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Measurement of environmental efciency and

productivity: a cross-country analysis

SURENDER KUMAR and MADHU KHANNA

Environment and Development Economics / Volume 14 / Issue 04 / August 2009, pp 473 -

495
DOI: 10.1017/S1355770X08005032, Published online: 06 March 2009

Link to this article: http://journals.cambridge.org/abstract_S1355770X08005032

How to cite this article:

SURENDER KUMAR and MADHU KHANNA (2009). Measurement of
environmental efciency and productivity: a cross-country analysis. Environment
and Development Economics, 14, pp 473-495 doi:10.1017/S1355770X08005032

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Environment and Development Economics 14: 473–495 
C 2009 Cambridge University Press
doi:10.1017/S1355770X08005032 Printed in the United Kingdom
First published online 6 March 2009

Measurement of environmental efficiency

and productivity: a cross-country analysis

SURENDER KUMAR
Faculty of Business Administration, Yokohama National University, 79-4,
Tokiwadai, Hodogaya-ku, Yokohama 240-0067 Japan, and Department of
Policy Studies, TERI University, India Habitat Centre, Lodhi Road,
New Delhi 110003 India.
E-mail: surenderkumarbansal@hotmail.com

MADHU KHANNA
Department of Agricultural and Consumer Economics, University of Illinois
at Urbana-Champaign, 440 Mumford Hall, 1301W. Gregory Dr., Urbana,
IL 61801 USA

ABSTRACT. This paper measures environmental efficiency (EE) and environmental

productivity (EP) in 38 countries over the period 1971–92 and analyzes differences in
these across countries. It explores several macro-economic factors that could explain
these differences, such as income levels and the degree of openness in these countries.
The average EE and EP indexes are found to be almost steady over the period 1971–
92. In the annex-I countries, an increase in income levels initially leads to an increase
in the average EE but subsequently to a decline in EE. In non-annex I countries, EE is
increasing over the range of income in these countries. This study also finds an EKC type
relationship between EP and per capita GDP in annex-I countries. The degree of openness
has a significant positive impact on EE in annex-I countries.

1. Introduction
There is growing concern about carbon emissions because of their potential
for causing global warming. At the same time, concerns about the costs
of abating carbon emissions and its impact on factor productivity have
made countries hesitant about reducing these emissions. Reduction in
carbon emissions is expected to require transformation of the production
technology by adopting environment friendly technologies and diverting
some productive resources towards abatement. The costs of carbon
abatement and the impact of abatement on productivity are likely to
vary across countries due to differences in technology which influence the
productivity of inputs, differences in resource availability which influence
the mix of energy, capital, and labor used by these countries, and differences
in public policies/pressures to improve environmental quality.
The purpose of this study is to quantify these costs of abatement
and impacts on productivity and to analyze differences in these across
countries. We also explore the macro-economic factors that could explain
474 Surender Kumar and Madhu Khanna

these differences and in particular examine whether these differences can be

explained by income levels in these countries. This will provide insight on
the extent to which development and technological progress can be relied
upon to mitigate carbon emissions and on the validity of concerns about
the economic impact of carbon abatement. This analysis is undertaken for a
set of 38 countries including nineteen annex I countries and nineteen non-
annex I countries for the period 1971–1992.1 By focusing our analysis on the
period when public policies and public concern for global warming were
minimal, we can examine business-as-usual trends in costs of abatement
and environmental productivity of countries. The first United Nations
Framework Convention on Climate Change in Rio was held in 1992 and
before that CO2 was not much of a policy issue. While our analysis is for
the pre-Kyoto period, the results of our analysis are still applicable as many
developed countries and all developing countries still lack any regulations
to control CO2 .
In the absence of direct data on the costs of carbon abatement and
environmental productivity of a country, we rely on a distance function
approach that incorporates both the desirable output (gross domestic
product, GDP) and undesirable output (CO2 ) to provide a measure of
‘how far’ each country’s output vector is from the best practice output
frontier, given an input vector. This approach recognizes that pollution
is an undesirable output that is not freely disposable; rather it is weakly
disposable, that is some productive resources have to be given up in order to
reduce the level of pollutants. The extent to which a country would need to
sacrifice its desirable output to reduce pollution represents its opportunity
cost of pollution reduction, referred to here as environmental efficiency (EE).
Firms that are less constrained are considered to be more environmentally
efficient because they have chosen a more appropriate mix of desirable
outputs, undesirable outputs and inputs, and would potentially find it less
costly to reduce pollution.
We also examine the trends in total factor productivity (TFP) for
individual countries. The approach used here to measure TFP differs
from that used conventionally where the contribution of TFP to output
growth is measured residually after accounting for growth in all inputs. The
conventional measurement of TFP assumes there is an aggregate production
function that represents the production technology of all firms, and that
firms are operating on their production frontiers producing the maximum
possible output given their inputs and realizing the full potential of their
technology (see survey of Nadiri, 1970; Murillo-Zamorano, 2004; Murty and
Kumar, 2004). These studies treat TFP as analogous to technical change.
They either disregard pollution or model it as an additional input (which
is not consistent with the material balance approach as discussed in Murty

1
The annex-1 parties to the United Nations Framework Convention on Climate
Change are those developed countries, or regional organizations (like the EU),
that are listed in the annex-I of the Climate Convention. The choice of period and
countries is constrained by the availability of data, particularly on capital stock.
The Penn World Tables provide capital stock data only up to 1992, especially for
developing countries.
 Environment and Development Economics 475

and Russell, 2002). The approach used to measure TFP in this paper is
based on the premise that firms do not operate on their production frontier
due to organizational and other reasons and are technically inefficient; thus
technical progress is not the only source of growth in TFP. Instead, TFP
growth can be decomposed into that due to technical progress and changes
in technical efficiency. We use this approach towards TFP measurement to
obtain a measure of the environmental productivity (EP) of a country. EP is
the ratio of two estimates of TFP, one obtained under the assumption that
CO2 emissions are weakly disposable and the other obtained by ignoring
the generation of these emissions. The EP of a country can be interpreted
as the efficiency with which environment friendly technologies are utilized
and the costs of these technologies (e.g. Jaffe et al., 2003).2
EE and EP are two different ways to measure the effects of carbon
abatement. While EE is a static measure of the extent to which a country’s
ability to increase GDP would be constrained by carbon emission reduction
targets at a point in time, EP is a measure of the impact of those targets on
a country’s ability to move towards the best practice frontier and to shift
that frontier over time. The EP can be considered as an extended measure
of TFP that credits activities that reduce emissions. It provides a measure
of the extent to which countries are becoming more efficient over time by
increasing good outputs while reducing bad outputs. We show that EE at a
point in time is one of the several components of EP and that the two are
not perfectly correlated.3
There are several studies on the measurement of efficiency and
productivity changes in industries, which produce good and bad outputs
simultaneously during the production process. Some of these studies have
treated the bad outputs as inputs,4 while others have treated them as a
synthetic output such as pollution abatement (e.g., Gollop and Roberts,
1983). The approach adopted by Gollop and Roberts to treat the reduction
in bad output as a good output creates a different non-linear transformation
of the original variable in the absence of base constrained emission rates
(Atkinson and Dorfman, 2005). To overcome this problem, Pittman (1983)
proposed that good and bad outputs should be treated non-symmetrically.
Following Chung et al. (1997), we use the directional output distance

2
The more efficient utilization of pollution abatement technologies, at least in part,
influences the cost of alternative production and pollution abatement technologies
(e.g., Jaffe et al., 2003). An extensive body of theoretical literature examines the role
of environmental policy in encouraging (or discouraging) productivity growth.
On the one hand, abatement pressures may stimulate innovative responses that
reduce the actual cost of compliance below those originally estimated. On the
other hand, firms may be reluctant to innovate if they believe regulators will
respond by ‘ratcheting-up’ standards even further. Therefore, in addition to the
changes in environmental regulations and technology, management levels also
affect environmental performance levels or environmental productivity, which
explains how efficiently pollution is treated, defined by Managi et al. (2005).
3
The relationship between EP and EE is specified in equation (9) in section 2.
4
Cropper and Oates (1992); Kopp (1998); Reinhard et al. (1999), Murty and Kumar
(2004) among others.
476 Surender Kumar and Madhu Khanna

function to calculate production relationships involving good and bad

outputs while treating them asymmetrically.
Several studies have used the distance function approach to estimate the
EE of countries. These studies include Zaim and Taskin (2000), Zofio and
Prieto (2001), and Taskin and Zaim (2001). The former two studies focus
on OECD countries only, while the third study examines the impact of
international trade on EE for a sample of 49 developed and developing
countries over the period 1977–1990. These studies find a U-shaped EKC
exists between EE and per capita income among OECD countries.5 Taskin
and Zaim (2001) find this to be the case for high-income countries but
an inverse U-shaped relationship for low- and middle-income countries.
They also find that increasing openness of a country above a threshold
level increases environmental efficiency among the high-income countries
but does not have a significant impact on environmental efficiency of low-
and middle-income countries. This paper differs from Taskin and Zaim
(2001) in that it classifies countries according to whether they are annex-I or
non-annex-I and thereby provides insights useful for the dialogue between
these two groups of countries on climate change mitigation. Unlike previous
studies, we examine the pattern of EP across countries and whether factors
explaining EE and EP are similar or different for annex-I and non-annex-I
countries. Like Taskin and Zaim (2001), this paper includes per capita GDP
and openness of a country among other explanatory variables to explain
differences in EE and EP across countries.
The remainder of the paper is organized as follows: in section 2, we
discuss the theoretical construct of the paper. The empirical model is
presented in section 3. Section 4 describes and discusses the data used in the
study and the results. The paper closes in section 5 with some concluding
remarks.

2. Theoretical construct
Suppose that a country employs a vector of inputs x ∈ K + to produce a
vector of good outputs y ∈ M + , and undesirable outputs b ∈ N + . Let P(x)
be the feasible output set for the given input vector x and L(y, b) is the input
requirement set for a given output vector (y, b). Now the technology set is
defined as
T = {(y, b, x) : x can produce (y, b)} (1)
The technology is modeled in alternative ways. The output is strongly or
freely disposable if (y, b) ∈ P(x) and (y , b ) ≤ (y, b) ⇒ (y , b ) ∈ P(x), which
implies that if an observed output vector is feasible, then any output vector
smaller than that is also feasible. This assumption excludes production
processes that generate undesirable outputs that are costly to dispose. For

5
The environmental Kuznets curve relating pollution and GDP per capita is
expected to have an inverted-U shape. One would therefore expect the relationship
between 1-EE and GDP per capita to be an inverted U-shaped one, while the
relationship between EE and GDP per capita would be a mirror image of that and
therefore U-shaped.
 Environment and Development Economics 477

example, concerns about CO2 and other greenhouse gases imply that these
should not be considered to be freely disposable. In such cases, bad outputs
are considered as being weakly disposable: (y, b) ∈ P(x) and 0 ≤ θ ≤ 1 ⇒ (θ y,
θ b) ∈ P(x). This implies that pollution is costly to dispose of and abatement
activities would typically divert resources away from the production of
desirable outputs and thus lead to lower good output with given inputs.
Note that if a technology satisfies strong disposability, it satisfies weak
disposability also; however, the converse is not true (Färe et al., 2005). In
figure 1, we illustrate how P(x) is constructed for a technology that satisfies
the assumptions of weak and strong disposability. The line segment cd is a
feasible part of the technology under the assumption of strong disposability
of bad outputs since a movement from d to c would be possible without
reducing any good output. The line segment ef represents the strong
disposability of good outputs, while the segment de represents the best
practice frontier, which is a convex combination of observed mixes of good
and bad outputs. Thus, the output set bounded by the line segments 0cdef
represents technology when there is strong disposability of bad outputs. If
bad outputs are not freely disposable and resources have to be expended
to clean up, then any reduction in bad output below the level observed at
d requires either a reduction in the good output or an increase in the use
of inputs if good output is not to be reduced. Both possibilities are costly;
hence, disposal is not free. The output set is now represented by 0adef.
A functional representation of the technology is provided by the
directional output distance function, which also provides a measure of
inefficiency. The directional distance function seeks to increase the good
outputs whilst simultaneously reducing the bad outputs. Formally, the
directional distance function6 is defined as
 o (x, y, b; g) = sup{β : (y, b) + βg ∈ P(x)}
D (2)
where g is the vector of directions in which outputs can be scaled. Following
Chung et al. (1997), the direction taken is g = (y, −b), such that as the
good outputs are increased and the bad outputs are decreased.7 Figure 1
illustrates the directional output distance function for the direction vector
g = (y, −b). A firm n, with output coordinates (y, b) produces inside the
output set P(x)w . If it were to operate efficiently given the direction vector,
g (represented by the ray 0g) it could expand y and contract b to be at the
boundary of P(x)w at point a, under weak disposability conditions. Under
strong disposability, it could expand y and contract b to be at point k on the
boundary of P(x)s .

6
For the properties of directional distance function; see Färe et al. (2005).
7
Although directional distance function allows various sets of directional vectors
in which outputs are expanded while inputs remain constant or inputs are
contracted while keeping output constant, it also allows one to consider non-
proportional changes in outputs and inputs and an expansion in one output with
a contraction in another output. The vector chosen here is consistent with the
policy objective of increasing desirable output such as GDP and reducing the
emissions of CO2 .
478 Surender Kumar and Madhu Khanna

y = good output

k
c d

P(x)s
a

n
e

P(x)w
g = (y, –b)

b = bad output
0 f
Figure 1. Output sets for strongly and weakly disposable bad outputs, and directional
output distance function

2.1. Environmental Efficiency (EE)

We assume that the directional output distance function is separable in
good and bad outputs8

D  0t (yt , x t ),
 0t (yt , b t , x t ) = B(b t ) D (3)
 
where D  t (yt , x t ) = sup {β : (x t , yt + βg) ∈ T} and T = {(yt , x t ) : x t can produce
0  μ
y }. The set T is a technology set restricted to the production of good outputs
t

only without any consideration for undesirable outputs b t . Therefore, with

this assumption one can decompose technical inefficiency into the factors
that reflect the influence of ‘pure’ technical inefficiency, D  ot (yt , x t ) and the
t
effect of undesirable outputs, B(b ). Thus, EE is defined as
   
EE = 1 + D  it (yt , x t )
 it (yt , b t , x t ) / 1 + D (4)

EE will take values less than or equal to one. It represents the extent
to which a country would be constrained in increasing outputs by its
potential to transform its production process from free disposability to
costly disposal of CO2 emissions. Countries that are less constrained have
a lower opportunity cost of transformation in the production process and
are considered to be more environmentally efficient. This measure takes

8
Färe et al. (1996) and Camarero et al. (2008) assume separability between good
and bad outputs and Färe et al. (1995) assumes separability between outputs and
attributes. These studies use input distance function as an analytical tool.
 Environment and Development Economics 479

a value one only for those countries which are on the segments de and
ef or for those countries whose expansions fall on these segments (fig-
ure 1). Moreover, de and ef are common to both technologies with different
assumptions on the disposability of bad outputs. For countries that lie on
these segments, the cost of transforming the production process from strong
disposability of bad outputs to weak disposability of these outputs would
be zero. For countries located along the line segment 0ad, or in the interior
part of the weakly disposable output set, the EE index will assume values
less than one, indicating that there is an opportunity cost of transforming
the production process from strong disposability to weak disposability of
bad outputs.

2.2. Environmental Productivity (EP)

Following Färe et al. (1995), the EP at time t + 1 using directional distance
function is defined as


 1+ D  t (yt , b t , x t ) 1 + D t+1 (yt+1 , b t , x t+1 )
E Pt = 
t+1 0 0
(5)
1+ D t (yt , b t+1 , x t ) 1 + D
 t+1 (yt+1 , b t+1 , x t+1 )
0 0

As explained above, we assume that the technology admits strong

disposability of good outputs and weak disposability of bad outputs; so
if b t+1 < b t , D  t (yt , b t+1 , x t ) ≤ D
 t (yt , b t , x t ) and also D  t+1 (yt+1 , b t+1 , x t+1 ) ≤
0 0 0
D t+1 (yt+1 , b t , x t+1 ). Hence, if less pollution is produced, the index value is
0
greater than or equal to one, i.e. E P ≥ 1.
Chung et al. (1997) define the Malmquist–Luenberger (ML) index between
period t and t + 1 as

    
 1+ D  t+1 (yt , b t , x t ) 1+ D  t (yt , b t , x t )
ML t = 
t+1  0
 0
 (6a)
1+ D  t+1 (yt+1 , b t+1 , x t+1 ) 1 + D  t (yt+1 , b t+1 , x t+1 )
0 0

which can be further decomposed as

 
1+ D  t (x t , yt , b t )
ML t =
t+1 0
1+ D  t+1 (x t+1 , yt+1 , b t+1 )
0

 
MLEFFCH

  
 1+ D  t+1 (x t+1 , yt+1 , b t+1 )
 t+1 (x t , yt , b t ) 1 + D
×   0
  0
 (6b)
 t (x t , yt , b t )
1+ D  t (x t+1 , yt+1 , b t+1 )
1+ D
0 0

 
MLTECH

The first term, MLEFFCH, represents the efficiency change component, a

movement towards the best practice frontier, while the second, MLTECH,
the technical change.
In order to illustrate the relationship between the EP index (5)
and the ML index (6) we note by introducing 1 + D  t (yt , b t+1 , x t ) and
0
480 Surender Kumar and Madhu Khanna

 t+1 (yt+1 , b t , x t+1 ) twice into (6) that

1+ D 0

ML t+1
t

(1+ D 0t+1 (yt ,b t ,xt )) (1+ D 0t (yt ,b t ,xt )) (1+ D 0t+1 ( yt+1 ,b t ,xt+1 ))(1+ D 0t ( yt ,b t+1 ,xt ))
=
(1+ D0 ( y ,b ,x )) (1+ D 0t ( yt+1 ,b t+1 ,xt+1 )) (1+ D 0t+1 ( yt+1 ,b t ,xt+1 ))(1+ D 0t ( yt ,b t+1 ,xt ))
 t+1 t+1 t+1 t+1

 
(1+ D 0t ( yt ,b t+1 ,xt )) (1+ D 0t+1 (yt ,b t ,xt ))
= EPt+1 . (7)
t (1+ D 0 ( yt+1 ,b t+1 ,xt+1 )) (1+ D 0 ( yt+1 ,b t ,xt+1 ))
t t+1

i.e. the ML index can be written as a product of the EP index and a

measure of change in productivity for the given bad output vectors. We
note that if the bad output vectors are dropped (using the assumption of
separability between good and bad outputs), the term in the parentheses is
the conventional measure of productivity (MS), i.e.

    
 1+ D  t (yt , x t ) 1+ D  t+1 (yt , x t )

MS =  0
 0
 (8a)
 t (yt+1 , x t+1 ) 1 + D
1+ D  t+1 (yt+1 , x t+1 )
0 0

which can be further decomposed into two component measures of

productivity change
 
1+ D  t (x t , yt )
MSt =
t+1 0
 t+1 (x t+1 , yt+1 )
1+ D 0

 
MSEFFCH

  
 1+ D  t+1 (x t , yt ) 1 + D t+1 (x t+1 , yt+1 )
×   0
  0
 (8b)
 t (x t , yt )
1+ D  t (x t+1 , yt+1 )
1+ D
0 0

 
MSTECH

Furthermore, it is possible to decompose EP into environmental efficiency

change (EEC) and environmental technological change (ETC) as follows

1+ D  it (yt , b t , x t )
 it+1 (yt+1 , b t+1 , x t+1 )
1+ D
EP =
1+ D  it (yt , x t )
 it+1 (yt+1 , x t+1 )
1+ D

 
EEC
  

 it+1 yt+1 , b t+1 , x t+1 1 + D
1+ D  it+1 (yt , b t , x t )

  it (yt+1 , b t+1 , x t+1 ) 1 + D  it (yt , b t , x t )
 1+ D
×   . (9)
 1+ D  it+1 yt+1 , x t+1 1 + D  it+1 (yt , x t )

1+ D  it (yt+1 , x t+1 ) 1 + D
 it (yt , x t )

 
ETC
 Environment and Development Economics 481

Thus, EP = EEC.ETC where EEC is environmental efficiency change and

ETC is environmental technological change.

3. Empirical model
The distance function can be computed in various ways, but three are
of particular interest: parametric linear programming (PLP) (e.g., Murty
and Kumar, 2002; Färe et al., 2005), data envelopment analysis (DEA) (e.g.,
Färe et al., 1989; Kumar, 2006), and econometric methods (e.g., Hetemaki,
1996; Kumar and Rao, 2003). There are two essential differences between
the econometric approach and mathematical programming methods. The
econometric approach is stochastic, and attempts to distinguish the effects
of noise from the effects of inefficiency. Mathematical programming
(parametric or non-parametric) is non-stochastic and lumps noise and
inefficiency together. The parametric approaches confound the effects of
misspecification of functional form (of both technology and inefficiency)
with inefficiency. The DEA approach is non-parametric and less prone to
this type of specification error.
We use DEA to compute the directional distance functions. The
directional distance function for observation k’ in period t, using period
t technology can be calculated by solving the following LP problem.
 t (x t , yt , b t ; yt , −b t ) = max β
D 0
s.t.

K
zkt ykm
t
≥ (1 + β)ykt  m , m = 1, . . . , .M
k=1

K
(10)
zkt b ki
t
= (1 − β)b kt  i , i = 1, . . . . , I
k=1

K
zkt xkn
t
≤ xkt  n , n = 1, . . . . , N
k=1
zkt ≥ 0, k = 1, . . . . . , K

To measure the ML index, four DEA programs need to be solved for each
observation. Two use observations and technology for time period t, or
t + 1, and two use mixed periods using, for example, technology calculated
from period t with the observation t + 1. Mixed period problems can cause
difficulties in calculation, whereby the observed data in period t + 1 are
 
not feasible in period t. For example, the observation (y t+1,k , bt+1,k ) may
t t+1
not belong to the output set P (x ). To minimize this problem, we follow
Färe et al. (2001), whereby multiple year ‘windows’ of data are the reference
technology. All frontiers are constructed from three years of data, hence
the frontier for 1973, for example, would be constructed from data in 1973,
1972, and 1971, which reduces the likelihood of ‘non-solutions’.9 Note that

9
In the computation of directional distance functions although we used multiple
year “windows” of data as the reference technology to minimize the problem
of infeasible solutions, the problem still exists for some countries such as Hong
Kong and the Netherlands. For these countries we observed infeasible linear
482 Surender Kumar and Madhu Khanna

we compute a common frontier for all the countries included in this study
using different disposability conditions with respect to bad outputs.10

4. Data and discussion of results

We obtain data on five variables, GDP, CO2 , labor force, capital stock, and
commercial energy consumption, for 38 countries for the period 1971–1992.
Out of these five, the first two variables, GDP and CO2 , are considered as
proxies for good and bad outputs respectively, and the remaining three are
inputs into the production process. Data on GDP, labor force, and energy
consumption are collected from the World Development Indicators (WDI)
(World Bank), whereas the data on the CO2 emissions are obtained from
the website of the World Resources Institute.11 Capital stock12 data are
obtained from the Penn World Tables (Mark 5.6). GDP and capital stock are
measured in 1985 US dollars, whereas CO2 and energy consumption are
measured in thousand metric tons. The labor force data are in millions of
employees. The 38 countries13 included here are those with data on capital
stock and other variables over the period of 1971–1992. The choice of the
period to be studied was also determined by the availability of capital stock
data. Due to missing data for some countries for some years, we have 416
observations for annex-I countries and 405 observations for non-annex-I
countries. Since EP is measured as a change in the levels of the distance
function over two consecutive years, the number of observations available
to analyze the determinants of EP is 19 less for each group of countries as
compared to the observations available on EE.
Annex-I countries have higher GDP per capita, a higher share of industry
and energy in GDP, and a larger openness index and a lower emission
intensity of output measured by the ratio of CO2 emission to GDP. However,
they have lower rates of growth of GDP, capital, labor, CO2, and energy
consumption as compared to the non-annex-I countries. During the study
period, non-annex-I countries not only had higher growth rates of income
and emissions relative to annex-I countries, but there was also a higher
degree of variability within this group. The newly industrialized country
Hong Kong registered the highest growth rate of GDP (7.9 per cent) and
it also had a high growth rate for CO2 emissions (6.5 per cent). Thailand

programming for at least one of the mixed periods when the carbon emissions are
included as bad.
10
Alternatively, the frontier can be computed separately for each of the groups. But
that would not be helpful in making comparison between groups.
11
http://earthtrends.wri.org/searchable_db/index.cfm?theme=3
12
Capital stock does not include residential construction but does include gross
domestic investment in producers’ durable, as well as nonresidential construction.
These are the cumulated and depreciated sums of past investment.
13
We have grouped all the countries in two categories: annex I and non-annex
I countries. We have 19 annex I countries (Australia, Austria, Belgium, Canada,
Denmark, Finland, France, Greece, Iceland, Ireland, Italy, Japan, Netherlands, New
Zealand, Norway, Spain, Sweden, United Kingdom, United States) and 19 non-
annex I countries (Chile, Colombia, Ecuador, Guatemala, Honduras, Hong Kong,
India, Kenya, Mexico, Morocco, Nigeria, Paraguay, Peru, Philippines, Syrian Arab
Republic, Thailand, Venezuela, Zambia and Zimbabwe).
 Environment and Development Economics 483

experienced the second highest growth rate of GDP of 7.3 per cent but a more
rapid rate of growth in the production of CO2, i.e. 8.3 per cent. The highest
growth rate with respect to CO2 was in the Syrian Arab Republic (9.14 per
cent). On the other hand, Sweden, France, Belgium, United Kingdom, and
Denmark registered negative CO2 growth rates of 2.93, 1.71, 1.57, 0.66, and
0.32 per cent, respectively.14

4.1. Estimates of directional output distance function

The directional output distance function is estimated with and without
including CO2 . This allows us to examine the importance of the inclusion
of CO2 emissions in the analysis of efficiency and productivity changes.
As described earlier the directional distance function provides a measure
of technical inefficiency, the average values of this function for both
models at certain points of time are presented in table 1.15 We observe
that the inefficiency scores when CO2 emissions are ignored are higher in
comparison to the situation when this pollutant is weakly disposable. It
reveals that the potential to increase the production of desirable output and
reduce bad outputs with a given bundle of inputs is about 2.3 per cent.
The group averages were constructed by pooling the data of annex-I
and non-annex-I countries over the period, respectively. On average, the
value of directional distance function for non-annex-I countries when CO2
emissions were included ranges from about zero for Paraguay to 0.087
for Nigeria, with mean value 0.055. This implies that 5.5 per cent of the
GDP could have been increased and CO2 emissions could have been
saved by improving efficiency and achieving the best practice frontier
for these countries. For the annex-I countries this figure ranges between
about zero for Japan to 0.057 for Canada. Under the weak disposability
assumption the pooled average values of directional distance function over
the period 1972–1992 for non-annex-I and annex-I countries are 0.042 and
0.005, respectively. The measure of inefficiency under weak disposability
of CO2 can alternatively be interpreted as the extent to which there exist
potentially win–win opportunities to reduce CO2 while increasing GDP
given a country’s distance from the best practice frontier facing it. This
win–win opportunity is higher for non-annex-I countries than for annex-I
countries (table 1).

4.2. Environmental efficiency of countries

The estimates of EE are presented in table 1. Results for non-annex-I
and annex-I countries show that on average the EE scores are 0.912 and
0.976, respectively, implying that, on average, these countries have an
environmentally binding production technology. Under both disposability
assumptions, inefficiency in the non-annex-I countries is higher in
comparison to annex-I nations. In the non-annex-I group, countries with
larger inefficiency differentials under the strong and weak disposability
of CO2 assumption are Ecuador, Honduras, India, Kenya, Nigeria, Syrian

14
Descriptive statistics of the variables used in the study is available on request from
authors.
15
Disaggregated results can be obtained from authors on request.
484 Surender Kumar and Madhu Khanna

Table 1. Descriptive statistics of efficiency measures (geometric mean)

Environmental
 0 (x, y, b)
D  0 (x, y)
D efficiency

Year Mean S.D. Max Mean S.D. Max Mean S.D. Min

Annex-I countries
1973 0.004 0.003 0.010 0.016 0.017 0.049 0.981 0.018 0.948
1975 0.004 0.003 0.011 0.018 0.016 0.050 0.978 0.017 0.946
1980 0.004 0.003 0.010 0.021 0.018 0.057 0.976 0.020 0.939
1985 0.004 0.003 0.010 0.022 0.021 0.061 0.975 0.023 0.935
1990 0.005 0.004 0.012 0.022 0.020 0.059 0.974 0.022 0.934
1992 0.005 0.004 0.014 0.022 0.020 0.059 0.974 0.023 0.933
Non-annex-I countries
1973 0.044 0.034 0.132 0.051 0.025 0.085 0.913 0.047 0.816
1975 0.044 0.034 0.132 0.051 0.023 0.083 0.965 0.027 0.892
1980 0.043 0.032 0.130 0.052 0.024 0.085 0.967 0.025 0.905
1985 0.041 0.029 0.113 0.058 0.026 0.091 0.966 0.025 0.918
1990 0.042 0.029 0.099 0.058 0.025 0.089 0.967 0.023 0.913
1992 0.040 0.027 0.105 0.058 0.025 0.090 0.968 0.022 0.921

1.4

1.2

0.8

0.6

0.4

0.2

0
73
74
75
76
77
78
79
80
81
82
83
84
85
86
87
88
89
90
91
92
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19
19

EP-NA EP-A EE-NA EE-A

Figure 2. Environmental efficiency and productivity index

Note: EE-NA-I: EE Index for non-annex-I countries; EE-A-I: EE Index for annex-I
countries; EP-NA-I: EP Index for non-annex-I countries; EP-A-I: EP Index for annex-I
countries.

Arab Republic, Zambia, and Zimbabwe. These countries have more

environmentally binding production technology than others. Among the
annex-I countries, there are only two countries that have non-binding
production technology, i.e. Japan and Netherlands. We also find that the
EE index on average is almost steady over the sample period in both the
groups of countries (figure 2).
 Environment and Development Economics 485

Countries with efficiency scores that differ under the assumption of weak
disposability and strong disposability of CO2 suffer congestion from CO2
emissions, i.e. if these countries were to reduce emissions, they would
have to sacrifice their GDP. Once this inefficiency is translated into loss
of desirable output, the results indicate that developing countries like
Ecuador, Honduras, India, Kenya, Nigeria, Syrian Arab Republic, Zambia,
and Zimbabwe would have to lose more than 10 per cent of their GDP due
to congestion of production technology. As a whole, countries in our sample
would lose 5.6 per cent of GDP on average due to environmentally binding
production technology. The relative output loss due to imposition of costly
abatement for non-annex I countries is higher than the overall average of
the entire sample.

4.3. Determinants of environmental efficiency

We now examine the factors that determine the changes in the EE index
over time and the differences across countries. It is hypothesized that
specific attributes of an individual country contribute to the environmental
performance of that country. Using a Tobit model which recognizes the
censored nature of the dependent variable, we examine the relationship
between EE and its determinants by including variables such as GDP
per capita, share of industrial output in GDP, the capital–labor ratio,
energy intensity measured by the use of commercial energy per unit of
GDP, population density, and openness index, defined as the ratio of total
exports and imports to GDP. This measure of openness suffers from the
limitation that it may combine the effects of ‘natural’ openness and the
openness of the trade policy of a country. It may also depend on the level
of development, distance from potential trading partners, country size, and
factor endowments. Efforts to correct for these factors to determine effective
openness and to control for trade policy effects also suffer from a number
of drawbacks (Berg and Krueger, 2003). We include openness, as defined
above, simply to control for the effect of actual trade openness (whatever
its determinants) on environmental efficiency (as in Neumayer and Soysa,
2005). The source of data on per capita GDP, share of industrial output,
openness index and population density is the WDI.
The equation below specifies a possible form for the relation between the
EE and the variables discussed above

EEit = β1i + β2 GDPPCit + β3 (GDPPC)it + β4 (GDPPC)it + β5 INDSHAREit
2 3

+ β6 (INDHSARE)2it + β7 CAPLABit + β8 ENGDPit + β9 POPDENSit


T−1
+ β10 OPEN + β11 (OPEN)2 + βt Dt + βa A+εit (11)
t=1

where i is country index, t is time index, ε is the disturbance term such that
ε ∼ N(0, σε ), GDPPC is GDP per capita, INDSHARE is share of industrial
output in GDP, CAPLAB is capital per labor, ENGDP is use of commercial
energy per unit of GDP, POPDENS is population density, OPEN is the
openness index defined as the ratio of total exports and imports to GDP, Dt
486 Surender Kumar and Madhu Khanna

are the time dummies, and A is a dummy variable equal to 1 if a country

belongs to the annex-I group.
The shape of the polynomial shows the relationship between EE and
GDP per capita. It is expected that in the initial phases of industrialization
EE would deteriorate but that it would show an improvement once a
critical level of industrialization had been reached. This implies a quadratic
relationship between EE and the share of industrial output in GDP, with
the first-order coefficient being positive and the second-order coefficient
being negative. A positive sign is expected for capital per labor variable if
capital intensity leads to an increase in EE, otherwise it should be negative.
A negative sign is expected for the ENGDP variable since it can be assumed
that higher energy intensity of output leads to a decline in EE. The sign
of the population density variable can be either positive or negative.16 The
openness variable could have either a positive or a negative sign depending
on the way in which dependence on trade of a country affects EE. A
negative sign could indicate that dependence on trade has environmentally
deteriorating effects on EE. This could be the case if such countries seek
to improve their competitiveness in the world market by using low cost
but highly polluting technologies or if dirty industries migrate to the
countries where environmental standards are weak. Trade liberalization
might also encourage rapid extraction of natural resources and use of
energy to produce and transport an increased volume of exports. On the
other hand, a positive sign would suggest that trade has environmentally
beneficial effects. These could arise due to easier access to cleaner inputs
and technologies as well as greater availability of financial resources for
environmental protection as the country grows. The sign and significance
of the openness variable (and its quadratic term) will help selection among
the competing hypotheses on the relationship between environment and
international trade.
Table 2 provides the parameter estimates of the Tobit model for the EE
index under alternative specifications. The choice between a fixed effects
model and common intercept model is made using the log likelihood ratio
test. We accept the null hypothesis that suggests the fixed effects model
is the appropriate specification for each group of countries. In the case of
joint sample, it is not possible to estimate a fixed effects model with a time
invariant dummy for annex-I countries and hence for the joint sample we
use common intercept model. In the joint sample model, we find that the
group dummy variable, A-1, is statistically significant at the 1 per cent
level. This implies that we should analyze these two groups of countries

16
For the effect of the population density variable on EE, there are alternative prior
expectations in the literature. For example, Selden and Song (1994) hypothesized
that ‘sparsely populated countries are likely to be less concerned about reducing
per capita emissions, at every level of income, than more densely populated
countries’. On the other hand Cropper and Griffith (1994) found that high
population density is a major cause of increased deforestation. Therefore, we
expect a positive sign for POPDENS variable in annex-I countries and a negative
sign in non-annex-I countries.
 Environment and Development Economics 487

Table 2. Determinants of environmental efficiency (EE)

Non-annex-I
Annex-I countries countries All countries
Common intercept
Fixed effects model Fixed effects model model
Variable Coefficient t-Statistics Coefficient t-Statistics Coefficient t-Statistics
∗
GDPPC 8.78E-06 4.229 1.43E-05∗ 3.542 1.8E-05∗ 8.396
(GDPPC)2 −8.50E-11 −0.868 1.20E-10 0.164 −7.2E-10∗ −5.071
∗
(GDPPC)3 −1.60E-15 −0.92 −2.29E-14 −0.769 1.1E-14 3.559
INDUSTRY 0.00253∗∗ 1.842 −0.00105∗∗ −2.271 −4.4E-03∗ −5.524
(INDUSTRY)2 −3.08E-05∗∗∗ −1.66 1.54E-05∗ 2.616 5.8E-05∗ 4.989
CAPLAB −4.85E-07∗ −2.675 −6.01E-06∗ −17.683 −2.4E-06∗ −17.835
ENGDP −0.0723∗ −6.285 −0.02395∗ −13.148 −2.8E-02∗ −19.209
DENSITY 0.000294∗ 4.511 −3.09E-05∗ −2.789 −5.6E-06∗∗ −2.179
OPEN 7.36E-05 0.523 −0.00012 −1.24 2.8E-04∗ 4.114
(OPEN)2 4.95E-07 0.709 1.46E-07 0.201 −1.0E-06 −2.452
Constant 0.9327∗ 90.718 1.00197∗ 72.987
ANNEX-I −0.0268∗ −3.388
Dummy
Sigma 0.00452 27.568 0.00544 27.568 0.0198 38.987
Log 1512 1441.97 1901.47
likelihood
N 380 380 760

Note: ∗ , ∗∗ , and ∗∗∗ show the level of significance at 1%, 5%, and 10% respectively.
Coefficients of time dummies are not reported to save space.

separately. The following discussion is therefore based on the group specific

regressions.
The most apparent outcome from the model based on the joint sample
is that GDP per capita, its quadratic and cubic terms are statistically
significant. However, for the group-specific models only, the first-order term
is statistically significant. For the annex-I countries we find an increase in EE
in the initial phases of growth (up to a per capita GDP level of approximately
US$ 53,000) (figure 3) and then a phase of decline in EE. For the non-annex-I
countries, we find a continuous increase in EE (figure 4) with respect to their
observed per capita income. This implies that non-annex-I countries are
adopting environmentally responsible technology much earlier (in terms of
their GDP per capita) than annex-I countries.
The effect of the share of industrial output in GDP on EE in the annex-
I countries is inverted U-shaped. In non-annex-I countries, the observed
shape of EE with respect to industrial share in GDP is U, the linear coefficient
is negative, and the coefficient of the quadratic term is positive and both
the coefficients are statistically significant. This indicates that in the initial
phases of industrialization in these countries, EE declines, but as the process
of industrialization deepens, EE improves.
Moreover, we find that the coefficient of POPDENS is consistently
significant for both groups of countries, across all models; this variable
is positively related to EE in annex-I countries and negatively for the
other group. The coefficient of the energy intensity variable is negative
488 Surender Kumar and Madhu Khanna

1.200
1.150
1.100
1.050
1.000
EE
0.950
EP
0.900
0.850
0.800
0.750
0.700
0

0
00

00

00

00

00

00

00

00

00

00

00

00

00

00

00

00
10

13

16

19

22

25

28

31

34

37

40

43

46

49

52

55
GDP Per Capita

Figure 3. EKC in EE and EP for Annex-I countries

Note: EE: environmental efficiency; EP: environmental productivity.

1.400

1.200

1.000

0.800 EE
EP
0.600

0.400

0.200

0.000
500
1000
1500
2000
2500
3000
3500
4000
4500
5000
5500
6000
6500
7000
7500
8000
8500
9000
9500
10000
10500
11000

GDP Per Capita

Figure 4. EKC in EE and EP for non-annex-I countries

Note: EE: environmental efficiency; EP: environmental productivity.

and statistically significant for both groups, indicating that the increase in
energy intensity leads to decrease in EE. An increase in capital per labor
leads to decrease in EE in both groups.
Other variables that we included in the model are the index of openness
and its quadratic term. We find that in the joint sample the coefficient
of the linear term of openness index is positive, while the sign of the
quadratic term is negative and both the coefficients are significant. This
implies that for the sample countries, although trade is beneficial for the
environment, deepening the openness of the economy leads to decrease
in EE. However, for the individual groups neither of the coefficients of
openness is statistically significant.
 Environment and Development Economics 489

Table 3. Cumulative values of productivity indexes, and their components

(1971 = 1)

Annex-I countries Non-annex-I countries

Year MS EC TC ML EC TC

Productivity (excluding CO2 emissions)

1975 0.991 0.987 1.004 0.974 1.019 0.956
1980 1.048 0.996 1.055 0.952 1.083 0.888
1985 1.115 0.981 1.145 0.902 1.067 0.855
1990 1.182 0.941 1.278 1.010 1.097 0.925
1992 1.167 0.908 1.304 1.014 1.112 0.916
Productivity (including CO2 emissions)
1975 0.995 0.980 1.016 0.999 0.996 1.004
1980 1.040 0.961 1.081 1.007 0.995 1.012
1985 1.110 0.955 1.162 1.033 0.955 1.082
1990 1.151 0.959 1.199 1.026 0.960 1.070
1992 1.153 0.964 1.195 1.020 0.955 1.068
Environmental productivity
Year EP EEC ETC EP EEC ETC
1975 1.007 0.993 1.014 1.032 0.983 1.050
1980 1.003 0.969 1.037 1.071 0.945 1.147
1985 1.027 0.981 1.059 1.183 0.946 1.274
1990 1.017 1.037 0.999 1.070 0.928 1.160
1992 1.050 1.083 0.988 1.056 0.907 1.169

Note: MS: Malmquist productivity index, ML: Malmquist-Luenberger

productivity index, EC: Efficiency change, TC: Technological
change, EEC: Environmental Efficiency Change, ETC: Environmental
Technical Change, EP: Environmental Productivity.

4.4. Environmental productivity of countries

Measures of productivity change in each set of countries are presented in
table 3 at an aggregate level and at five-year intervals. Recall that index val-
ues greater (less) than one denote improvements (deterioration) in the rel-
evant performance.17 Here we have calculated the Malmquist−Luenberger
index and its components for both cases: including and ignoring CO2
emissions. Our method of computing productivity change utilizes a
fixed base year (1973), and compares all subsequent years to that
base.
The overall average of cumulative conventional productivity value that
ignores the CO2 emissions had grown by about 9 per cent during the period
1973–1992. Moreover, the results show that the growth in productivity
in annex-I countries was about 17 per cent and in non-annex countries
its growth rate was only 1 per cent during the study period. Ecuador,

17
Technological improvement implies outward shift in the aggregate production
function of a country and technological deterioration implies an inward shift of
the aggregate production function.
490 Surender Kumar and Madhu Khanna

Nigeria, Peru, Venezuela, Colombia, and Syrian Arab Republic experienced

the highest decline in TFP among the developing countries. Hong Kong
experienced the highest growth in MS among the non-annex-I countries.
In the developed countries, Greece, Iceland, New Zealand, and Spain
experienced the decline in productivity when the emissions of CO2 were
ignored and the Netherlands experienced the highest growth rate in TFP.
Again we observe that most countries have lower growth in TFP when
CO2 is considered an undesirable output in comparison to the conventional
TFP growth. Kopp (1998) finds that, between 1970 and 1990, developed
countries experienced technical progress in a way that economizes on CO2
emissions but that developing countries did not. This variation in findings
may be due to differences in estimation methods and in the group of
countries considered developed and those that belong to annex-I. Among
the non-annex-I countries, Hong Kong experienced the highest growth and
Ecuador experienced the highest decline in TFP index. Among the annex-I
countries, Belgium, Norway, France, Ireland, and Japan experienced the
highest growth in environmentally sensitive TFP. Nevertheless, it was both
technological and efficiency changes that governed the change in overall
productivity indices in all countries.
Table 3 reports the cumulative value of EP index and its components at
certain points for both of the groups. Figure 2 reveals that the growth in EP
is almost equal over time in both of the groups. In non-annex-I countries, the
index of EP varies from 0.60 to 1.43 and in annex-I it varies from 0.49 to 1.45.
Thus, there was higher variability in EP index among developed countries
in comparison to the developing ones. Moreover, the gap over time in EP
remains almost constant between these two groups except during the mid
eighties (figure 2).

4.5. Determinants of environmental productivity

We hypothesize that the level of EP is determined by level of EE in the
previous year, GDP per capita, capital per labor, share of industrial output in
GDP, energy intensity, population density, and openness index. We examine
the existence of an EKC type relationship between per capita income and
EP as well as a relationship between EP and openness by estimating the
following equation

EPit = γ1i + γ2 EEt−1 + γ3 GDPPCit + γ4 (GDPPC)2it + γ5 INDSHAREit

+γ6 CAPLABit + γ7 ENGDPit + γ8 POPDENSit + γ9 OPENit

T−1
+γ10 (OPEN)2it + γt Dt + γa A+νit (12)
t=1

where νit is the disturbance term. Table 4 provides the parameter estimates
of the regressions for the EP index under alternative specifications. The log
likelihood ratio test rejects the null hypothesis of a common intercept against
the fixed/random effects model for both the groups of countries. However,
for the regression of all the countries taken together we use a common
intercept model for reasons stated above. The signs and significances of
 Environment and Development Economics 491

Table 4. Determinants of environmental productivity (EP)

Annex-I countries Non-annex-I countries All countries
Common intercept
Fixed effects model Fixed effects model model
Variable Coefficient t-statistics Coefficient t-statistics Coefficient t-statistics
EE 3.898888∗ 6.006 −4.21962∗ −7.809 1.17885∗ 4.249
GDPPC −4.67E-05∗ −2.985 −0.00014∗ −1.561 −3.01E-05∗ −3.437
(GDPPC)2 6.81E-10∗∗ 2.185 3.07E-09 1.223 5.55E-10∗∗ 2.167
INDUSTRY 0.008442∗ 3.75 −0.0051∗ −4.51 0.006389∗ 6.972
CAPLAB 1.02E-05∗ 4.367 2.43E-05∗ 4.933 2.32E-06∗∗ 1.913
ENGDP 1.284783∗ 8.09 0.23947∗ 9.729 0.070767 ∗
5.693
DENSITY −0.00747∗ −8.222 4.34E-05 0.548 5.51E-06 0.318
∗∗
OPEN −0.00102 −0.558 −0.00064 −0.573 −0.00105 −1.986
(OPEN)2 1.13E-05 1.231 8.69E-06 1.057 1.13E-06 0.343
Constant −3.334∗ −5.423 4.0556∗ 8.257 −0.1581 −0.597
ANNEX-I 0.1138∗∗ 2.351
DUMMY
Sigma 0.0572 26.87 0.0607 26.87 0.1504 38
Log 520.68 499.10 343.35
likelihood
N 361 361 722

Note: ∗ , ∗∗ , and ∗∗∗ show the level of significance at 1%, 5%, and 10% respectively.
Coefficients of time dummies are not reported to save space.

all coefficients are however robust across alternative models. We observe

that most of the coefficients of time dummies are statistically insignificant.
Similar to the model explaining variation in EE, we find that the country
group dummy in the EP model that includes both groups of countries is
statistically significant at the 5 per cent level. This suggests that we should
use separate regression analyses to explain variations in EP in the two
groups of countries.
For annex-I countries, we find that except for the coefficients for
openness, all the other coefficients are statistically significant. Similarly,
for non-annex-I countries, we find that except for openness and the
linear term of industry variables, all the coefficients are statistically
significant. The positive relationship between the environmental efficiency
and environmental productivity index for the annex-I countries favors the
existence of divergence hypothesis. However, for the non-annex countries
we find the existence of convergence hypothesis, as the relationship between
EE and EP is negative.18 There is a positive relationship between capital
per labor and EP for both the groups of countries, which implies that

18
The convergence theory could be restated through the relationship between
productivity and lagged technical inefficiency. This relationship would state that
those countries that were near the production frontier would see a lower level of
productivity growth than those farther away. Therefore, the positive relationship
between productivity level and lagged technical inefficiency level would indicate
the presence of convergence hypothesis (Kumar, 2006).
492 Surender Kumar and Madhu Khanna

capital intensity leads to increase in EP. Furthermore, population density is

negatively affecting EP in annex-I group.
We find that energy intensity contributes positively to EP in both the
groups of countries. Similarly, we find that for the sample of all countries
taken together energy intensity and EP are positively related. Since EP can
be decomposed into environmental efficiency change and environmental
technical change, the finding that energy intensity leads to decline in EE
but an increase in EP implies that countries with higher energy intensity of
their production processes are more likely to make environment friendly
technological changes.
Of particular interest are the signs and significance of the coefficients of
GDP per capita and its quadratic term and those of the openness index
and its quadratic term. For annex-I countries the coefficients of GDP and
its quadratic terms are statistically significant, and their signs imply the
existence of an ‘U-shaped’ EKC type relationship for EP in these countries
(figure 3). For non-annex-I countries, we observe that the linear term
is negative and the quadratic term is positive, but both the terms are
statistically insignificant (figure 4).
Moreover, the openness variable also exhibits an inverted U-shaped
relationship between EP and openness for the joint sample. For the
individual groups the sign of the linear and quadratic terms of the openness
index are statistically insignificant. This implies that there is decline in
environmental innovations up to a certain level of openness and then the
environmental innovations start to improve once a critical threshold level
is reached. The negative effect of international trade may be due to energy-
related environmental damage such as carbon emissions that stem from
increased transportation that is more pronounced below a threshold level of
openness. However, as the degree of openness increases, this negative effect
seems to be offset by the positive effects of harmonization of international
environmental standards and technological transformations.

5. Conclusions
This paper estimates EE and EP indices using production frontier analysis,
and compares them across countries and over time. The particular emphasis
is on potential for transformation of production processes that allow free
disposability of carbon emissions to costly disposal of these emissions
to construct these indexes. As opposed to methods that measure the
environmental quality with the levels of emissions of pollutants, the
indexes that are derived in this study are based upon a production
approach that differentiates between the disposability characteristics of the
environmentally desirable and undesirable outputs.
EE and EP indexes are calculated using the non-parametric directional
output distance function for two groups, annex-I and non-annex-I, each
having 19 countries for the period of 1971 to 1992. On average, the world
witnessed environmentally binding production technology during these
two decades. The opportunity cost of the transformation of the production
process from free to costly disposal of CO2 emission was about 5 per cent
of GDP. The relative output loss due to imposition of costly disposal of CO2
emissions for non-annex-I group was higher than the average. The EE index
 Environment and Development Economics 493

was almost steady for the annex-I group, while its value is declining for the
non-annex-I group over time.
TFP measures show that the progress witnessed by the world during
the 1970s and 1980s was the combination of both factor accumulation and
improvement in the productivity of factors of production. EP measured as
the ratio of TFP under weak to strong disposability of CO2 emissions shows
that it stagnated over time in both of the groups. However, there is high
variability across countries over time.
A closer inspection of the EE index reveals that there was an improvement
in EE in the initial phases of growth followed by a phase of decline in
environmental quality once a critical level of per capita GDP was reached in
the annex-I countries. This finding is similar in spirit to the results obtained
in an EKC analysis. In the annex-I countries, the opportunity cost of the
transformation of a production process from free to costly disposal of CO2
emission is becoming smaller after a certain threshold income level. But
the non-annex-I countries are far behind in development in comparison
to the annex-I countries, and the opportunity costs of transformation in
production process are increasing. A closer inspection of these indexes
reveals that after accounting for the effect of changes in the per capita
income level on EE, there remains some variation in these indexes that
can be explained by energy intensity, degree of industrialization, capital
per labor, trade related variables, etc. We find in general that openness
initially has a positive impact on EE but that this changes as openness
increases, implying an inverted ‘U’ shaped relationship between EE and
openness. However, we find a U-shaped relationship between EP and
openness. This implies that initially trade liberalization negatively affects
the environmental productivity of countries as they strive to compete in
the world market but as they become more integrated in the world market,
their environmental productivity improves. The results suggest that we
must be careful in suggesting technological and managerial assistance
to developing countries by the developed countries in increasing EE
and EP in these countries apart from those associated with economic
development.

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