Inclusive Green Growth and Sustainable Finance
Through Ecotax - a System Dynamics Model
Joachim Block, Bo Hu’, Armin Leopold
Universitat der Bundeswehr Miinchen, Germany
Abstract
This paper examines the possibility of combining the efforts for socio-economic improvement
and environment protection through an ecotax. Based on a previous model on sustainable
finance of economic growth through several socio-economic options, the new model
extension and simulations demonstrate that both the rate of the ecotax and the use of the
ecotax revenue matter. A properly imposed ecotax may contribute to the achievement of both
inclusive green growth and sustainable finance.
Keywords: ecotax, inclusive growth, indebtedness, sustainable growth
1. Introduction
Ruinous exploitation leads to depletion of non-renewable nature resources, environmental
pressure and indebtedness of national economies. Addressing these issues with one single
policy may help to form a successful coalition facilitating political changes towards a
sustainable system on a national or multi-national level.
Based on a previous model on sustainable finance of economic growth through several socio-
economic options (Block 2013) this paper examines the possibility of combining the efforts
for socio-economic improvement and environmental protection through an ecotax. The new
model extension and simulation demonstrate that both the rate of the ecotax and how ecotax
revenues are used do matter. A properly imposed ecotax may contribute to environmental
protection while facilitating economic growth in the long run. Simulation runs reveal that an
ecotax based policy can result in inclusive green growth and sustainable finance if the right
balance between green investments and income improvement is found.
In the following Section 2, we first introduce some related research works. Section 3 presents
the extended model. Using this model some scenarios are simulated and presented in Section
4. Section 5 concludes this paper.
2. Background
Climate change and other environmental issues are among the most critical challenges we are
facing in the modern world. The strategy seeking well-being through an ever increasing GDP
has already met its limits - the limits to growth (Meadows 1972). Well-being, health, and life
expectancy may decrease in a growing economy. Particularly, the dramatic air pollution
problems in China’s mega cities clearly illustrate the negative effects of GDP growth at the
cost of the environment (Chan 2008). Furthermore, increasing production and consumption,
per definition a prerequisite for GDP growth, often results in an exploitation of non-renewable
resources.
Governments all over the world are forced to implement policies to reduce ecological pressure.
Modern technological and systematic innovations may drive the markets into the right
' Corresponding author. E-mail address: bo.hu@unibw.de
direction. The overall aim is to counter climate change and other environmental pressures,
such as increasing pollution or irreversible biodiversity loss, without putting economic growth
at risk. Green growth is supposed to break the established link between the ,,environmental
bads“ and the ,,economic goods“ (OECD 2002).
The United States government for example provides a US$ 7,500 tax credit to subsidize the
production of each electric vehicle in order to both reduce carbon emission and develop an
electric vehicle supply chain in the United States (Canis 2013). Norway implemented one of
the highest carbon taxes per ton CO) in the world to fulfill the Kyoto Protocol (Bruvoll 2002).
Dramatically increased fossil fuel prices directly lead to new energy efficient technologies as
well as carbon mitigation technologies both in households and in industry production
processes. Despite some fossil fuel intensive industries the ratio of carbon dioxide emissions
to GDP decreased by 12%. In 2012 Germany initiated a program for the sustainable use and
conservation of natural resources (BMUB 2012). The goal of this ambitious program is to
foster Germany’s economy while simultaneously reducing environmental pollution. On the
one hand, the extraction and use of natural resources are to be made more sustainable. On the
other hand, stable employment and social cohesion must be guaranteed.
Meanwhile, stable employment and social cohesion is endangered by indebtedness in many
national economies. In 2013 the estimated size of the global debt and securities market has
reached incredible $100 trillion (Drehmann 2014). Many research works have shown that
indebtedness is mainly caused by income inequality (see, e.g., Kumhof 2010, Charpe 2012).
A sustainable policy has to be aimed at an inclusive green growth (OECD 2012). Such a
policy-mix may include tax break and subsidies to direct private investment toward green
technology as well as taxing undesirable behavior. The latter is called ecological or
environmental taxation or short ecotax.
The introduction of an ecotax can involve significant political economy challenges (OECD
2010). For instance, taxes on certain energy sources like carbon fuel applies to all residents
and can be a burden for low-income households (see, e.g., Bach 2001). It is up to the
governments to secure the social system by not only carefully considering the design and
coverage of ecotaxes but also guaranteeing a useful usage of the generated revenues. The
OECD proposes to handle revenues from ecotaxes as general government revenues that
should be used for example to reduce other taxes or debts (OECD 2011). Discussing the rate
of the ecotax and its usage is the aim of this paper.
3. A system dynamics model
In a previous paper (Block 2013) we focused on the relations and driving forces between
gross domestic product (GDP), consumer debt — including public debt, and income inequality
within a national economy. In this section the updated and extended model starts likewise
with a substructure describing the GDP, which is given by the sum of investor
consumption, non-investor consumption and invest total together with net
export which is expressed by net export share of GDP. A consumer price index (CPI)
is included to reflect the price change over time (Figure 1). Notice that both private and
public households are summarized as non-investors.
basic investor eon
invest consumption
total TZ d
investor
\ onconn a
eo pe rvs
severe rate CP!
net export Ys
mae we
CPI
basic labor
consumption
non-investor Time
consumption,
non-investor
money start
Figure 1: GDP and factors influencing consumption
A higher production, service and innovation capacity (Johnson 2005) may trigger a higher
investor and non-investor consumption.
Figure 2: Conventional capacity
The capacity outflow or the capital depreciation is characterized by the parameter
duration (Figure 2). To counteract the depreciation or even to raise capacity one has to
invest or to activate the inflow of the capacity. Notice that it is the (expected) return
which drives the investment. Three reinforcement loops are identified which are drivers of
growth.
capacity
total _
investor
comeumption
basic investor akon.
“retumn — invest consumption
total A
investor
consumption ,
A
basic labor
consumption
non-investor
‘consumption add-
on
so
net export GZ
share
Time
Tominvestor | __consumpiion
vey =O
non-investor
money start
= Se.
duration
depreciation
investor
comsumption
basic investor .cd-0}
consumption Ps )
change
rate CPI non-investor
us ‘consumption add-
art on
basic labor
consumption
non-investor Time
consumption,
ee
Figure 3: Green capacity
In this model we differentiate between the conventional capacity and the capacity green
(Figure 3). In analogy to capacity, green capacity is subject to depreciation green.
Green capacity depicts the results of all successful efforts to reduce usage of non-renewable
resources in all production, service and innovation processes. As an ideal model assumption
green capacity does not consume non-renewable resource at all. A real national economy is
depicted by a combination of a certain share of green capacity and conventional capacity
consuming fully non-renewable resources (see, e.g., Hu 2010). Greening an economy means
to steadily increase the share of green capacity (green share). Notice that an additional
reinforcement loop can be identified which is the driver of green economy. Since the returns
from the conventional and the green capacity may differ, a parameter for sensitivity analysis —
green efficiency — is introduced.
duration
depreciation’
green eee | depreciation
& SP
)
capacity
. invest
a invest
green share start
stat
e
a green
-_
efficiency
investor
+E) comsumption
basic investor add-on
consumption
tal
investor
_—"s consumption
change
° eo fate oP
CPI Z
_-—
non-investor Time
consumption,
basic labor
consumption
non-investor
money start
Figure 4: Consumer debt
Non-investors’ or households’ income consists of work income and — in the case of public
household — of taxation. The higher the capital share, the lower the income of households.
Under increasing income inequality households with their non-investor money can
often not afford all products and services offered by the existing capacity. A short-termed and
short-sighted way to keep economy growing is to provide easy access to consumer credits.
Not a small fraction of non-investors fund or are forced to fund their consumption by taking
up loans (Figure 4). Repaying loans further reduces non-investor money. The repayment
includes the interest rates for the loans. Financial institutions usually determine
interest rates by calculating loan default risks so that a risk add-on factor to the
interest rate has to be taken into account. In the long run a high and increasing Debt /GDP
ratio will reduce reinvest share and cause an economic down turn.
a ae
—— ——
a duration
depreciation
& J LO capacity &
\ siart
t+) reinvest capacity
share *
basic investor ro)
consumption
a investor eal
/ nsumption
green share
stant
green
OP suc
a
efficiency
SO -
at sip sean
come. [<<Go
co cS
non-investor acy
ey a a
Figure 5: Three policy options to reduce debt and achieve rebalancing
As debts rise, a significant amount of income has to be used for repaying loans. Without
taking more and more loans non-investors cannot hold their life standard, i.e. their level of
consumption. To counter indebtedness non-investors might be forced to implement debt
reduction policies, like austerity. Although austerity indeed contributes to reduce at least
the growth of public and private debts, such a reduction happens at the cost of economic
development because of resulting in a non-investor consumption reduction
(Figure 5). Compared to austerity, achieving more income of public and private
households seems to be a better method to limit and reduce debt while enhancing economic
growth (Block 2013).
The simulation results of the previous SD model illustrate that decreasing inequality is a much
more preferable policy than austerity. However, a sustainable economy does not necessarily
result in a green economy. The updated model enables users to analyze the effects when an
ecotax is in place. An ecotax is aiming to promote environmental behavior and is usually
charged on the utilization of non-renewable resources. An ecotax not only contributes to the
preservation of non-renewable resources and to the decrease of environmental pressure by
forcing investors to invest in green technologies and systems (capacity green) instead of
classical ones (capacity), ecotax revenues can also be distributed to non-investors in order to
counter inequality.
invert SS occ
LOE 3 ° 2
invest
green
Dh er
green
green
debtiGDP
efficiency
investor
consumption
4 tt)
OF Qo
‘Austerity
debt __»—
Figure 6: Causal loop diagram
Figure 6 shows a causal loop diagram which gives a simplified view of the model discussed in
this section. It is obvious that there are multiple loops and side effects which make numeric
simulations necessary.
4. Simulation results
We have conducted simulation runs with different ecotax policies and analyzed the effects on
GDP, consumer debt levels, and investment. The policies under investigation are (a) no
ecotax, (b) an ecotax is in place and fully redistributed to the non-investors, (c) 100% of
ecotax revenues are used to subsidize green investments, and (d) 26% of ecotax revenues are
used to subsidize investments in green technologies and systems. In addition, an adaptive
sensitivity analysis has been carried out on the effect of green efficiency on the development
of green share.
GDP. consumer debt and ecotax
—— “=|
° aaa
° =
o 2 4 6 8 1 12 14 16 18 20 22 28 26 28 30
Tine (Yea)
opp
consumer debt
ecotax
invest total
GDP conventional
capacity total
Figure 7: A non-sustainable growth. Notice that only capacity total has a fourfold
range on the Y-axis. The units are B€ and BE/a.
Figure 7 illustrates the baseline scenario (a). Debts of consumers rise sharply. GDP increases
until it peaks in the 27th year and falls afterwards because a high indebtedness will discourage
further investment. The economy shows a non-sustainable growth because of the exponential
growing consumer debt.
GDP, consumer debt and ecotax
GDP
consumer debt
invest total
GDP conventional
‘capacity total
Figure 8: Sustainable finance through ecotax
If an ecotax (b) is introduced at year 15 the situation changes completely. In the scenario
shown in Figure 8 all the ecotax revenues which have an amount of about 23% of the
revenues generated by conventional capacity are distributed to the consumers to achieve more
income equality. The consumers in turn use this additional income for non-credit financed
consumption or to repay loans. Logically the revenues generated by green capacity are free
from ecotax. Ecotax does have a short-termed negative impact on economic growth. However,
because of its redistributive effect the ecotax contributes positively to sustainable economic
development in the long run. The economy benefits from a slight growing GDP, drastically
reduced debt-levels, and steady in’ nts. This is what can be called a sustainable finance.
The desired ecological impact is rather small: the growth rate of GDP conventional or
the GDP produced or served by conventional capacity is only slightly below the one of GDP.
GDP, consumer debt and ecotax
GDP
consumer debt
invest total
GDP conventional
capacity total
Figure 9: Using all ecotax revenue to subsidy ,, green“ investments
The next simulated scenario is that all revenues from the ecotax are used for investment in
green technologies and systems (c). The outcome shown in Figure 9 is very similar to the
policy without ecotax (a). The sole difference is that GDP conventional differs significantly
from GDP. Like in scenario (a) and in contrast to the expectation, using all ecotax revenues
for green investment does not result in an inclusive green growth. There is a greening effect.
However, it does not sustain because of the exponential growth of debts.
GDP, consumer debt and ecotax
2,500
10,000
1,250
5,000
|
GDP
consumer debt
capacity total
Figure 10: Using a part (26%) of the ecotax revenue to subsidize ,, green“ in
Figure 10 illustrates the impact upon the economy if 74% of ecotax revenues are redistributed
to consumers and the rest is taken for subsidy of green investments. In contrast to policy (b)
GDP has a much higher rate of growth. Debts stop increasing. Remarkable is that total
investment does not change significantly: conventional investments are replaced by green
investments. The desired ecological impact becomes visible: GDP conventional does not
grow at the same rate of GDP. The intensity of the usage of non-renewable resources
decreases.
iniesahyane green efficiency 4o%] 50%] 80%] 100%] 120%)
lecorax share | 7a.5%| 23.5%] 24.5%] _23.5%| 23.594
35.0% subsidy share | 32,0%| 30.2%| 28.1%6| 26.0% 23.094
green share | 12.3% | 16.1%| 20.8%| _25.3%| 31.634
eee al .sbP (Be) 216s] 2165| 2167| 2160] 2169)
Taba Hara comsumerdebr(Bé)| _920[ 927] 930| _930| 928]
Ae green share!
ath Ste eceneicieney —[—10%| ss] ane aoo%e| 208
= eect srett Fax] a.a%| 97.38] 77.396) 47.38)
ce ot" subsidy share 10.6%| 6.6% 61%] 35% 0.0%
iacenshatal 4.2%{ 6.5%] 20.0% 43.7%] 19.3%
anne GDP (BE) 2iei| 2161] 2162| 2162] 2168)
= comsumer debe (@) | 930| 929 930 928] 79
a ane =<
0.0% —
10% 20% 30% A «SOK GOR 70% OK OK IDK 110% 120%
sreenefliiency
Figure 11: An adaptive sensitivity analysis
Based on (d) an adaptive sensitivity analysis has been carried out to identify the effect of the
green efficiency upon the development of the green share. As shown in Figure 11, the higher
the green efficiency, the higher the green share will be reached in the 30" year, and the lower
the subsidy share is to be set to reach the target values of GDP and consumer debt of about
2165 BE resp. 930 B€. The ecotax provides sufficient political alternatives for achieving both
economic and ecological goals.
5. Conclusions
Economic developments often contain two major unsustainable trends at the same time:
indebtedness and depletion of non-renewable natural resources, which particularly include
fossil energy sources and unpolluted air, water and soil. This paper examines the possibility to
combine the efforts for socio-economic improvement and environment protection through an
ecotax.
Based on a previous model analyzing the relationship between economic growth and
consumer debt from a financial and redistribution perspective, the model extension allows to
analyze the effects if an ecotax is imposed and the revenues are spent in several different
ways. The total production, service and innovation capacity of a real national economy is
depicted in this model by a combination of a green capacity, which does not consume non-
renewable resources at all, and of a conventional capacity consuming fully non-renewable
resources.
The model simulations show that ecotax does have a short-termed negative impact on
economic growth. Because of its redistributive effect the ecotax contributes positively to
sustainable economic development in the long run. The prerequisite is that a significant share
of the ecotax revenues is used to improve income of households and thus reduces
indebtedness in the national economy. In contrast, fully using tax revenues for subsidy of
green investments will fail because a high and increasing debt to GDP ratio will slow down
both conventional and green investment and lead even to an economic crisis providing even
less headroom for sustainability policies. Properly imposed and meaningful spent, ecotax
seems to be an important instrument to achieve inclusive green growth and sustainable
finance.
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