Statistics on national production levels and indicators of environmental pressure have been collected during the past few decades (and reconstructed for the more distant past) to document the link between world economic growth and the environment. The theory of world economic growth and economic theories of world natural resources provide explanations and interpretations of the trends as well as methods to assess future developments. The basic approach in most statistical and theoretical analyses is the decomposition of aggregate production function of a nation into, on the one hand, the current state of technology and, on the other hand, the inputs into the national production process. The main inputs are labor (hours worked), capital (produced means of production that can be used over a certain time period), and world natural resources.
World natural resources comprise energy inputs and material inputs. An important distinction is between renewable and nonrenewable resources. Renewable resources are biotic populations, flora, and fauna, which have the potential to grow by means of natural reproduction. For example, the theory of renewable resources studies fishery and forestry. Nonrenewable resources are minerals of which physical supplies do not grow on a relevant timescale for humans. Examples are metals (e.g., aluminum, copper, and gold) and fossil fuels (e.g., oil, coal, and natural gas).
The basic characteristic of world natural resources is that they cannot be produced, but they serve as an essential input in production. A higher rate of resource usage implies faster depletion of the available stock of the resource. In this sense, resource inputs differ in a fundamental way from other inputs used in production, such as labor and capital: Labor is not used up and man-made capital can be accumulated. Another important difference is that the available resource stock may directly affect welfare as an amenity (nonuse value).
Resource economics studies the trade-off between extraction of the resource for current consumption and conservation for later dates. Environmental quality standard can also be considered as an input in the aggregate production function process. Pollution is an inevitable by-product of production. Pollution can be seen as a environmental degradation resources, such as clean air and soil.
World economic growth is the result of growth in inputs and increases in the productivity of the inputs—that is, changes in technology. Economics further explains why inputs and technology change over time. Inputs such as materials, labor, and capital are traded in factor markets. Prices match demand and supply and provide consumers and suppliers with information and incentives.
Economic growth population, for example, increases the potential working force and the supply of labor inputs in the economy increases. This fuels growth if wages adjust so that the growing working force is employed in production. With more labor in production, capital can be operated at a higher productivity level. This increase in the return to capital fuels investment in new capital so that growth in capital inputs also fuels output growth. Similarly, the demand for materials and energy increases. If these are available in limited supply, their prices increase, which provides incentives to develop technologies that save on their use. Thus, although growing scarcity of inputs may impose a drag on growth, it may also induce technological change that fuels world economic growth.
Markets provide a powerful coordination mechanism. In sectors of the economy in which the demand for resources such as materials or labor is high, prices increase and this attracts resources to these sectors, away from other sectors. Thus, resources tend to be allocated to those sectors in which they are in highest demand.
The market can only coordinate social preferences (demand for certain goods or services) and (technical) possibilities and resource endowments in a welfare-maximizing way if prices reflect these preferences and possibilities. This requires (i) that the owners of production factors (the inputs such as labor, capital, and materials) can charge a price that reflects their production cost and (ii) that consumers can express their willingness to pay.
For many environmental goods, these preconditions are not met. In the absence of environmental regulation, there are no markets for clean air or climate. Pollution entails a cost to society but not a cost to the polluting producers. Waste can be disposed freely but imposes a cost on society.
We can now more precisely define the cost of pollution for society in related to economic growth population. From an economic perspective, pollution (and, similarly, environmental degradation or resource depletion) is costly to the degree that it causes externalities. Because the value of environmental quality standard is not reflected in the prices in the economy, the economic decisions that are based on these prices give rise to more pollution than society finds optimal.
The ideal (optimal) environmental regulation imposes measures to eliminate all external costs of pollution; that is, it makes all parties in society internalize all social costs of pollution. In such a situation, welfare is maximal, but pollution is not necessarily (and very unlikely) at the technical mini- mum. Although depletion of natural resources and polluting consequences of production are by definition bad for the environment, they are not necessarily bad for welfare. They provide the inputs for production of valuable things. As long as the benefits from increases in production outweigh the costs of environmental degradation, world economic growth enhances welfare.
