The environmental Kuznets curve is a hypothesized relationship between various
indicators of environmental degradation and income per capita.
In the early stages of the economic growth degradation and pollution increase, but beyond some level of income per capita the trend reverses, so that at high-income levels economic growth leads to environmental improvement.
This implies that the environmental impact indicator is an inverted
U-shaped function of income per capita. Typically the logarithm of the indicator is
modeled as a quadratic function of the logarithm of income. An example of an
estimated EKC is shown in Figure 1. The EKC is named for Kuznets (1955) who
hypothesized income inequality first rises and then falls as economic
development proceeds.
The EKC is an essentially empirical phenomenon, but most of the EKC
literature is econometrically weak. It is very easy to do bad econometrics and the
history of the EKC exemplifies what can go wrong. The EKC idea rose to
prominence because few paid sufficient attention to econometric diagnostic
statistics. Little or no attention has been paid to the statistical properties of the
data used such as serial dependence or stochastic trends in time series and few
tests of model adequacy have been carried out or presented. However, one of
the main purposes of doing econometrics is to test which apparent relationships,
or "stylized facts", are valid and which are spurious correlations.
When we do take such statistics into account and use appropriate
techniques we find that the EKC does not exist (Perman and Stern 2003).
Instead we get a more realistic view of the effect of economic growth and
technological changes on environmental quality. It seems that most indicators of
environmental degradation are monotonically rising in income though the
"income elasticity" is less than one and is not a simple function of income alone.
Time related effects reduce environmental impacts in countries at all levels of
income. However, in rapidly growing middle income countries the scale effect,
which increases pollution and other degradation, overwhelms the time effect. In
wealthy countries, growth is slower, and pollution reduction efforts can overcome
the scale effect. This is the origin of the apparent EKC effect.