and environmental quality has relied on the EKC approach which combines the influence of all explanatory variables into one single measure (income) and, therefore, yields limited policy implications. Our results show that a naive view of EKC is that the role of government is simply to encourage growth; a deeper view of the EKC is that underlying mechanisms such as the scale of economic activity and endogenous policy responses are at work.

Our results revealing the existence of technique effects that reduce pollution is important in its own right. The finding suggests that the income induced policy response in Canada is successful in reducing pollution during periods of growth. This is important because the technique effect is one of the few forces that can decouple the inextricable link between economic growth and environmental quality. Given Canada’s current climate policy, there may be potential for creating higher technique effects through mechanisms like carbon pricing at the federal level, coordination between different levels of government in policy design, and raising awareness in the absence of aggressive abatement policies.

Our study also provides a general approach for modeling the response of environmental quality to specific sources of economic growth. In our case study of Canada we model a “multiplier effect” of income which can be seen as a mapping of the effect of any policy that increases economic growth onto the environment. More specific answers can be gleaned by using our model to explicitly specify the source of growth.