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9 Economy-Wide Policies and the Environment: Developing Countries

Editor(s):
Ved Gandhi
Published Date:
June 1996
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Author(s)
Mohan Munasinghe and Wilfrido Cruz 

During the 1980s, economic crises in many developing countries resulted in economic hardship, characterized by severe internal and external imbalances. Stabilization and adjustment reforms were designed to address these problems and redirect economies toward growth and development, but these policies often required the adoption of stringent economic and fiscal reform measures. Very broadly, stabilization measures were implemented to reduce domestic demand and the pressure on foreign reserves, while structural adjustment policies focused on improving the efficiency of resource allocation and competitiveness of markets.

In spite of the economic gains achieved through these reforms, other problems have persisted, especially in natural resource and environmental management. Thus, there is a growing concern that environmental and sustainable development issues have not been sufficiently integrated into the mainstream of economic policymaking. Traditionally, conventional economic reform efforts (including structural adjustment programs) have been guided by the objectives of efficiency and income distribution. These policies are not directed toward influencing the quality of the natural environment, but to the extent that they have a major impact on relative prices or on incomes, such reforms can either help or harm the environment.

Ongoing initiatives both within the World Bank and in other development agencies have emphasized project-level environmental issues. Because of the significance of broad economic policies for the environment and the relative paucity of knowledge regarding the links involved, this paper focuses on the environmental implications of economy-wide policy reforms—that is, measures undertaken at the sectoral or macroeconomic level. Economy-wide policies primarily involve economic instruments ranging from pricing in key sectors (for example, energy or water) and broad sectoral taxation or subsidy programs (for example, agricultural production subsidies, industrial investment incentives) to macroeconomic policies and strategies (exchange rate, interest rate, wage policies, trade liberalization, privatization, and so forth). Economy-wide policies are often packaged within programs of structural adjustment or sectoral reform aimed at promoting economic stability, efficiency and growth, and ultimately human welfare.

In this paper, we will address three related questions.

  • What are the implications of economy-wide policy reforms on the environmental concerns of developing countries?
  • How do existing policy distortions or market imperfections under-mine environmental objectives and subsequently affect prospects for improving economic performance?
  • What role can environmentally oriented policies potentially play in conjunction with programs of economy-wide policy reforms?

Although the emphasis of the discussion is on economic policies, other noneconomic measures required to achieve environmental and sustainable development objectives are also relevant, such as social, institutional, and legal actions (see Box 1). Thus, while the focus of this paper is on economic-environmental links, it also includes a discussion of associated social issues like poverty, income distribution, and property rights. However, because of the complexity of the subject, other key social objectives, such as popular participation, empowerment, and the rights of indigenous peoples, fall outside the scope of this paper.

Case Studies

Based on a comprehensive review of recently completed World Bank case studies as well as outside research, this paper uses examples that reflect a wide range of country conditions and environmental problems. The findings are grouped according to the ways in which economy-wide policies tend to interact with the environment.

  • First, many economic reforms initiated to promote more efficient resource allocation and use are also environmentally beneficial, but residual imperfections often give rise to environmental harm.
  • Second, stabilization measures meant to restore macroeconomic stability are necessary for sustainable development, but short-term contractionary aspects of these programs also may harm the environment.
  • Finally, economy-wide policies have longer term implications for economic growth and income distribution that may also lead to environmental changes.

These broad findings are illustrated below with the help of World Bank country studies and other studies.

Efficiency-Oriented Reforms

Consolidating Environmental Gains

Economic liberalization programs that address price-related distortions (getting prices right) can contribute to both economic and environmental goals by promoting efficiency and reducing waste.

In many developing countries, misplaced efforts to promote specific regional or sectoral growth and general economic development have created complex webs of commodity, sectoral, and macroeconomic price distortions, resulting in economic inefficiency and stagnation. Often these economic distortions also lead to unanticipated changes in production and input-use that promote resource overexploitation or pollution. Such economic distortions may arise from a macroeconomic policy (such as the overvaluation of the local currency) or from a sectoral policy with economy-wide implications (such as subsidized energy prices).

In either case, economy-wide policies that correct such price-related distortions will also result in environmental gains. Among the broadest are macroeconomic remedies to correct the foreign exchange rate and taxes that distort trade. More sector-specific reforms seek to shift relative prices, for example, by setting efficient prices for energy or water (which have pervasive effects) or removing taxes or subsidies on commodities or factors of production.

Box 1.Approaches to Sustainable Development

Current approaches to the concept of sustainable development draw on the experience of several decades of development efforts. Historically, the development of the industrialized world focused on production. Not surprisingly, therefore, the model followed by the developing nations in the 1950s and the 1960s was dominated by output and growth, based mainly on the concept of economic efficiency. By the early 1970s the large and growing numbers of poor in the developing world and the lack of “tricicle-down” benefits to them led to greater efforts to improve income distribution. The development paradigm shifted towards equitable growth, where social (distributional) objectives, especially poverty alleviation, were recognized as distinct from, and as important as, economic efficiency.

Protection of the environment has now become the third major objective of development. By the early 1980s, a large body of evidence had accumulated that environmental degradation was a major barrier to development. The concept of sustainable development has, therefore, evolved to encompass three major points of view: economic, social, and environmental (see the figure in Munasinghe, 1993a).

The economic approach to sustainability is based on the Hicks-Lindahl concept of the maximum flow of income that could be generated while at least maintaining the stock of assets (or capital) that yield these benefits. There is an underlying concept of optimality and economic efficiency applied to the use of scarce resources. Problems of interpretation arise in identifying the kinds of capital to be maintained (for example, manufactured, natural, and human capital) and their substitutability, as well as in valuing these assets, particularly ecological resources. The issues of uncertainty, irreversibility, and catastrophic collapse pose additional difficulties (Pearce and Turner, 1990).

The social concept of sustainability is people oriented, and seeks to maintain the stability of social and cultural systems, including the reduction of destructive conflicts. Equity is an important aspect of this approach. Preservation of social diversity and cultural capital are desirable. Modern society would need to encourage and incorporate pluralism and grass-roots participation into a more effective decision-making framework for socially sustainable development.

The environmental view of sustainable development focuses on the stability of biological and physical systems. Of particular importance is the viability of subsystems critical to the global stability of the overall ecosystem. The emphasis is on preserving the resilience and dynamic ability of such systems to adapt to change, rather than conservation of some ideal static state. Natural resource degradation, pollution, and loss of biodiversity reduce system resilience.

Reconciling these various concepts and operationalizing them as a means to achieve sustainable development is a formidable task, since all three elements of sustainable development must be given balanced consideration. The interfaces among the three approaches are also important. Thus, the economic and social elements interact to give rise to issues such as intragenerational equity (income distribution) and targeted relief for the poor. The economic-environmental interface has yielded new ideas on valuation and internalization of environmental impacts. Finally, the social-environmental linkage has led to renewed interest in areas like intergenerational equity (rights of future generations) and popular participation.

The environmental benefits of macroeconomic reforms were observed in Zimbabwe (Muir-Leresche, Bojo, and Cunliffe, 1994). From an environmental perspective, wildlife-based economic activities (including ecotourism, safaris, hunting, and specialized meat and hide production) are better suited to that country’s semiarid climate and poor soils than cattle ranching, which competes for the same limited land resources. The former also constitute some of the fastest growing sectors—wildlife-based tourism alone grew at the rate of 13 percent in 1991, accounting for 5 percent of the GDP. Despite its economic and environmental advantages, sectoral land policies have generally discouraged wildlife activities since these are perceived as “underutilizing” land. Livestock marketing and price policies have traditionally subsidized cattle ranching.

More important, for many years, the government’s foreign exchange and trade policies indirectly penalized the wildlife sector. The Zimbabwean dollar was overvalued by 50 to 80 percent during 1981–90. This meant that export-oriented sectors were implicitly taxed, among them wildlife and nature tourism. Foreign exchange earnings were diverted to other sectors, depressing incomes and investment in wildlife. In the early 1990s, the government introduced an adjustment package, including measures aimed at boosting the level of exports. The currency was devalued by 25 percent and more liberal access to foreign exchange was allowed. These moves were beneficial on both economic and ecological grounds. Although the economy still has a long way to go, exports have improved. At the same time, the wildlife sector had become more profitable, leading to an expansion of land allocated to wildlife, which is also environmentally more desirable.

The environmental implications of sectoral reforms in energy pricing were studied in Sri Lanka and in rangeland management in Tunisia. The Sri Lanka study demonstrates that energy sector reforms can contribute to both economic and environmental goals (Meier and others, forthcoming). As in most developing countries, electricity prices in Sri Lanka have been well below the incremental cost of future supplies. Many studies show that eliminating power subsidies by raising tariffs closer to the long-run marginal cost of power generation, will encourage more efficient use of electricity.

In projecting future electricity requirements, the study found that the economic benefits of setting electricity prices to reflect long-run marginal cost is supplemented by an unambiguously favorable impact on the environment (including local air quality, less biodiversity loss, and fewer greenhouse gas emissions). In addition, pricing reforms were found to have better economic and environmental impacts than purely technical approaches to demand-side management, such as promoting the use of energy-saving fluorescent lights.

The negative effects of underpricing resources in the agricultural sector is illustrated in the Tunisia study. The government’s concern with ensuring sufficient supply and affordability of livestock products in Tunisia has resulted in a web of pricing and subsidy interventions. A variety of subsidies has intensified livestock production in certain parts of Tunisia, while in other regions it has encouraged herd maintenance at levels beyond rangelands’ carrying capacity. Particularly during dry years, subsidized feed imports have substituted for natural pasture and have averted herd contraction. This failure of herds to respond to diminished feed availability in natural pastures has contributed to significant rangeland degradation primarily in the central and southern regions of the country. Reversing such environmental damage will require policy reforms relating especially to subsidies to the livestock sector (Partow and Mink, forthcoming).

A recent World Bank study suggests that trade policies that encourage greater openness in Latin America have tended to be associated with better environment, primarily owing to environmentally benign characteristics of modern technologies.1 The nature of the environmental impact of adjustment reforms (such as the exchange rate changes and trade liberalization examples above) has been questioned for some time. The broader issues raised by links between trade and environment are summarized in the Annex.

In Zambia, foreign exchange reforms have had a positive impact on wildlife populations, particularly of large mammals—by reducing the incentives for illegal trophy hunting to obtain scarce foreign currency (Mupimpila and others, 1994). In Tanzania, a case study of structural adjustment policies and the impact on the environment suggests that exchange-rate adjustment could provide greater incentives to protect national parks, game reserves, and nature conservation areas (Bagachwa and others, 1994). In Vietnam, a computable general equilibrium (CGE) model simulation of forest-policy reforms indicates a significant increase in forest area and the creation of 24,000 new jobs, as well as benefits from avoiding land degradation and loss of property and lives owing to flooding (DSI and HIID, 1994).

Avoiding Environmental Harm

While liberalizing policies typically help both the economy and the environment, other unaddressed policy, market, and institutional imperfections may cause environmental harm unless they are addressed through specific additional measures that complement the broader reform programs.

Reform is typically undertaken in stages, with the initial adjustment package aimed at the most important macroeconomic issues. Existing distortions that policymakers intend to address later in the adjustment process or other constraints that have been overlooked may cause environmental harm. Paralleling the way in which the social consequences of adjustment should be handled, such potential adverse environmental consequences owing to remaining inefficiencies or inequities in the economic system may therefore require additional measures to complement the original reform program.

In Morocco, low water charges constitute a prevailing policy distortion that have artificially promoted production of water intensive crops, such as sugarcane. Thus, rural irrigation water accounts for 92 percent of the country’s marketed water use, while charges cover less than 10 percent of the long-run marginal cost of irrigation (Goldin and David-Host, 1993). Going beyond the traditional sectoral remedy of proposing an increase in water tariffs, the study employed a computable general equilibrium (CGE) model to link sectoral policy reforms with the macroeconomic adjustment program, focusing on trade liberalization.

In the CGE simulation, removal of nominal trade tariffs led to a small rise in real GDP. Household incomes and consumption grew as import barriers were reduced, exports became more competitive, domestic purchasing power rose, and resources were allocated more efficiently across the economy. However, environmental implications were negative, as domestic water use increased substantially owing to the expansionary effects of liberalization. To remedy the environmental harm, water-price increases need to be combined with trade liberalization, so that the beneficial expansionary economic effects of the latter may be largely retained, but now with substantial reductions in water use as well.

Aside from existing policy distortions, the absence of price signals for environmental services can undermine the contribution of efficiency- and growth-promoting reforms. The specific role of market failure in influencing the environmental implications of economic reforms is illustrated in the case of liberalization policies and industrial promotion in Indonesia (Wheeler and Martin, forthcoming). In this case, adjustment reforms successful in the traditional sense of stimulating industrial growth may cause pollution because of market failure—no price signals prevent excessive buildup of pollution.

The study identifies growth patterns that can help control pollution. In terms of emissions per unit of output, or pollution intensity, the study found that processing industries (for example, food products, pulp, and paper) tend to be dirtier than assembly industries (garments, furniture). Liberalization in the 1980s promoted a surge in assembly industries, thereby reversing the 1970s pattern of more rapid growth in dirty processing sectors. Projections indicate that the share of basic processing industries in total industrial output will fall from 72 percent in 1993 to about 60 percent by 2020. In addition, industry expanded rapidly outside densely populated Java, reducing the health impact of industrial concentration. However, industrial output growth has been so rapid that general pollution levels have nevertheless increased. Thus, while decreases in pollution intensity and industrial decentralization have helped to limit pollution, formal regulations will also need strengthening to avoid health and environmental damage in the future.

The nature of macroeconomic effects on the environment is also contingent upon prevailing regulations or institutions governing resource use. Thus, institutional constraints that are pervasive may undermine the potential contribution of policy reforms. For example, the eventual impact of economy-wide reforms (such as those affecting international and domestic terms of trade) on the incentives facing farm households will be influenced by intervening institutional factors, especially those affecting access and use rights over agricultural resources, such as land and water.

The role of institutional constraints in macroeconomic reform programs is examined in the Ghana case study (Lopez, forthcoming). In this example, trade liberalization, by reducing the taxation of agricultural exports, encourages production, while efforts to reduce the government wage bill tend to increase the pool of unemployed. Thus, adjustment helps to stimulate production of export crops and combines with rapid population growth and lack of employment outside the rural sector to increase pressure on land resources, encroachment onto marginal lands, and soil erosion. This effect on resource use is influenced by the allocation of property rights. Whether in relation to the security of land tenure of peasant farmers or to the right to extract timber by logging companies, uncertainty normally results in environmental degradation. In Ghana, as in many regions of Africa, agricultural lands are governed by traditional land-use institutions, and farms are communally owned by the village or tribe. These common property regimes may have allowed sustainable use of agricultural lands, when the population was much smaller and sufficient fallow periods could allow land to regain its fertility. However, such traditional arrangements have been overwhelmed by economy-wide forces, resulting in reduced fallowing, loss of soil fertility, and environmental decline.

Another common institutional problem relates not to the rules and regulations themselves, but rather to the government’s capacity to establish and enforce such rules. Regulating large numbers of potentially environmentally degrading activities is especially difficult, even for industrial country governments. Substantial reductions in institutional monitoring may be achieved with the use of indirect measures or modified pricing-regulation approaches. This is illustrated in Mexico by the Mexico City air pollution study, which shows that while, in principle, pollution taxes are the most desirable means of achieving reductions in pollutants, in practice, administrative feasibility demands that less-refined instruments, such as taxes on consumption of fuels, may have to be used (Eskeland and Ten-Kate, forthcoming). While recourse to blunt instruments will help, the magnitude of the institutional capacity-building challenge nevertheless remains clear. Building the relevant institutional capacity in developing countries should therefore be underscored, and appropriate resources should be made available early in the adjustment process to assist country governments in this task.

A study of energy prices in Poland concludes that energy intensity and excessive pollution are due not only to the undervaluation of coal in the centralized price system, but, more important, to institutional problems rooted in state ownership that encourage output maximization rather than cost minimization (Bates and others, 1994). This means that price responsiveness is blunted, since financial losses are simply absorbed by the public budget or passed on to consumers in the form of higher output prices. Thus, energy restructuring efforts have recognized the need to create a new institutional and legal framework that will facilitate competition and greater private participation. Coupled with aggressive energy pricing reforms, this strategy appears to be making some headway.

The need for complementary environmental reforms is illustrated also in the case of forestry in Tanzania, where specific reforms in forest sector pricing and regulation are needed to ensure that the incentives from currency devaluation and trade liberalization do not lead to increased timber exports and unsustainable forest exploitation (Bagachwa and others, 1994). Similarly, in Jamaica, an ongoing study shows how foreign exchange reforms have increased the revenue generated by tourism (Alleyne and others, 1994). However, the increasing pressure of associated economic activity has caused considerable degradation of natural habitats and increased urban pollution—thus calling for complementary environmental protection measures.

Macroeconomic Stabilization Measures

Consolidating Environmental Gains

Measures aimed at restoring macroeconomic stability will generally yield environmental benefits since instability undermines sustainable resource use.

The relationship between environmental issues and policy reforms is fairly straightforward at a general level. Macroeconomic instability is not only disastrous for the economy, but also frequently detrimental to the environment. For example, high interest rates associated with economic crises can severely undermine incentives for sustainable management of resources, as producers seek to maximize current yields at the expense of future output.

Thus, to the extent that policy reforms can help restore macroeconomic stability, their impact will be unambiguously beneficial for long-term natural resource management and environmental concerns. This link is illustrated in a Costa Rica case study, which used a macroeconomic model incorporating timber harvesting activities to examine the deforestation implications of various macroeconomic factors (Persson and Munasinghe, 1995). Simulation results demonstrate that lower interest rates associated with a stable economy allow the logging sector to anticipate correctly benefits from future returns to forestry, thereby leading to a decline in current logging activities.2 In Brazil, a recent Bank study found that if interest rates are very high, farmers would choose farming practices that have initially high returns but lead to significant subsequent declines in productivity (Schneider, May 1994). Thus, to the extent that adjustment policies can help restore macroeconomic stability, their impact will be unambiguously beneficial for long-term natural resource management and environmental concerns.

The issue of high debt levels (often associated with sustained periods of government budget deficits and macroeconomic instability) and its implications for environmental degradation were also raised some time ago. However, the available evidence indicates that the linkage is neither clear cut nor significant, as summarized in Box 2.

Avoiding Environmental Harm

While restoring economic stability is needed for sustainable development, specific measures to promote stabilization may have an unforeseen adverse impact on the environment, and compensating environmental measures will be needed.

To the extent that economy-wide policy reforms promote new economic opportunities and employment, in the long term they will clearly alleviate poverty and reduce unsustainable exploitation of fragile resources by the unemployed. However, in the transition period, when fiscal austerity is required to arrest deteriorating economic conditions, short-term distributional problems may arise, linked to the recessionary aspects of reforms.

Apprehension over the short-term environmental impact of adjustment-related reforms parallels concerns regarding the social impacts of adjustment. With austerity measures, it was feared that the poor, who would be most vulnerable to the effects of macroeconomic contraction, would also be adversely affected as social services were cut. Indirectly, short-term negative effects on poverty may have environmental implications (see Box 3). However, the main source of concern regarding environmental impacts was that government budgetary restrictions might disproportionately affect environmental protection programs.

In a study by ECLAC, 1989, it was concluded that adjustment policies pursued in Latin America during the 1980s led to cutbacks in current expenditure allotments for managing and supervising investment in sectors such as energy, irrigation, infrastructure, and mining.3 This limited the funds available for environmental impact assessments and the supervision of projects to control their environmental impacts. Muzondo and Miranda, 1991, in an IMF survey, recognized this problem and suggested that high levels of government expenditure in other areas may lead to reduced funding of environmental activities.4 Recent case studies attributed increases in air pollution problems in Thailand and Mexico to reductions in expenditures for adequate infrastructure.5

Box 2.Debt and the Environment

One of the early antecedents of the concern about the relationship between economy-wide policies and the environment was the debt and degradation link noted by the Brundtland Report, 1987: debt that cannot be amortized forces raw material-dependent countries in Africa to deplete their fragile soils, with the result that good land is turned into desert.

The perception was that many countries reacted to the external shocks during the economic crisis years of the early 1980s by exploiting natural resources unsustainably. However, evidence from country case studies and from cross-country statistical exercises does not support this view.

For example, a World Wildlife Fund report, based on case studies for Côte d’Ivoire, Mexico, and Thailand, concluded that there is no simple relationship between external debt levels and environmental degradation. In the case of Côte d’Ivoire the research team found that although the country’s deforestation rate was one of the highest in the world, external debt did not affect environmental degradation in general or the forestry sector in particular (Reed, 1992). In another study, using econometric models with cross-country deforestation data, no consistent statistical relationship was found between debt and forest depletion (Capistrano and Kiker, 1990).

In fact, many factors are at work, and the export of primary commoditie, such as timbe, do not exhibit any simple trend during the debt crisis and adjustment periods. For example, in the early 1980s, primary commodity exports were subject to falling international commodity prices. Thus, production, domestic absorption, and price effects need to be assessed for specific commodities and countries (Reisen and Van Trotsenburg, 1988). Indeed, since the debt crisis was associated with falling export prices and domestic economic contraction for many developing countries, it would not be unreasonable to expect that in some countries the rate of resource extraction, instead of increasing, would have actually declined during this period.

Ideally, countries go into debt with the expectation that the benefits from the productive activities to be funded will more than pay for the loan. In practice, debt is often incurred to support balance of payments deficits. In the environmental context, debt-for-nature projects represent an effort to directly channel debt (or in this case its converse, debt-relief) to beneficial environmental activities. Such debt-relief efforts have enabled environmental organizations to leverage their available funds significantly. In countries, such as Costa Rica, debt relief programs have allowed environmental agencies to fund forest or biodiversity protection initiatives.

While the argument sounds reasonable enough that government cutbacks undertaken as part of adjustment austerity efforts may undermine the funding for environmental initiatives, empirical assessment of its true importance is difficult. Usually only general categories of expenditures can be identified in most government budgets, so that detailed assessments of environmental programs usually cannot be initiated. In one effort undertaken to assess the social consequences of adjustment lending in Africa, it was found that despite a decline in government expenditure, the budget proportion going to social expenditures and agriculture actually increased during the adjustment period.6

The results of studies focusing on social safety nets during adjustment programs confirm that pursuing fiscal discipline and macroeconomic stability need not take place at the cost of increased hardship for the poor. In much the same way, specific environmental programs could be protected when stabilization efforts are being pursued. For example, it has been reported that in many countries in sub-Saharan Africa, forestry departments and their activities have always been severely underfunded.7 Thus, targeted efforts to support forestry management activities could, with modest costs, be included in reform packages as part of a proactive environmental response.

In Cameroon (Tchoungui and others, 1994), government retrenchment measures eliminated successful village extension programs (thereby causing a major setback in rural development), and also cut back on forest services, (affecting the monitoring of logging and collecting of stumpage fees). Similarly, in Zambia, because of adjustment-related budget cutbacks, urban water pollution problems have worsened, in part owing to the shrinking budget of the Water Affairs Department (Mupimpila and others, 1994). Indirect, recessionary effects are being studied in Tanzania, where the government has sought to control inflation by restricting the money supply, and also abolished government controlled rural cooperatives (Bagachwa and others, 1994). The impact of these policies has reduced farmers’ access to credit, and the overall economic and environmental impacts are likely to be negative—owing to an increase in deterioration of irrigation networks and depletion of soil fertility, as well as greater pressure to clear new land.

Box 3.Poverty and the Environment

It is no accident that assessments of the impact of pollution invariably bring up concerns about poverty. In many cases, the worst effects of environmental pollution and resource degradation are borne by the poor, especially health problems and reduced productivity. In both urban and rural areas and in various occupations, the poor can least afford to protect themselves from environmental degradation: they spend long hours in polluted factories; they are exposed to agricultural chemicals; and services, such as clean water and trash disposal, which are usually taken for granted by the better-off, are normally unavailable in slums and rural areas.

Environmental degradation is also systematically linked to the problem of access to productive resources. The rural poor and landless workers often depend on the exploitation of fragile, open-access resources to supplement their meager livelihood. For example, agricultural plantation workers may depend on seasonal fishing or slash-and-burn agriculture for subsistence. In addition, if poverty and unemployment are pervasive, the poor may be forced to migrate to environmentally vulnerable areas, such as hilly lands or coastal fisheries, where there is open access.

Such open-access conditions in the face of increasing population and unemployment result in overexploitation. The situation in many coastal fisheries illustrates this problem of the “tragedy of the commons.” As long as there is a surplus to be gained from fishing, more households will migrate to the coastal fishery areas, until eventually output declines and everyone is relegated to equally poor levels of subsistence. Population pressure on hilly lands lead to similar results for shifting cultivators. In both cases, the landless poor are driven to overexploit open-access resources and, in the process, degrade their source of livelihood. In brief, the very poor, struggling at subsistence levels of consumption and preoccupied with day-to-day survival, have limited scope to plan ahead and make natural resource investments (for example, soil conservation) that give positive returns only after a number of years. Such short time horizons are not innate characteristics, but rather the outcome of policy, institutional, and social failures. The poor’s use of natural resources is also affected by their facing greater risks, with fewer means to cope. These risks range from misguided policy interventions in input and output markets to changing land tenure systems that favor those with greater political clout. This means that the poor will have little choice but to overexploit any available natural resources.

How can policy reforms help alleviate the problem? From an individual decision-making perspective, policies that alter relative prices will affect current production and consumption activities of farming households as well as their future use of available resources. Thus, price policy reforms could promote environmentally benign crops and farming practices or discourage excessive water or pesticide use. Land improvement and soil conservation could also be encouraged if increased income and welfare allowed farmers to invest more in land and water management. Clearly, this “resource endowment” effect owing to the increased valuation of the household’s resources would be sensitive to whether or not access to such resources is secured, for example, through well defined land-tenure arrangements.

Beyond the microeconomic aspects of poverty-oriented reforms, broad sectoral price changes and macroeconomic prices, that alter factor flows and change the structure of the economy, will also affect conditions of poverty and the environment. Thus, to the extent that economy-wide policy distortions have contributed to population pressure on fragile resources, adjustment-related reforms should also help. Import-substitution, industrial protection, and regressive taxation have historically been associated with lagging employment generation, income inequality, and poverty. These reforms, including those that promote export growth, will lead to higher incomes for sectors producing exportable crops and manufactured goods, generally reducing poverty among rural and industrial workers. Better economic conditions in agriculture and industry would also reduce the problem of frontier migration that has been associated with agricultural extensification. Because of their economy-wide impacts, the potential contribution of such policies to alleviating poverty and reducing environmental degradation could be substantial.

Longer-Term Poverty and Income Effects

In addition to the short- to medium-term concerns discussed earlier, economy-wide policies will have significant longer-term environmental impacts—both positive and negative.

The crucial long-term links between poverty and environmental degradation in developing countries are recognized (Dasgupta and Maler, 1990). For example, the World Development Report 1992 noted that the growing evidence of the relationship between reducing poverty and addressing environmental goals points to the need to undertake poverty and population programs as part of environmental efforts.8 The need to break the cycle of poverty, population growth, and environmental degradation has also been identified by the International Development Association as a challenge to sustainable development.9

An important result of examining the general equilibrium effects of macroeconomic policy is that indirect resource allocation effects are important and may dominate the more direct effects of some price or income policy changes. In the Costa Rica study, the economic and environmental implications of wage restraints in structural adjustment are examined with the use of a computable general equilibrium model, which highlights the economic activities and factors affecting deforestation in Costa Rica (Persson and Munasinghe, 1995). The model differs from standard approaches in two important respects. First, it can simulate the effect of introducing property rights on forest resources, thus allowing the private valuation of future forestry returns to contribute to sustainable management. Second, it includes markets for logs and cleared land—loggers deforest to sell timber to the forest industry and squatters clear land for agricultural production and for sale as agriculture expands and requires more land.

The importance of indirect effects in Costa Rica is demonstrated in the analysis of economy-wide policy changes, such as an increase in the wage rate. Because the role of intersectoral resource flows is incorporated in the CGE model, the effects of changes in wages differ from partial equilibrium results. If the wage of unskilled labor were increased owing to, say, minimum wage legislation, the model predicts that deforestation could expand rather than shrink. Although logging declines because of increased direct costs, this is more than made up by the indirect effect of intersectoral flows since the industrial sector (where minimum wage legislation is more binding) is much more adversely affected by the higher labor costs. Labor and capital thus tend to flow from industry to agriculture, leading to greater conversion of forest land for farming.

This simulation exercise suggests the need for caution in attempting to legislate income improvements by increasing minimum wages. Introducing higher wages initially improves labor incomes, but the resulting contraction of industrial and agricultural employment leads not only to higher unemployment but to environmental degradation as well. Higher unemployment leads to cultivation in forest lands.

Beyond pricing and intersectoral environmental links that can be identified in general equilibrium approaches, policies addressing rural poverty and unemployment would also affect the environment. This link occurs within the broader context of the social and demographic problems of inequitable land access and rapid population growth.10 Import substitution, industrial protection, and regressive taxation have historically been associated with lagging employment generation, income inequality, and poverty. Unequal distribution of resources and inappropriate tenure also contribute to the problem. Inequitable assignment of endowments and rapid population growth result in unemployment and income inequality, which force the poor to depend on marginal resources for their livelihood, with consequent pressure on fragile environments. This effect can be analyzed in conjunction with the assessment of migration, which may occur as part of resettlement programs or may be induced by inappropriate policies, such as land colonization programs.

With regard to sustainable agriculture concerns, a World Bank study entitled Population, Environment and Agriculture Nexus in Sub-Saharan Africa explicitly links the related problems of rapid population growth, agricultural stagnation, and land degradation in Africa.11 The study found that shifting cultivation and grazing in the context of limited capital and technical change cannot cope with rapid population growth. At the same time, the traditional technological solution of relying on high yielding crop varieties is not available. Thus, the study identified the need for a mix of reforms to remove subsidies for inappropriate land uses, improve land-use planning, recognize property rights, provide better education, and construct appropriate rural infrastructure to promote production.

Regarding economy-wide factors affecting deforestation, the Philippines case study evaluates the policy determinants of long-term changes in rural poverty and unemployment that have motivated increasing lowland to upland migration (Cruz and Francisco, forthcoming). This process has led to the conversion of forest lands to unsustainable agriculture and has contributed to deforestation. The inability of the government to manage forest resources is a direct cause of deforestation, but economic policies, both sectoral and economy-wide, also significantly contribute to the problem. The study links lowland poverty to agricultural taxation, price controls, and marketing restrictions, and uses an econometric model to demonstrate that poverty contributes to migration to forest lands.

Trade and exchange rate policies have also played important roles in the Philippines, but have been biased toward the urban consumer and industrial sector. The agricultural sector was implicitly taxed by an average of about 20 percent for most of the 1970s and early 1980s. Because the industrial sector did not provide an alternative source of growth, poverty generally has worsened and rural incomes in particular have suffered. The study indicates that these economic problems affect the environment mainly through migration and the conversion of forest lands to unsustainable agriculture. Population pressure already evident in the 1970s grew during the 1980s. The net upland migration rate grew from 3.4 percent in 1970 to 9.4 percent in 1975, and increased substantially to 14.5 percent by 1985. Consequently, upland cropped area grew at annual rates exceeding 7 percent from 1971 to 1987. These results suggest that while forestry conservation programs are needed, economy-wide policy reforms could be as important in arresting deforestation.

The environmental impact of reform policies depends largely on how the benefits are distributed among society. Several current studies point out that the benefits accruing to the poor, especially the rural poor, are disproportionately low. Based on a review of five structural adjustment programs (Côte d’Ivoire, Ghana, Indonesia, Philippines, and Jamaica), a World Bank study showed that the poor benefited most through an increase in demand for their services. Although incomes of farmers may increase owing to higher prices for crops, the net effect of reform policies depends on whether they are net buyers or sellers. Price liberalization, elimination of subsidies on food products, and high inflation often result in lowering the purchasing power of the poor in real terms.

A pattern of disproportionate distribution of benefits is illustrated in Zambia. The study contends that adjustment policies (elimination of government subsidies on food products, price liberalization measures, higher real interest rates, and fiscal contractionary policies) will have a greater impact on the poor. Although a social program targeting services most crucial to the poor (health, nutrition, and education) was developed, it received minimal funding.

In the case of Cameroon, the study explains that rural farmers were adversely affected by the reform policies. The overvalued exchange rate, combined with Cameroon’s deteriorating terms of trade, created unfavorable conditions for the country’s major export crops, such as coffee and cocoa. The government was forced to reduce support prices by about 50 percent, which amounted to a direct reduction of farmers’ incomes. Between 1983 and 1993 the percentage of rural households living below poverty increased to 71 percent from 49 percent. Many farmers were forced to curtail investments on improving the land. Perennial cash crop cultivations were abandoned or converted into cultivation of subsistence food crops, which generally implied more erosive and environmentally unsound practices. Farmers expanded cultivated areas and civil servants undertook farming on the side to supplement their incomes. The overall result was increased pressure on forests and marginal lands.

The persistence of other economic distortions not addressed in reform programs may also have a constraining effect on the environmental contribution of reforms. This is illustrated by several Western African countries in the CFA franc zone. The CFA franc, which remained firmly linked to the French franc until January 1994, was highly overvalued throughout the duration of adjustment programs in such countries as Cameroon. In spite of extensive stabilization and structural adjustment policies adopted by these countries, the overall economic impact was limited. Thus, in Cameroon budgetary problems remained unresolved in spite of drastic measures to reduce public expenditure.12 The tradable goods sector suffered a major setback owing to the overvaluation of the currency. As the formal sector declined, the informal sector expanded, particularly in cities. Along with a deterioration of social services in health and education, these trends had a negative impact on poverty alleviation and on the environment.

Links Between Economy-Wide Policies and the Environment—Conclusions

Evidence from the studies discussed above allows an answer to the three questions posed in the introduction. As to the first question, do economy-wide policy reforms have significant implications for the environment, the studies indicate that they have important effects, but in the less-than-perfect economic and policy conditions in which they are being undertaken, there is no assurance that efficiency-oriented reforms will also be environmentally beneficial.

In relation to the second question on the role of existing environmental policy imperfections and their subsequent (feedback) implications for the economy, recent studies show that these preexisting policy distortions or externalities have a crucial role in the environmental sector. When policy reforms are undertaken elsewhere to stimulate the economy, perverse incentive signals may be transmitted to environmentally sensitive sectors, owing to intervening imperfections. These could lead to overexploitation of resources and environmental degradation. In most such cases, mitigating this harm will require the introduction of additional and more specific measures to complement (rather than halt) economy-wide reforms.

There is much less evidence, however, regarding the feedback effect of continuing environmental problems on the economy. Resource accounting studies in the past few years suggest that the depletion of productive natural resources has been significant and that conventional measures of economic performance may be inflated. For developing countries, the first such study was done for Indonesia, and estimates of the “depreciation” of forest, agricultural land, and petroleum resources were made for the period 1971–87 (Repetto and others, 1989). The main purpose of the exercise was to value the depreciation of “natural capital” in generating economic activity and to use this resource depreciation to adjust estimates of GDP. Other resource accounting exercises followed in Costa Rica (Solorzano and others, 1991), Philippines (Cruz and Repetto, 1992), and Mexico (Lutz, 1993).

From such studies, the rate of economic growth has been adjusted downwards, but environmental and resource accounting studies, being primarily accounting exercises, cannot shed light on the interaction between current depletion and future economic performance. The review of studies above provides some limited information on this interaction. On a sectoral basis, the Ghana study represents one of very few attempts in the developing world to quantify the implications for agricultural productivity of deforestation and land degradation. At the country-wide level, the CGE studies (e.g., on Costa Rica) suggest that environmental degradation could constrain growth, but more work needs to be done to better understand the mechanisms involved.

On the third and last question posed at the beginning of this paper, the potential contribution of improved environmental policies, the studies indicate substantial scope for undertaking such complementary policy actions in coordination with economy-wide reform efforts. The following section describes in detail the practical implementation of this approach.

Integrating the Environment in Economic Policy Reform

The challenge posed by these findings on economy-environment interactions is the need explicitly to incorporate environmental components in economic reform programs. Traditionally, economic development initiatives and environmental management efforts have followed separate tracks. On the economic planning side, ministries of finance or economic planning often formulate development plans or initiate growth-oriented reforms without serious consideration of resource use and environmental implications. On the environmental side, ministries of environment or environmental protection agencies have proposed national environmental action plans that have rarely incorporated analysis of the underlying economic causes of environmental problems.

The economy-environment links identified in the country studies described above indicate that a coordinated analysis of the economic policies and priority environmental problems can be undertaken. While the relationships between economy-wide policies and the environment are complex, and involve many economic and noneconomic variables, the main concerns may often be limited to a small subset of priority environmental problems. Specific steps for addressing these concerns are presented below, together with a framework for undertaking integrated economy-environment analysis at the country level.

  • Problem Identification. Decision-makers could be more systematic in monitoring environmental trends and anticipating emerging problems when policy reform proposals are being prepared. Currently available environmental information should be analyzed to identify preexisting or emerging environmental problems and their sensitivity to policy measures.
  • Analysis. The potential environmental impact of proposed economy-wide reforms identified in the problem identification stage could then be subjected to careful environmental analysis— to the extent that data and resources permit. Many techniques and examples presented in this paper will be helpful in tracing the simpler and more obvious links between economy-wide policies and the environment.
  • Remedies. Where potential adverse impacts of economy-wide reforms can be identified, targeted complementary environmental policies or investments should be implemented as soon as feasible to mitigate predicted environmental damage and enhance beneficial effects. Where links are difficult to trace ex ante, greater reliance will need to be placed on preparing contingency plans to be invoked expost (see below).
  • Monitoring and Follow-Up. A follow-up system for monitoring the impacts of economic reform programs on environmentally sensitive areas (identified earlier) should be designed, and resources made available to address environmental problems during implementation.
  • Economic-Environmental Coordination. Beyond analyzing specific reforms or programs, there should be an effort to institutionalize a synergistic approach in planning and management. Economic planning exercises (represented by economic development plans or economic strategy papers) should more systematically discuss environmental issues. Similarly, environmental documents should strengthen their analyses of economic linkages.

Action Impact Matrix

To implement systematically the steps described above, an Action Impact Matrix (AIM) approach may be utilized. This approach introduces a framework for identifying the thrust of policy actions in government reform programs and their potential environmental impact. A simple example is shown in Table 1, although an actual AIM would be larger and more detailed. Such a matrix helps to promote an integrated view, meshing economic decisions with priority environmental and social impacts. The first column of Table 1 lists examples of the main development interventions (both policies and projects), while the first row indicates some sustainable development issues. Thus the elements or cells in the matrix help to (1) identify explicitly the key links, (2) focus attention on valuation and other methods of analyzing the most important impacts, and (3) suggest action priorities. At the same time, the organization of the overall matrix facilitates tracing impacts, as well as the coherent articulation of the links between a range of development actions, that is, policies and projects.

Table 1.Action Impact Matrix (AIM)
Matrix of Other Impacts on Key Sustainable Development Issues
Activity/PolicyMain ObjectiveLand degradationAir pollutionResettlementOthers
1. Macroeconomic and sectoral policiesMacroeconomic and sectoral improvementsPositive impacts owing to removal of distortions

Negative impacts mainly owing to pre-existing constraints
Exchange rateImprove trade balance and economic growth(−H) (deforest open-access areas)
Energy pricingImprove economic and energy use efficiency(+M) (improve energy efficiency)
2. Complementary measuresSpecific or local social and environmental improvementsEnhance positive impacts and mitigate negative impacts (above) of broader macroeconomic and sectoral policies
Market-basedReverse negative impacts of market failures and policy distortions(+M) (pollution tax)
Non market-based(+H) (property rights)(+M) (public sector accountability)
3. Investment projects (examples)Improve efficiency of investmentsInvestment decisions made more consistently with broader policy and institutional framework
Project 1 (Hydro dam)Use of project evaluation (cost-benefit analysis, environmental assessments, multi-criteria analysis)(−H) (inundation)(+M) (displace fossil fuel use)(−M) (displace people)
Project 2 (Reafforestation)
Note: A few examples of typical policies and projects as well as key environmental and social issues are shown. Some illustrative but qualitative impact assessments are also indicated; thus, + and − signify beneficial and harmful impacts, while H and M indicate high and moderate severity. The AIM process focuses on the highest priority environmental issues and related social concerns.
Note: A few examples of typical policies and projects as well as key environmental and social issues are shown. Some illustrative but qualitative impact assessments are also indicated; thus, + and − signify beneficial and harmful impacts, while H and M indicate high and moderate severity. The AIM process focuses on the highest priority environmental issues and related social concerns.

An objective of the AIM-based process would be to help in problem identification— by preparing a preliminary matrix that identifies broad relationships without necessarily specifying with any accuracy the magnitudes of the impacts or their relative priorities. For example (Table 1), a currency devaluation may make timber exports more profitable and lead to destruction of open-access forest. The appropriate remedy might be to strengthen property rights or restrict access to the forest. A second example might involve equating energy prices with marginal costs to improve energy efficiency and decrease pollution. Adding pollution taxes to marginal energy costs will further reduce pollution. Increasing public accountability will reinforce favorable responses to these price incentives by reducing the ability of inefficient firms to pass on cost increases to consumers or to transfer their losses to the government. In the same vein, a major hydroelectric project is shown in Table 1 as having two adverse impacts—inundation of forested areas and inundation of villages, as well as one positive impact—the replacement of thermal power generation (thereby reducing air pollution). An afforestation project coupled with adequate resettlement efforts may help address the negative impacts. The matrix-based approach therefore encourages the systematic articulation and coordination of policies and projects to achieve sustainable development goals. Based on readily available data, such an initial matrix could be developed for individual countries.

This process may be developed further to assist in analysis and remediation. For example, more detailed analyses may be carried out for the subset of main economy-wide policies and environmental impact links identified in the cells of the preliminary matrix. This in turn would lead to a more refined final matrix, which would help to quantify impacts and formulate additional measures to enhance positive links and mitigate negative ones. The more detailed analyses that could help to determine the final matrix would depend on planning goals and on available data and resources. They may range from the application of conventional sectoral economic analysis methods (appropriately modified to incorporate environmental impacts) to fairly comprehensive system or multi-sector modeling efforts.

The difficulties of analyzing the potential environmental impacts of proposed economy-wide reforms should not be underestimated. Linking specific causes with particular effects is especially problematic in countries where many conditions are simultaneously changing. Nevertheless, this paper indicates the many direct links that may be traced using existing methods, and the potential gains from integrating environmental aspects into policy reform discussion could be substantial.

World Bank Work and Future Directions

An outreach program has already been initiated in the World Bank to integrate environmental issues into country economic and sector work. The preparation of AIMs is already being initiated in Bolivia, Ghana, Philippines, and Sri Lanka, and more country examples are being planned. Training workshops have been held to disseminate the results of the case studies reported in this paper.

Concurrent with dissemination, more work is required in tracing the environmental implications of economy-wide policies. A broad collaborative program, including several specific initiatives and country case studies, is being implemented in the Bank and this is being complemented by collaboration with researchers undertaking related work in development institutions, nongovernmental organizations, and the academic community. The next round will rely on studies that relate comprehensive packages of economy-wide policy reforms to the full range of priority environmental concerns in a variety of countries. Current research interest, such as development of environmental indicators and environmental analysis of trade reform and privatization policies, will receive early attention.

In addition to these topics, distributional, political economy, and institutional issues need to be emphasized in future work. Greater attention needs to be paid to the identification, evaluation, and mitigation of the social impacts of economy-wide policies. The nature of environmental and social problems depends on the allocation of political and institutional power, and policy reforms may have substantial implications for the distribution of income and wealth. Thus, implementation problems, such as asymmetries in the incidence of environmental costs and benefits (especially health impacts), consultation and empowerment of disadvantaged groups, timing of reforms, and the role of environmental conditionalities, will have to be studied.

Annex
Trade and the Environment

As noted by the World Development Report 1992: Development and the Environment, concern with environmental implications of trade involves both the domestic implications of policy reforms as well as the global environmental dimension of international trade agreements. Although liberalizing reforms generally promote more efficient resource use (including use of environmental resources), in practice there is no clear-cut reason to expect that trade liberalization will be either good or bad for the environment, because trade reforms may be undertaken, but the presence of preexisting market, policy, or institutional imperfections in the environment sector may lead to adverse environmental impacts. The following discussion illustrates various environmental initiatives that will be needed to complement reforms in the trade sector.

Regarding national or domestic trade reforms, early concerns about negative effects were raised regarding the North American Free Trade Agreement (NAFTA) and pollution in Mexico. Similar concerns involved cassava exports and soil erosion in Thailand, and exchange rate depreciation and deforestation in Ghana. However, more recently there has been increased recognition that the links between trade and the environment are much more complex since economic expansion from trade is characterized not only by growth but also by changes in the intersectoral composition of output, in production techniques and input-use, and in location of economic activity.

For example, if liberalized trade fosters greater efficiency and higher productivity, it may also reduce pollution intensity by encouraging the growth of less-polluting industries and the adoption of cleaner technologies. In Mexico, as Grossman and Krueger, 1991, conclude, increased specialization owing to NAFTA-related trade liberalization would result in a shift to labor-intensive and agricultural activities that require less energy input and generate less hazardous waste per unit of output than more capital-intensive activities. Similarly, in the Indonesia case study (cited in the text), both pollution and energy intensity declined owing to such shifts. Pollution impacts probably declined as well, because of the dispersion of industry away from Java. However, the rapid growth of the industrial sector in recent years has also meant an increase in total pollution in spite of reduced pollution intensities. As more countries succeed in attaining rapid and sustained growth, there will be an increasing need to examine more carefully the relationship between the changing structure of high growth economies and the danger of excessive pollution. In such cases, the pollution problem may need to be addressed aggressively, with a combination of regulations and economic incentives.

On agriculture and forestry, contrary to popular perceptions, a shift in cropping patterns towards export crops expansion does not necessarily imply increased erosion. Repetto, 1989, using examples for sub-Saharan Africa, concludes that many export crops tend to be less harmful to soils. In West Africa, tree and bush crops are grown with grasses, and erosion rates are two to three times less than similar areas planted for locally used food crops, such as cassava, yams, maize, sorghum, and millet. In Malawi, Cromwell and Winpenny, 1991, found that adjustment led to changes in product mix and production intensity instead of changes in cultivated area or production techniques. Soil improving crops were adopted and agricultural intensification helped absorb a rapidly growing population on less land. Also, contrary to popular belief, export crop expansion has not generally occurred at the cost of reduced food crop output, with subsequent potentially negative social and environmental effects. However, in a study of 11 developing countries, it was found that rapid expansion of cash crops, in fact, does not tend to reduce food production (Braun and Kennedy, 1986). This complementarity rather than competition has been observed in countries where initial productivity is low and is partly explained by technology spillovers from cash crop activities that also enhance food crop production.

The more pressing question is whether these export crops displace forests. In Sudan, Stryker and others, 1989, found that trade and other adjustment-related reforms resulted in significant deforestation because increased producer prices encouraged woodland clearing for crop cultivation. However, recent studies have shown that in such cases, deforestation pressures are due to prevailing distortions within the forestry sector, such as very low stumpage prices or poor forest management capacity that are not corrected with the trade reforms. Inadequate land tenure and land clearing, as a requirement for tenure, prevent more efficient exploitation of existing agricultural lands, and have also contributed to the problem. For example, in Côte d’Ivoire, the effects of price-related policies were believed to have led to deforestation, but to a lesser extent than the lack of a consistent and secure land tenure system (Reed, 1992). The Ghana study (cited in the main text) also analyzed the interaction between effects of price changes and the institutional factors governing resource ownership and management. Using both household data and remote sensing information on agricultural and forest resources, the study found that increased crop incentives have contributed to pressures for deforestation. However, if producers had secure tenure and could internalize the implications of excessive land exploitation, these pressures would have been reduced significantly.

With regard to the global environmental dimension of international trade, the debate has revolved around the issue of whether freer trade is beneficial to global and national environmental conditions and whether it should be used to influence national and international environmental standards and agreements. Studies arising from a General Agreement on Tariffs and Trade (GATT) symposium have concluded that expanding global production and consumption does not necessarily cause greater environmental degradation (Anderson and Blackhurst, 1992). Indeed, with appropriate national policy reforms, greater trade would generally contribute to environmental gains. In the case of coal, trade liberalization and the removal of price supports in richer countries would reduce coal output, lead to higher international prices, and consequently decrease coal consumption. This would be beneficial for the environment. In the case of food production, the reduction of agricultural trade protection in rich countries would lead to a relocation of production to poorer countries, leading to greater incomes, and reduced agricultural pollution in developed countries. In poorer countries, it is recognized that the incentive to produce more will probably increase fertilizer and pesticide use. However, maintaining high levels of agricultural protection in rich countries is not an effective way of protecting the environment.

Domestic tax incentives and regulations would be a better way of limiting environmental degradation (Anderson and Blackhurst, 1992; Lutz, 1993). The same general conclusion is reached in recent studies on biodiversity and forestry. For example, the overexploitation of biodiversity and wildlife for international trade plays a minor role in species extinction since the major cause is habitat destruction (Burgess, 1991). Thus, attempts to ban wildlife trade will have limited benefit plus large cost; proper trade mechanisms, such as taxes and subsidies, would be better at encouraging conservation.

With respect to global deforestation, Barbier and others, 1991, found that the timber trade has not been the major source of deforestation. The domestic factors (distorted prices, subsidies, tax regimes, regulations, management capacity) leading to conversion of forest land to agriculture has played the larger role. In general, an appropriate combination of domestic environmental and agricultural policy measures, combined with trade reforms, will result in both welfare gains and in better environmental quality (Harold and Runge, 1993). On the international front, however, the challenge is to initiate coordinated international action on domestic reform measures to counter the environmentally negative effects of scale—any country attempting to implement domestic reforms in isolation will lose income and jobs to its neighbors.

An early view on the effect of freer trade given different national environmental standards between North and South, was that dirty industries would migrate to poor countries, where environmental standards were either less strict or nonexistent (Leonard, 1989). Recent work indicates that pollution abatement and control expenditures by firms do not appear to have had a significant effect on competitiveness in most industries since these expenditures represent a modest share of total costs. For example, environmental costs generally comprise only 0.5 percent of the value of output and only 3 percent for the most polluting industry (Low, 1992). Thus, environmental costs are not a dominating factor in decisions for locating new industrial investments. In fact, trade openness, which may promote newer technologies, may tend to have positive environmental effects since most new technologies are also cleaner (Birdsall and Wheeler, 1992; Huq and Wheeler, 1993).

These findings also suggest that there is no pressing reason for requiring national environmental standards to be made identical. Patterns of resource exploitation and pollution are primarily affected by economic and social conditions, with environmental regulations or standards (especially in poor countries) playing a minor role. Promoting acceptance of similar environmental principles, such as requiring that polluters pay for the damage they inflict, or incorporating environmental values in cost-benefit analysis, will probably be more effective as well as politically more acceptable.

Further work in this field should include efforts to establish more clearly (a) the environmental implications of liberalized trade flows, (b) the extent to which pollution from industrial growth may under-mine declining pollution-intensity effects from trade reforms, and (c) whether trade measures should be resorted to as “second best” policies when international coordination fails to remove domestic distortions (for example, green labeling in the timber trade when the timber resource is underpriced in exporting countries).

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Discussion

Discussant’s Comments

Cielito Habito

It was not very long ago that structural adjustment programs (SAPs) were being roundly indicted by various people as having done great harm to the environment wherever they were implemented, leading to the outright condemnation of such programs and of the institutions that were seen as their main purveyors, the World Bank and the IMF. Having headed our country’s ministerial delegations to some recent international meetings on social development and sustainable development, including the Cairo population conference, the Copenhagen World Summit on Social Development, and the recent Third Session of the UN Commission on Sustainable Development, I could not help notice a change in the language now being used by the critics from the NGO circles and representatives from the developing countries (i.e., that SAPs are important, but that they must also integrate sustainable development concerns). This is in marked contrast to the messages I heard about three years ago in an international conference on the topic held in Berlin, for example, where I recall Ved Gandhi almost single-handedly defending the Bretton Woods institutions on this matter before a predominantly hostile group. Most recently, in New York, the language used by the Group of Seventy-Seven in calling on the multilaterals to address this issue—which I had expressed in behalf of the Philippines as chair of the Group of Seventy-Seven this year—was to call on these institutions to “reorient their mandates to integrate sustainable development concerns” in their work.

All this tends to affirm what Munasinghe and Cruz conclude in their paper, that is, the environment would have been worse off if these structural reforms had not been undertaken. We all agree that macroeconomic reform programs are not inherently bad for the environment; in fact, in many, if not most cases, they have actually been beneficial to the environment. Admittedly, they could have detrimental short-, medium-, or even long-term effects that must be guarded against, or mitigated. I like the way the authors have systematically summarized the circumstances under which these negative effects can arise, which has provided a good basis for organizing their paper, that is, (1) when residual imperfections give rise to environmental harm, (2) when short-term contractionary aspects of such programs may have adverse implications on the environment, and (3) when negative long-term changes in the environment could result from such reforms.

While the paper steers clear of issues on displacement of indigenous peoples and resettlement of communities, unfortunately these issues have consistently provoked strong public emotions among the critics of policies and projects that promote sustained economic growth. However, these issues normally arise not as a result of economy-wide policies, but more in connection with specific development projects, especially the large infrastructure projects that the World Bank has often been associated with. Nonetheless, these have tended to be associated by the critics with structural adjustment programs because of the usual thrust toward industrialization embodied in these SAPs, which in turn entails public investment in infrastructure that often give rise to such issues. It is for this reason that we still have strident critics in the Philippines who condemn our Medium-Term Development Plan, and our vision for Philippines 2000, on the misplaced notion that it is based on a strategy that displaces or penalizes poor communities, a perception coming out of the development projects that are part of the concrete implementation of the Plan.

Looking at the Philippines, excessive industrial protection and a concomitant bias against agriculture in past decades contributed significantly to our environmental degradation, and this has been cited by the authors. The overall economic policy regime led to a weak industrial base, a high degree of geographical concentration in economic activities in the national capital region, at the expense of the countryside, pervasive rural unemployment and underemployment, and a high incidence of poverty.

Perhaps the best way to examine the links between economy-wide policies and environmental degradation in the Philippines is to work back from the main environmental problems besetting the country today. These are (1) forest degradation, (2) soil erosion and siltation of major waterways, (3) depletion of coastal and inland fishery resources, (4) water and air pollution, and (5) urban congestion.

The severe degradation and depletion of forest resources of the Philippines has been the result both of indiscriminate logging owing to past liberal licensing rules and unduly low stumpage charges and of encroachment on the uplands by poor rural folk practicing unsustainable agriculture. Some analysts claim that the latter has been the more telling factor in the destruction of our upland environment. In turn, this has resulted from widespread rural poverty that traces its origins from macroeconomic policies biased against agriculture, lack of access to land because of a highly inequitable asset distribution, and lack of nonagricultural employment. Soil erosion and siltation problems likewise arise from forest degradation.

The depletion of coastal and inland fishery resources is likewise the result of the dearth of employment in rural areas, which has driven too many to rely on fishing as a livelihood and driven fisherfolk to overfish their fishing grounds. Again, this ultimately traces back to an overall economic policy environment that inhibited growth of economic activity in the Philippines countryside.

Air pollution is the result of the excessive industrial protection of the past, which appeared to have had the effect, among other things, of weakening the incentive to invest in newer, more efficient, and cleaner equipment and technologies. Coupled with the lack of appropriate regulatory or market-based instruments to check pollutive practices of firms, the atmosphere in the major cities has deteriorated to alarming proportions. It has been noteworthy that the economic reforms we have recently undertaken toward an open, competitive economy are now leading to a surge in new investments by existing enterprises in newer, more productive and more environmentally friendly technologies.

It has been established that the greater part of our water pollution comes more from domestic sources than from industries, because of lack of sanitary sewerage facilities and garbage collection services, especially with the congestion in the cities resulting from migration from the countryside. As I have already cited above, the past economic policy regime that favored the traditional cities led to this situation, which is now being addressed under the government of President Ramos through a regional development strategy that expects to stem the tide of urban migration by providing job opportunities in the countryside.

The authors suggest a framework for analyzing and addressing the links between economy-wide policies and the environment through the Action Impact Matrix, or AIM. The value of the matrix is enhanced by the fact that there appears to be wide diversity in circumstances in different countries, leaving little scope for drawing standard lessons. The various case studies cited by the authors attest to this. But while the AIM does appear to be a useful tool for a more systematic approach to the issues, drawing one up would be more complicated than it initially appears. The authors themselves admit that linking specific causes with particular effects on the environment is especially problematic when many conditions are simultaneously changing, and the Philippines is one such case, where several factors and policies at once impact on a particular environmental system. Furthermore, the relative magnitudes of the effect of economy-wide policies on particular elements of the environment are difficult to isolate from more direct policies impinging on the environment (e.g., logging license regulations or lack thereof, lack of enforcement of municipal fishing laws).

Thus, appropriate corrective adjustments cannot be defined with any degree of precision, a situation that can be dangerous when the level or magnitude of a policy instrument (e.g., exchange rate, tax policy) can have profound implications on other variables in the system (e.g., inflation, employment, interest rates). Thus, I agree with the Gandhi and McMorran paper that macroeconomic policies are not the best instruments for improving the environment. Mohan also indicated this by saying that appropriate complementary measures need to be relied on to address the environmental “side effects,” if you will, of macroeconomic policies. I may be too much of a pessimist, but it seems to me that the usefulness of the AIM for analysis and remediation, as suggested by the authors, would be extremely limited given these constraints and the reality of scarce data and quantitative tools needed for the purpose. I am a CGE modeler myself and I am only too familiar with the constraints on the usefulness of such models.

Nonetheless, I see the construction of such a matrix as a useful exercise even if only to provide a tool for problem identification, thereby providing policymakers a better understanding of the environmental problem, and for providing some general indications of policy implications. Thus, I keenly await the AIM for the Philippines that the authors indicate is being constructed. For such a matrix for the Philippines, I would include in the list of economy-wide policies

  • trade liberalization/tariff reform policies
  • investment liberalization
  • anti-monopoly policy
  • fiscal reforms
  • privatization program (including Board of Trade for public infrastructure)
  • Key Production Areas program of the Department of Agriculture
  • Regional Industrial Centers program.

On the list of investment projects, the matrix should highlight the so-called Flagship Projects of the Ramos administration, of which there are about 18, and should proceed with the other projects in the Medium-Term Public Investment Program for 1993–98.

On the list of key sustainable development issues, I would include

  • land degradation
  • forest degradation
  • indiscriminate land conversions
  • water pollution
  • air pollution
  • fisheries depletion
  • soil erosion/siltation
  • resettlement.

Finally, I would just like to address an issue mentioned by the authors that is relevant to economies like that of the Philippines, which are seeking a transformation toward a more industrialized structure from one in which the agricultural and other primary industries dominate. Under our circumstances, an industrialization strategy that initially stresses processing industries is deemed desirable on the basis of stronger links with the rural (and predominantly agricultural) economy, thereby promoting more equitable growth. But as indicated by the authors, these types of industries also tend to be more pollutive than assembly-type industries, which usually do not lend themselves to location in the countryside, but are more attractively located at or near cities where the ports are. Thus we seem to encounter a situation where there is a trade-off between equity and environmental concerns. This suggests the crucial need for newly industrializing countries to adopt the necessary complementary measures that will address the higher levels of pollution that would otherwise occur in successfully industrializing economies.

I have not dealt at all with the feedback effects of environmental protection or lack thereof on economic growth, for which the authors admit there remains lack of more systematic evidence. But the value of environmental protection as a goal that goes hand in hand with economic development should no longer be in question in a world where people have become more forward looking, caring not only for the welfare of the current generation, but also for that of our children and grandchildren to come.

Other Discussion

Peter Bartelmus: The sounds that I hear from Mohan Munasinghe on remedial actions appear to me a bit like the add-on policies to deal with the environment after the effects on the environment have occurred. The proposal of complementary actions seems to be nothing more than improved environmental impact assessments, which is no different from previous approaches at the World Bank when environment was added to economic policy reform, as an afterthought.

I also hear sounds like let us not touch our well-established macroeconomic policies, which are producing the required necessary benefits. Have we examined the possibilities of revising macroeconomic policies, which, after all, are the enabling conditions—both for the success of project implementation and for environmental outcomes. It looks to me that we are still marginalizing environmental objectives when we use an add-on approach.

Salah El Serafy: I am delighted to hear that there is now an active process in the Bank to integrate the national environmental action plans (NEAPs) and strategies into the economic work. I hope now, in addition to meaningful NEAPs and strategies, it has been mandated for the country economists in the World Bank to think about the long term, which is the essence of environmental issues.

Ved Gandhi: Given the importance of complementary environmental policies, such as appropriate environmental taxes, proper user charges, removal of subsidies, removal of price distortions, raising energy prices, and raising water charges, I have a question essentially for Cielito Habito. What, as a technocrat-politician, does he see to be the probability that the policymakers of any country can be pushed into adopting such environmental policies in the short run? Or, must we all take a longer-term perspective until the politicians themselves have realized the urgency of implementing environmental policies, when these policies will be adopted? We in the Fund can pursue environmental objectives as a part and parcel of our work only if there is some probability of appropriate environmental policies being adopted. Without an assessment of the political feasibility, we may well be wasting our time in talking about environmental policies on our missions.

Ian Johnson: I have a question about the supply responses in response to the removal of subsidies. I do not believe that the removal of subsidies alone would be enough to ensure sustainability. Consider the price of water, which is highly subsidized in a country such as Morocco. Its true efficiency price is certainly far above the price that people would be required to pay after the water subsidies have been removed. The latter will only mean that actual costs are being met. If the full efficiency prices were charged, there would be a strong negative supply response, and these will affect the country’s agricultural programs. Given that the World Bank is in the business of economic development as well as sustainability, it will be interesting to know whether the Bank staff really considers water subsidy removal as a first step or the only step toward sustainable agricultural water policy.

David Reed: Both the Fund and the Bank staff have emphasized that there are a number of situations in which the “win-win” opportunities exist. Indeed, we all recognize that price changes can lead to economic efficiency, which can also have positive environmental effects. I am not quite sure, however, what proportion of adjustment policies actually do result in win-win outcomes and how broad and comprehensive they are.

My broader concern is with the impact of macroeconomic reforms on social structures, and it is unclear to me how the IMF staff deals with them. We have an ongoing debate about this issue based on the latest WWF studies relating to the impact of the adjustment programs on the environment of nine countries. I am very concerned with the response I got yesterday when I raised this issue, the response to which was that the Fund is basically a monetary organization and does not have any sociologists and does not plan to get any soon. I think it is important to point out the Fund has done extensive work on the impact of macroeconomic policies on the breadth and depth of poverty as well as on the delivery of social services, on the efficiency of that delivery, and alternatives to it. The Fund staff could easily continue exploring the impacts of stabilization programs on the environment, for example, through the impacts of fiscal reductions on poverty. Ignoring the environment, in my opinion, will be really shortsighted.

From our WWF studies it is clear to us that it is not the price changes—whether expenditure switching or expenditure changing policies—that have an impact, it is the social dimension that has the most direct and enduring impact on the environment. For the Fund staff to simply argue that they have no capacity will be very short-sighted.

Ganga Ramdas: Is it correct to prescribe taxes that should be proportional to the physical emissions? How will they be designed and implemented?

Responses

Wilfrido Cruz: In responding to some of the comments, let me say that there is no real counterpart to the use of benefit-cost analysis in calculating the environmental impact of the projects. If you want to think of the methodological counterpart, perhaps domestic resource costs is the closest counterpart of a benefit-cost ratio. Unfortunately, the complex analysis of macroeconomic policy-environment links does not fit neatly into these analytical frameworks.

Regarding the effects of macroeconomic policies on social structures pointed out by David Reed, without doubt, these are some of the thorniest issues. The whole idea of social safety nets and complementary social policies and initiatives to accompany the need for macroeconomic adjustment or stabilization is in response to these effects.

I fully agree with David Reed that social issues are closely related to environmental ones. But I do not think that the social scientists and the environmentalists have invested the kind of time and analytical efforts required to make progress on these questions, which, among other things, cover subjects as diverse as indigenous people, resettlements, gender issues, and so forth. In fact, in these areas, one sees somewhat of a disturbing trend of anecdotal statements being made such as, I went to a World Bank project and I saw this thing happening, which is terrible. I have nothing against first-hand experience and information—those are very important inputs—but the problem is that we need much more evidence and analytical work. We in the World Bank are starting to feel that just as macroeconomy-environment links are too important to be left to environmentalists alone, social issues-environment links, too, are just too important to be left solely to social scientists!

Mohan Munasinghe: The point Ian Johnson has made that subsidies can be important in causing environmental damage is absolutely correct. If you look at the extent to which energy and water prices are subsidized in many countries, they are large and, in my opinion, it is important to deal with them first before we deal with environmental externality, to get to a full sustainability price. I fully agree with Ian that it usually will involve a two-step process; however, the efficiency prices are easily calculable while the externalities are far more difficult to calculate.

I also agree with Salah El Serafy that we do need to bring the economic and the environmental tracks together, at least within the World Bank, if not in our member countries. One way is really to make sure that the National Environmental Action Plans and the Country Assistance Strategy documents are consistent with each other or, at least, are not at cross purposes from each other. I realize fully that this is easier said than done. We have to prove to the Bank staff that this kind of cross-fertilization is actually helpful to both—that the economic arguments are helpful on the environmental side and the environmental arguments are helpful on the economic side, and that they are not necessarily at cross purposes.

On the question that Peter Bartelmus raised, yes, we have talked about environmental measures in tandem with economy-wide reforms. Ideally, before you get into major dialogue with member countries, you have to identify what the environmental issues might be and build their solutions into the overall package, as an articulated set. Once again, easier said than done. We are trying this in four countries, and it is very hard going. For example, if you want to introduce property rights, which may be difficult because of legal factors or the entrenched interests and you cannot easily move on that front, the question is, should we hold off the devaluation of currency? The obvious answer is no. Thus, you must identify where remediation should take place, but whether or not you can implement it in time is something else. So that the intent is to anticipate rather than put a band-aid after the damage.

In response to the question raised by Ganga Ramdas, take something like air pollution and let us say we are considering fuel prices and taxes. Is it really a complicated process to design the right measures or to implement them? You first have to determine where you want to apply your tax—whether at the point of generation of electricity, somewhere along the chain, or at the consumer level—and whether or not it is going to be passed along. You also need to calculate the extent of the damage and decide on what exactly is causing the damage. Suppose it is the ambient concentration of particulate matter, then we have to look at the exposure of population, which, in turn, will depend on the location of population, how much people inhale, and how well nourished they are, and the amount of health care they actually receive. So, it is a very tangled problem and it is not very easy for us to either calculate the emission and tax, or to be able to evaluate its effects.

Let me reassure David Reed on social issues. The mandate we received from the organizers of this seminar was to explore the macroeconomics-environment links, but we do know that the third leg of the sustainability pyramid is social. How seriously would the economy-wide reforms work through the social side into the environment is an important question, and the Bank staff is working on it.

Peter Bartelmus: In connection with the question by Ganga Ramdas on how emissions should be taxed, I would like to flag something we encounter in green accounting. Indeed, there we would have to follow, on theoretical ground, the chain from emission to ultimate damages, and the principle is that marginal costs should equalize marginal benefits in the form of reduction of damages through environmental action, so that we have a marginal cost-benefit ratio for internalization purposes. There are two reasons why that is not possible. First, it is very difficult to measure benefits or damages or reduced benefits from environmental action. Second, in order to link the different costs generated to those that cause them, we have to apply the polluter-pays principle and it is not easy to decide on the incidence issues. That is why we continue to have this very crucial problem in environment cost accounting.

Further Discussion

Cielito Habito: I would also like to comment on the need to revise, if not overhaul, macroeconomic policies to truly integrate environmental concerns. I would be the first one to accept that macroeconomic policies are not the best instrument to achieve environmental objectives. But this is not to deny that there is some scope for adjusting macroeconomic policies, or, at least, redesigning the timing and phasing of some of these policies that could have important impacts on the environment, through their social impacts. I guess the problem here is that there is a difference between the short-term social impacts and the long-term social impacts of such policies. I would readily agree that the long-term social impacts may well be positively served by the reform of macroeconomic policies, while in the short term there may be negative social impacts. This is the reason why the phrase social safety net came into vogue—the idea was to do something about the short term while the longer-term positive impacts are not yet forthcoming.

There is an urgent need for continuing information and explanation to the outside world by the authorities on the benefits of macroeconomic policy reform or structural adjustment policies, because the agreement that these are necessary is not yet universal. Of course, economists are already convinced, that in the long term, both in the interest of sustained economic growth and to be able sustainably to address social and environmental concerns, we need macroeconomic stability and macroeconomic policy reforms. Others, including the environmentalists and sociologists, need to be educated.

In response to Ved Gandhi’s question, regarding the prospects of implementation of environmental policies in the short run, I can only speak for the Philippines, where the NGOs now enjoy a strong role in policymaking. They have a very active participation in most consultative and recommendatory bodies and there is a great willingness on the part of the government to listen to what nongovernment advocacy groups have to say about how we should be handling overall development problems. It is for this reason that I am quite optimistic that the kinds of adjustments in policies, whether it is the macroeconomic policies themselves or the complementary environmental policies, are going to be very positively received, at least in our context. The politicians in the Philippines also have been won over to the need for structural adjustment or macroeconomic reforms (it was an uphill battle over the last few years), but we now have a very supportive Congress. It should be easy, given the background of these debates that we are having here, to convince them that we do need many complementary measures in environmental policies to address the short-term negative impacts of macroeconomic adjustment. I am therefore quite optimistic that all these discussions we are having today are not going to come to naught.

Stein Hansen: Have there been any detailed and concerted studies on how the levels and patterns of environmental expenditures have been affected in countries that have gone through sustained periods of severe fiscal stringency?

Mohan Munasinghe: Some of the very early reviews in the World Bank of structural adjustment programs looked not only at the extent of environmental policies that were incorporated in those programs, but also at the expenditure side. However, the best systematic study we have seen is one done in Latin America and the Caribbean Regional Office of the World Bank, which looked at this. There is enough evidence in a number of our other ongoing studies that can help answer your question whether or not environmental expenditures are being badly slashed in the belt-tightening process of structural adjustment.

Ved Gandhi: The critics of structural adjustments keep on pointing out that social expenditures are being curtailed as a part of adjustment effort under the Bank and Fund structural adjustment programs. In this connection, we have recently completed a study covering eight countries that shows that during the adjustment period public expenditures on health and education as proportions of GDP did not decline in any of them.

Vito Tanzi: One aspect worries me. Whenever I meet ministers of the environment, they always castigate the Fund staff for not doing more in this area. Very often I remind them that the person who represents their countries on the Executive Board of the Fund does not wish the staff to get deeply involved in the environment. Perhaps he believes that one should use an organization for one main objective and that the Fund should remain the main instrument of macroeconomic adjustment and related monetary issues. I would like to point out that the Fund has a very powerful Executive Directors body, which represents all member countries and which gives specific instructions to the staff.

I have, of course, always argued that we cannot ignore environmental concerns, even if they are the side effects of our policy recommendations. We therefore try to encourage more involvement of the staff in the environment, but always emphasizing that we should not lose sight of the main objective of the Fund.

So, the point I would like to make is that very often the coordination between economic and environmental objectives must occur within a country. If one day we were to receive instructions from our Board that we should spend far more time on the environment than we are spending, there are lots of people in the Fund who would be perfectly willing to do that.

Note: Mohan Munasinghe is Division Chief, Environmental Economics and Pollution Division, Environment Department, and Wilfrido Cruz is Environmental Economist, Environment and Natural Resources Division, Environment Department, World Bank. This paper draws from the results of recently completed studies coordinated by the Environment Department of the World Bank. The overall study was managed by the authors, together with Jeremy Warford. The country case studies were carried out by Robin Bates, Jan Bojo, Wilfrido Cruz, Robert Cunliffe, Gunnar Eskeland, Boguslaw Fiedor, Herminia Francisco, Ian Goldin, Shreekant Gupta, David-Roland Host, Ramon Lopez, Paul Martin, Peter Meier, Stephen Mink, Kay Muir-Leresche, Mohan Munasinghe, Zeinab Partow, Annika Persson, Tilak Siyambalapitiya, Adriaan Ten-Kate, Hu Tao, Jeremy Warford, and David Wheeler—as cited in the text. Additional background studies and research inputs were contributed by Noreen Beg, Adelaida Schwab, Shreekant Gupta, and Sanath Ranawana. An advisory panel of external experts, consisting of Partha Dasgupta, Stein Hansen, Karl-Goran Maler, Jorn Rattsoe, and Hirofumi Uzawa, provided helpful advice and guidance. Many others, too numerous to list, gave valuable comments. This work was supported in part by generous contributions from the governments of Norway and Sweden. Opinions expressed herein are those of the authors and do not necessarily represent the views of the World Bank Group.
2The effect of inadequate tenurial security over the resource (and future benefits from it) parallel the results for high discount rates. This corresponds to the well-known result in renewable resource exploitation models that the effects on economic behavior of open-access resource conditions are formally equivalent to those of having secure property rights with infinitely high discount rates.
Note: The discussion was chaired and moderated by Naheed Kirmani.

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