Structural Change and Economic Dynamics 10 (1999) 161 – 176

Input–output theory and institutional aspects

of environmental policy
Albert E. Steenge *
Uni6ersity of Twente, Faculty of Public Administration and Public Policy, P.O.B. 217,
7500 AE Enschede, The Netherlands
Accepted 27 October 1998

Abstract

National accounting over the years has developed in close interaction with input – output
analysis. However, present developments involving core and satellite accounts seem to
suggest that this relation will become less close, with possible negative consequences for
analysis and policy. In this paper we show that also in the new frameworks the input – output
(I–O) table will most likely retain its central place. To illustrate this, we discuss the problem
of the choice of policy background principles in environmental pollution abatement. We
show that in the case of physical accounts of the NAMEA-type the question of the origin of
environmental pollution can be addressed in a novel way. This suggests alternative defini-
tions of the concept of ‘a polluter’, and new rules for the allocation of social cost. © 1999
Elsevier Science B.V. All rights reserved.

Keywords: Input–output theory; Environmental policy; National accounting

JEL classification: C82; D57; D63; H23; Q30

1. Introduction

In the previous contributions in this issue we have seen how national accounting
is changing to accommodate new developments. The basic system now consists of
a core in which the central elements in an economy, such as the interactions
between households, firms and government, are accounted for. The core accounts
for the fundamental national aggregates such as national income and product,
foreign trade, value added, consumption, investment and employment.

* Tel.: +31-53-4893211; fax: + 31-53-4894682; e-mail: a.e.steenge@bsk.utwente.nl.

0954-349X/99/$ - see front matter © 1999 Elsevier Science B.V. All rights reserved.
PII: S 0 9 5 4 - 3 4 9 X ( 9 8 ) 0 0 0 6 4 - 2
162 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176

Aspects which are not part of the core are dealt with in special modules or
satellites. For example, in several countries work is being done on separate research
and development or capital stocks modules. In today’s accounting systems, also
typical environmental issues are accounted for in terms of a special module. One
such module is the national accounting matrix including environmental accounts
(NAMEA). In the NAMEA, environmental problems are clustered in so-called
themes such as greenhouse effects and acidification. These themes, mostly in the
form of emissions of noxious chemicals in the atmosphere, are related to produc-
tion and consumption sectors, including those in foreign countries. In this way, the
origin of many environmental problems can be monitored straightforwardly (de
Haan and Keuning, 1996; Keuning and de Haan, 1996).
The structure of the national accounts is based on registered market transactions.
This is a main reason why typical ‘externalities’, such as the many forms of
environmental pollution, are dealt with in a separate satellite account. There is no
generally accepted translation of, say, emissions of carbon oxides into money
values. As an immediate consequence of this, we have to introduce a two-part
registration. The traditional parts of the economy are accounted for in terms of
financial flows, while the environmental parts are registered separately in physical
accounts.
This strict separation in accounting, naturally, does not mean that there is no
intricate relation between accounting systems of the type discussed in this issue and
economic theory. In fact, in many respects a system like the NAMEA can be
viewed as the latest stage in a long line of mutual interactions between accounting
and theory. Above all, many aspects remind us of the early models by Leontief
(1970) and Leontief and Ford (1972). In the real sphere, these models have been
designed to predict changes in outputs following a shift in environmental policy.
They are particularly specialized in investigating the effects of curbs on the
emissions of pollutants. The fundamental assumption Leontief (and authors in his
tradition) make is that the output of pollutants can be described in terms of fixed
coefficients similar to the traditional technologies. (Leontief did not work with the
make-use framework, which is at the core of the NAMEA-system; for this, see
below).
A weak point of the environmental models in the Leontief tradition, however, is
their price side. In the traditional type of models (without externalities), we have a
duality between price effects and the real world. Given appropriate information on
the real side, implied equilibrium prices straightforwardly can be calculated. How-
ever, if external effects are distinguished, this simple duality breaks down (see also
Section 3). In fact, we have to introduce separate sets of rules to allocate the costs
of environmental action. At present, there are several economy-wide background
principles to structure the way society should approach the problem of social cost.
The ‘polluter pays principle’ (PPP) probably is by far the most widely accepted
background principle. The problem is that it may not be the most appropriate and
effective. This is one major reason why the precise contents of this principle have
been under continuous debate. In fact, as we shall see later below, a number of
efforts are being put forward to formulate alternative policy principles that may be
 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176 163

more effective. In input – output (I – O) models up to now only very elementary

forms of the principle have been incorporated.
The NAMEA keeps its distance from what we may call the institutional side of
environmental data collection and presentation. Interestingly, as we have seen
above, also I – O models keep their distance here. In this area, we clearly are in need
of new concepts and theoretical foundations. A useful point of reference is provided
by the work of authors like Douglass North (1990, 1993) or Mancur Olson (1982).
In their view, institutions are to be seen as providing the general structure in which
human interactions develop. As such, institutions determine the possible actions of
socio-economic activity. Following North (1990), institutions are the ‘rules of the
game’ in society. In full: ‘‘Institutions are the rules of the game in a society or, more
formally, are the humanly devised constraints that shape human interaction. In
consequence they structure incentives in human exchange, whether political, social,
or economic. Institutional change shapes the way societies evolve through time and
hence is the key to understanding historical change’’. These rules consist of current
laws and jurisprudence, but also of currently accepted habits and formal or
informal codes of conduct. A basic function of institutions is to provide stability
and continuity by reducing the effects of sudden changes in the external or internal
environment of specific systems.
Organizations, on the other hand, structure the specific relationships between
actors. They are entities of actors that strive for a common goal within a specific
institutional setting. Mancur Olson (1982), e.g. has emphasized the role of organiza-
tions such as unions and cartels. Organizations, according to Olson, are ‘the players
of the game’. He showed that stable societies often develop organizations that have
a negative influence on society as a whole. These ‘distributional coalitions’ rather
aim to redistribute society’s surplus at the expense of the welfare of the entire
system: ‘‘Distributional coalitions slow down a society’s capacity to adopt new
technologies and to reallocate resources in response to changing conditions, and
thereby reduce the rate of economic growth’’ (Olson, 1982). That is, coalitions
block the reallocation of productive means of stagnating to productive sectors of
the economy.
In Section 2 we shall try to suggest a new way in dealing with environmental
policy issues, based on the NAMEA and on the present state of development of
I–O analysis. To this end, we shall present a brief selection of current issues in
social cost problems in environmental economics in Section 2. Hereafter, we shall
briefly discuss now available I – O theory and then introduce ways to handle
environmental policy issues in a Leontief framework. In Section 5 a number of final
remarks will be given.

2. Background principles for environmental policy

Environmental policy traditionally has been viewed in the light of the concept of
externalities or external effects. As indicated by these terms, markets for the
commodities involved either were absent or in an underdeveloped state, a situation
164 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176

of ‘market failure’. Typically we would be discussing harmful external effects, such

as smoke from producing factories, causing damage to others. The associated social
costs usually were not included in the price of the product. This would imply that
the production processes in question would be too cheap, leading to oversupply of
the relevant products. These costs could be quite substantial, including costs to
other producers, health or noise effects, damages to possessions and other nui-
sances. This called for government action to remedy such cases of market failure via
a system of government-initiated corrective taxes and subsidies (Pigou (1920), and
many others). Not taking action would result in significant negative welfare effects.
The introduction of the PPP is a direct consequence of these views.
This point of view was criticized by R.H. Coase in a well-known position (Coase,
1960). He rejected the concept of market failure, and thereby the idea of a
significant role for government action in correction those failures. Fundamental in
the Coasian system of thought is the idea of reciprocity. Suppose, returning to the
case of the smoke emitting factory, that governmental action would force the firm
to change its production process at great cost. The people living in the neighbor-
hood of the firm would, from the point of view of air quality, welcome the new
situation. However, from the point of view of the factory it would mean a severe
limitation of its freedom of action. Basically, following Coase, in cases of harmful
external effects, putting the burden of action at one party rather than another, is an
arbitrary action. Governmental action, favoring systematically one party above
another, rather would be harmful than beneficial. In Coase’s view, a balanced
system of property rights would constitute all that would be required to solve the
problem of social cost. Government’s only task would be to provide for an
appropriate allocation of property rights and, in general, to keep transaction costs
low by means of good registration, monitoring and arbitration. Once such a system
would be in place, the market would solve the problem via a system of bargaining
among parties concerned.
We find many aspects of the above two, extreme, positions in present debates on
the choice of appropriate background principles for environmental policy. First sets
of definitions for the PPP were introduced relatively recently, being designed with
specific goals in mind (OECD, 1975). According to the PPP, the polluter should be
the agent who is primarily accountable for measures to maintain desired environ-
mental quality levels (Barde, 1976; OECD, 1975, 1994). The primary goal was to
design a principle for pollution abatement up to the level which would be acceptable
to the relevant authorities. It should be interpreted as a no-subsidy principle, rules
should not contain any incentive not to abate pollution or delay implementation of
controls. The principle requires the polluter to be solely responsible for the costs of
controlling pollution to the acceptable level. It does require him to be financially
responsible for any residual damage. From the start it was realized that, in the
imposition of standards, difficulties of deciding what standards to set are
paramount.
At present the PPP has been accepted as a background principle for environmen-
tal policy and management in many countries. A significant factor in obtaining
national and international acceptance for the PPP was its adoption by the Organi-
 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176 165

zation for Economic Cooperation and Development (OECD) in 1972, followed by

the European Community in 1975. In later years the principle’s status has been
re-endorsed by the OECD several times. It occupies a prominent place in the
European Union’s Action Programmes, and recently it also was endorsed by the
Organization for Security and Cooperation in Europe (OSCE), formerly CSCE.
(For a discussion of the role of the PPP in the European Union, see O’Connor
(1997)).
Almost from the outset, doubts have existed regarding its legitimacy and effec-
tiveness, resulting in questions about the nature of the incentives, about prices not
reflecting relative scarcity, etc. (Segerson and Tietenberg, 1992). In practice, imple-
mentation of the PPP proved to be a complicated matter. One reason is the
persistence of many problems of a definitory nature. For example, what precisely is
an externality and how should we define the social (and private) costs associated
with it? These problems also exist regarding the question who should be considered
the polluting agent. Especially in the complicated networks of today’s industrial
complexes it may make a huge difference if the polluter is defined at the plant or
establishment level. And for precisely which control measures should the polluter be
accountable? Furthermore, often the imputation of full social costs may not be
socially or politically acceptable for a variety of reasons. Today’s practice is that
the OECD member states decide on the implementation of the principle as they
themselves see fit (Greenwood, 1994; OECD, 1994, 1997).
At the moment we may observe that the central role of the PPP is under pressure.
This is related in part to the shift to the larger theme of resource conservation and,
more in general, the issue of sustainability. This reflects the general idea that
conservation issues should be the concern of the entire society (rather than just the
polluter). Clearly, adoption of this perspective immediately points to many other
issues such as the durability of present-day consumption patterns (see here Duchin
and Lange (1994), Duchin (1997) or Duchin (1998) for an approach based on an
interesting interpretation of the causal chains in economic production and con-
sumption).
In this light a number of alternatives are being advanced at the moment as
possible substitutes for background principles. For example, to provide additional
incentives for resource conservation, it has been advocated that particularly the user
of resources should pay. This resulted in concepts such as ‘user-should-pay’ (UP) or
‘polluter-and-user-should-pay’ (PUPP). We may also mention principles based on
the idea of prevention or precautionary measures, which aim to limit the damage
via the imposition of specific safety margins in production and consumption.
Furthermore, there are efficiency principles which focus on the effectiveness of
standards and instruments, and principles which favor decision making and en-
forcement at the lowest governmental echelons (subsidiarity principles). A new
subject of discussion is the ‘victim pays principle’ (VP), designed for situations
where ‘rich’ parties suffer from the actions of ‘poor’ ones. Principles of this nature
may be particularly relevant in designing programs for cleaning-up heavily polluted
areas in Eastern Europe. Last but not least, we may mention the fact that in its
Fifth Action program the EU recently adopted the concept of ‘shared responsibil-
166 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176

ity’. This is intended explicitly to modify existing consumption and production

patterns. Shared responsibility should be implemented within the general context of
the PPP, which is still viewed as the cornerstone of environmental policy (Brusasco
Mackenzie, 1994; OECD, 1994). Thus, there appears to be sufficient evidence for
stating that the PPP often is ‘inefficient’. Despite this, we observe that policy makers
apparently wish to stick to the strict interpretation of the PPP, despite its apparent
shortcomings.
Seen in the light of the proliferation of these newly circulating principles, we may
ask if the PPP is still consistent with the growing interest in integral views of
economic activity in addressing environmental problems. Meanwhile, the prolifera-
tion may signal the risk of arbitrariness and ‘ad-hocness’, since many of the
problems associated with the PPP may resurface here: Who precisely is ‘a user’? On
what basis should a victim pay? etc. In addition, if more agents and more criteria
get involved, there is the risk that environmental instruments lose their bite and
simply fade away into a kind of general tax on everyone and everything. Clearly, we
are approaching the institutional aspects of production and consumption.

3. The standard model

The NAMEA fits in a long line of developments in national accounting,

developed in close interaction with economic theory. The basic structure resembles
the tables underlying traditional I – O modeling (for remarks on the make-use
framework, see further below). The standard models almost all go back to early
work by Leontief in the late 1960s and early 1970s we already referred to. (But see
also Cumberland (1966), Isard (1972), Victor (1972) or Steenge (1977) for early
contributions). The early environmental Leontief models accounted for emissions
and incorporated anti-pollution activities. They gave rise to a series of articles, partly
focusing on particular aspects such as nonnegativity of solutions. (See Leontief,
1970; Leontief and Ford, 1972; Flick, 1974; Steenge, 1978; Lowe, 1979; Lee, 1982).
Particularly, a lot of attention has been paid to pricing problems. Pricing was not
easy, because the property of duality of the original models was lost (see below).
Most exercises are based on an elementary application of the PPP. That is, those
sectors that generate pollution, also had to pay the costs of (partial) abatement.
Characteristic of a standard I – O model (without pollution and extraction) is that
real output and price model are dual to each other. They can be obtained from each
other by a simple application of the rules of linear programming. In the environmen-
tal I–O models this simple duality has been broken; in all these models that real and
price model are very different. The reason is not difficult to see. The real model tells
us, given the final demand bundle, which sectors generate pollution in which
quantities. In the price model we have to introduce a rule (or a set of rules) to
determine which sectors should pay for the elimination of pollution. In the existing
models, invariably the producing sectors pay for this. That is, they pay for the
elimination of a certain percentage of their own generated pollution. This may be
viewed as a strict application of the PPP.
 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176 167

Here, thus, we may observe a curious phenomenon. I–O theory almost exclu-
sively focuses on interconnections between the various sectors of the economy,
households and the producers of the primary factors. In I–O theory, prices and
values are based on the quantities of the relevant primary factors ‘embodied’ in
each good or service being produced. In this way the primary factor(s) become the
standard(s) of value which determine market clearing prices. For example, if labor
is the only standard of value, the labor content of each commodity determines the
price of that particular commodity. The determination of the labor content involves
the totality of indirect inputs in the form of the well-known Leontief inverse.
Now suppose that ecological-economists had been able to derive a generally
accepted standard of value based on the ‘use of the natural environment’ in
production. In that case, the economy’s prices would have been based on the
quantities of our natural environment embodied in each unit being produced. This
again would have involved the summation of all indirect (produced) commodity
inputs in each good being produced. Or, in other words, inputs from the natural
environment would have been imputed to each produced commodity taking into
account the networks of intricate interrelations in the economy.
The PPP on the other hand, in its standard interpretation, only concerns what we
may call ‘direct pollution’. That is, social costs, often in the form of the costs of
anti-pollution activities, are imputed on the basis of the directly produced emis-
sions. Thus, in the Leontief-based I –O models the cost allocation problems we
signaled in the previous section, are dealt with only in a rudimentary way. Before
continuing, we now shall present a brief exposition of the standard model.
The standard environmental model basically has been designed to account for the
existence of noxious discharges into air, water and soil. The model usually assumes
that the production of these substances per unit of output of conventional goods
such as grain or steel, is fixed. Abatement costs appear in the form of the costs
special anti-pollution processes or activities. In model terms, this means that to
describe physical interrelations, we now need a set of four coefficient matrices
(below we shall only discuss the so-called open form). Let A11 now stand for the
conventional coefficient matrix (previously A) and A12 for the (rectangular) matrix
of input coefficients describing the input structure of selected abatement activities.
Let the emission of pollutants be registered in A21, a rectangular matrix of emission
coefficients. Finally, to complete the system, Leontief allowed for pollution gener-
ated by the abatement activities themselves in a fourth matrix A22. Continuing, let
us denote final consumption of conventional goods by c1 and the tolerated level of
emissions by c2, total output of conventional goods by x1 and the total quantity of
pollutants being abated by x2. The physical balances for commodities and pollu-
tants now read

x1 =A11x1 +A12x2 +c1 (1)

and

x2 =A21x1 +A22x2 −c2 (2)

168 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176

Under certain well-defined conditions, nonnegative solutions to this system are

guaranteed. (For a recent application, see, e.g. Proops et al. (1993)). The PPP is
applied by imposing a rule concerning the quantities of its own pollution that each
sector has to eliminate. That is, we impose a rule like
x2 =A21Wx1 (3)
where W is a diagonal matrix; each diagonal element wi of W gives us the fraction
of its emissions that sector i has to eliminate. Commodity prices are readily
calculated from a correspondingly formulated price equation. Let us, for simplicity,
only distinguish one primary factor, to be called labor. Let l1 stand for the vector
of direct labor input coefficients for the conventional activities and l2 for the vector
of direct labor input coefficients for the abatement activities. Let p1 stand for the
prices of conventional goods and p2 for the prices of pollutants being eliminated.
We then have
p1 = p1A11 +p2A21W +l1 (4)
and
p2 = p1A12 +p2A22W +l2 (5)
This system is straightforwardly soluble for ‘realistic values’ of the coefficient
matrices. It is clearly based on the idea that ‘the polluter should pay’ because the
costs of eliminating pollution are charged to the polluting industries. Naturally, in
the type of model we are considering, price increases are passed on to intermediate
users and to final consumers.
Above we have briefly discussed the Leontief approach to environmental pollu-
tion. We have seen that the consequences of physical constraints on emissions can
be straightforwardly handled in terms of an extension of the standard model. This
extension gives us the total production of traditional goods required under emission
constraints. Elements of choice enter when we are discussing price implications. The
literature up to now only discusses cases where polluting industries pay for the costs
of eliminating a well-defined part of their emissions. That is, the costs the
corresponding anti-pollution activities have become part of the price of the com-
modities involved. These prices will rises and, consequently, because of indecom-
posability, the prices of all goods and services in the economy will rise.
At this moment, we should point out that the make-use core in the NAMEA
does not present any particular problems. We know, of course, that I–O theory for
many years was based on single product sectors. One reason for this was that I–O
theory could profit from a multitude of mathematical theorems on nonnegative
square matrices. It was the interaction between results of matrix theory and
empirically implemented inter-industry tables that proved to be a decisive factor in
the development of I – O models. The transition to the make-use system proved to
generate quite a few new problems. The make matrix was introduced to explicitly
account for various types of joint production. Mathematically, this meant that in
the appropriate formulas the unit matrix was replaced by a nonnegative (square)
matrix. It turned out that, as a consequence, many fundamental properties of the
 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176 169

‘old’ (i.e. single-product) system were difficult to translate satisfactorily into corre-
sponding properties of the new system. For example, the well-known property that
the Leontief inverse is positive if the input coefficients matrix is indecomposable
could not satisfactorily be reproduced in a mathematical equation system where the
make matrix replaces the unit matrix.
Many solutions have offered, none of which seemed quite acceptable. A most
promising result was obtained by Konijn (1994); see also Steenge and Konijn (1993)
and Konijn and Steenge (1995). In Konijn’s work it was empirically shown that the
micro data underlying the national accounting systems are consistent with a
three-matrix data system. Denoting the use and make matrix respectively by the
symbols A and B, Konijn showed that there can be found a non-negative matrix M
that satisfies A=MB if the statistical nature of A and B is taken into account. M
has the required properties of a traditional I–O coefficients matrix. The Konijn
framework now is part of the official Dutch system of national accounting.

4. Imputing pollution to sectors and households

In this section we shall show how pollution and pollution related costs can be
imputed to the productive sectors and households. We should remark that exercises
of this kind have been carried out before. A good example here is the work of
Keuning et al. (1999). They present an exercise, using data for The Netherlands, in
which specific pollution categories are imputed to final demand. The analysis is an
example of the type of imputation exercises that can be done using the I–O
framework. Nevertheless, there exists a certain degree of arbitrariness because one
may easily consider quite different principles to base any imputation on. Therefore,
in this section, we shall try to offer a procedure which uses the structure of I–O
models as reflected in its determination of equilibrium prices. That means that we
have to base our line of argument on the presence of well-defined standards of
value. We hope that an analysis of this type simultaneously can provide ways for
the introduction of principles like UP or PUPP (see Section 2) in I–O models. (For
additional background in an open model, see Steenge (1997)).
We start from a well-known numerical example (Leontief, 1970). We consider an
economy with two production sectors, to be called agriculture and manufacturing.
We also distinguish one category of ‘final’ consumers, households. The two sectors
use both commodities (let us call them grain and steel, respectively) and labor as
inputs. The households sector provides the quantities of labor required for produc-
tion. Sectoral interrelations, in real terms, are given by Table 1.
Let us now introduce pollution in the form of emissions into the natural
environment. For each sector the quantities emitted are measured in the appropri-
ate physical units, say tons per year. For reasons of simplification, we shall
distinguish only one type of pollutant. Assuming that households do not produce
any pollution, we obtain the following tableau (Table 2). We observe that the
agricultural sector is much more polluting than the manufacturing sector, both in
relative terms (i.e. per unit of production) and in absolute quantities.
170 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176

Table 1
Sectoral interrelations, in real terms

Agriculture Manufacturing Households Total output

Agriculture 25 20 55 100
Manufacturing 14 6 30 50
Labor 80 180 0 260

Following traditional Leontief theory, we assume that inputs per unit of output
are fixed. So we obtain the following input coefficients matrix, A:

Æ0.25 0.40 0.2115Ç

A = Ã0.14 0.12 0.1154Ã
È0.80 3.60 0 É

Now let us, following Leontief, also impose the fixed coefficients assumption
concerning the generation of pollution. We then obtain the following ‘extended’
coefficients table:

Æ0.25 0.40 0.2115Ç

à Ã
0.14 0.12 0.1154
A*= Ã Ã
0.80 3.60 0
à Ã
È0.50 0.20 0 É

In the traditional Leontief-based environmental economics literature, a second type

of activity is distinguished, abatement technologies operated by so-called anti-pollu-
tion sectors or activities. Following Leontief, these sectors produce only one,
characterizing product, namely the elimination of specific noxious substances.
Again following Leontief, also for these activities fixed input coefficients are
assumed.
Below we shall concentrate on the production of pollution. Or, more accurately,
on the question: ‘Who is a (the) polluter?’. At first sight, the answer should be
obvious: both sectors are polluters, only agriculture is much more polluting (both

Table 2
Assuming households do not produce any pollution

Agriculture Manufacturing Households Total output

Agriculture 25 20 55 100
Manufacturing 14 6 30 50
Labor 80 180 0 260
Pollution 50 10 0 60
 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176 171

absolutely and per unit of output being produced) than manufacturing. Following
this, in the traditional environmental I–O models, costs of anti-pollution activities
are imputed to the polluting sectors proportionally to their emissions. That would
imply, in our case, that agriculture would have to bear 5/6th of the costs involved,
and manufacturing (only) 1/6th.
This perhaps may be obvious, it does not help us much in addressing the issues
of Section 2. We may summarize the contents of that section as a plea for
alternative ways of looking at production or consumption externalities. As a first
step, let us rewrite the above tables in terms of a model. To obtain a form in which
the role of households can be treated analogously to the two productive sectors, we
shall adopt Leontief’s closed version, so we obtain

Æ100Ç Æ0.25 0.40 0.2115ÇÆ100Ç

à 50 à = Ã0.14 0.12 0.1154Ãà 50 Ã
È260É È0.80 3.60 0 ÉÈ260É

Denoting total output by the symbol x, we thus have

x= Ax (6)
To obtain insight into indirect effects, we now may proceed analogously to
procedures in the open model. That is, we take a look at powers of the coefficients
matrix. Thus, we ask which input coefficients describe the production of the
commodity bundle Ax. We straightforwardly obtain the answer; to produce the
bundle Ax, we need inputs as given by A(Ax)= A2x, where

Æ0.2877 0.9095 0.0990Ç

A2 = Ã0.1441 0.4858 0.0435Ã
È0.7040 0.7520 0.5846É

Continuing, we may ask which coefficients describe what is required to produce the
bundle A3x. We immediately see that the answer will be the that appropriate
coefficients are the elements of matrix A3. Continuing, we obtain the limit case;
‘infinite order’ input coefficients are given by the matrix A. Clearly, we may write
our numerical system in terms of matrix A,
x =Ax, (7)
or, numerically:

Æ100Ç Æ0.2817 0.7042 0.1408ÇÆ100Ç

à 50 à = Ã0.1408 0.3521 0.0704Ãà 50 Ã
È260É È0.7323 1.8309 0.3662ÉÈ260É
The above sequence shows that, ultimately, sectors and households, if we account
for all indirect effects, use commodities precisely in the proportions of the total
output vector x. Put differently, we apparently can describe the actual production
172 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176

relations in terms of a sequence of input matrices, A, A2, A3, …, each containing

input coefficients of higher order than the previous one. ‘‘Infinite order’’ inputs then
are provided by the columns of matrix A. As mentioned, the interpretation of the
elements of matrix A is, mutatis mutandis, analogous to the elements of the
powers of the input coefficients matrix of an open I–O model in the Leontief
inverse. Matrix A, as we may observe, is a positive matrix of rank one. Each
column is proportional to the right-hand Perron–Frobenius eigenvector of A.
Similarly, each row is proportional to the left-hand Perron–Frobenius eigenvector
of A. (For further discussion of this type of matrix and its mathematical properties,
including conditions that assure convergence to A, see Steenge (1995)).
Because the left-hand Perron – Frobenius eigenvector of A gives us the equi-
librium price proportions, the proportions between the columns of matrix A also
give us the price proportions. Calculation gives that price proportions are 2:5:1. So,
we see that total outputs (which equal total inputs) are being ‘used up’ by the
various sectors, at unit le6el, in the proportions of the price vector, i.e. in the
proportions 2:5:1. Looking at the entire system, we observe that the total output
vector (which equals the vector of total inputs) can be ‘imputed’ to the two
productive sectors and households according to Eq. (7). Now let us define a unit of
input. We can take any vector proportional to the total output vector x. Let us
adopt as our unit the vector

Æ0.1408Ç
x = Ã0.0704Ã
È0.3662É
We immediately observe that agriculture, at unit level, uses an input bundle equal
to 2x, manufacturing 5x and households inputs equal to x itself. Looking at Table
2, we see that the bundle x ( =710.2273x) is associated with 60 units of pollutant.
So, with the bundle x we can associate (1/710.2273)60 = 0.0845 units of pollutant.
So, with a unit of agricultural output being produced, we can associate 2 · 0.0845=
0.1690 units of pollutant, to a unit of output in the manufacturing sector
5 · 0.0845=0.4225 units, and to households, again at unit level, 1 · 0.0845= 0.0845
units.
We now obtain the absolute quantities to be imputed to the two productive
sectors and to households by weighing by sectoral scale of output. Thus, to
agriculture we should impute 2 · 100 · 0.0845= 16.90 units. Continuing, to manufac-
turing we should impute 5 · 50 · 0.0845= 21.125 units. The remaining units,
1 · 260 · 0.0845 = 21.97 units are imputed to households.
Earlier (Steenge, 1995) we have shown that in closed models of the type we have
employed, the total output vector (which simultaneously is the vector of aggregate
sectoral inputs) can be viewed as a ‘composite numeraire’. This numeraire, when
employed in the correct way, straightforwardly gives us commodity prices. The
numeraire is based on the equilibrium position of the entire system and, therefore,
is a real systemic numeraire. In this way, each sector’s demands and deliveries
co-determine the numeraire. By linking sectoral pollution to the system’s numeraire,
 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176 173

as proposed above, we may have opened up a new way to bring users and
consumers into the picture.
Finally, we should remark that our above model does not contain abatement
activities. These, however, can be added straightforwardly. The general principle of
our argument will remain the same. Also, we should add that the fact that the
Perron–Frobenius eigenvalue of A is equal to unity, does not mean that the system
would not be able to add abatement activities. The model we have used only gives
us the real expenses on the various input categories including labor. It does not
contain any capacity limits on, particularly, labor. If these limits are absent, mutatis
mutandis, adopted environmental programs can be carried out.

5. Additional remarks

In Section 1 we argued that an analysis of prices in environmental I–O models

requires additional inputs in the form of specific rules. These rules represent the
institutional background for decision making. Society, in some way or another, has
to decide about who is going to bear the brunt of the social costs associated with
modern industrial societies. We showed that the ‘polluter pays principle’ in many
respects is not ‘efficient’. That is, it does not provide the best support for society’s
stated purposes regarding environmental issues. For example, it does not fit into
modern ways of thinking which focus on the entire production–consumption cycle.
In terms of that cycle, concepts like ‘user pays’, or even ‘victim pays’ may become
sensible alternatives. Also in the light of the European Union’s policy principle of
‘shared responsibility’ solely focusing on the polluting activities seems insufficient.
Introducing the necessary institutional background is not a straightforward
matter, however. The ‘rules’ embody the institutional context, following Douglass
North terminology. Given these rules, the ‘players of the game’, the ‘organizations’
in Mancur Olson’s words, take over. In our case, these represent the industrial
organizations, coalitions of firms in particular organizations, consumer organiza-
tions, et cetera. The outcome of the ‘game’ determines ‘who pays what’. In the
framework we have presented in this paper, this means that ‘polluters’, ‘users’ or
‘victims’ may be called to pay the bill.
In the early sections of this paper we pointed out that in the now existing I–O
models pollution abatement invariably is viewed as a task of the polluting sectors.
In this sense we may view this as an implementation of the PPP. In the above
section we have showed that, based on the notion of sectoral interconnections, quite
different lines of argumentation may be developed. In Section 4 we have shown that
‘liability’ for pollution generation can be determined on the same basis as market
clearing prices. We demonstrated that with the closure of the static Leontief model
for households, a new, formal way to allocate responsibility for pollution between
producers and consumers can be introduced. This can be done on the basis of a
composite numeraire that depends on the A-matrix. The economic rationale behind
this new numeraire is that its adoption guarantees a scheme for allocating responsi-
bilities for pollution that is based on all (direct and indirect) interactions between
174 A.E. Steenge / Structural Change and Economic Dynamics 10 (1999) 161–176

production sectors and households. This then was used to introduce a new ‘rule’ for
allocating social cost. We observe that a natural property of our system is that only
part of produced pollution is imputed to the sector which actually produces the
pollution, the remaining parts being imputed to the users or consumers of their
products. Price implications thus depend on the set of policy rules policy we wish
to enforce. On the basis of our presented ideas, an appropriate set of price
equations easily can be developed.
Any real-world applications of our approach, naturally, may require additional
rules. Our most important goal has been to show that I–O models can be used to
give room to new ways of thinking about responsibilities of ‘producers’ and ‘users’.
We hope to have shown that the models actually are quite flexible in allowing for
new ways of addressing social cost issues. Apparently, Leontief methodology allows
us to define the concept of ‘a polluter’ such that—to a certain extent—also
consumers of a particular good or service are held accountable for any externalities
in its production. So, basically, we have suggested a new interpretation of the
concept of ‘a polluter’. Consequences may not be uninteresting for politicians. In
Section 2 we have seen that the adhering to a strict interpretation of the PPP often
prevents us from reaching optimal solutions in social cost issues. That is, in many
respects the principle forms the central element in a case of Arthurian lock-in
(Arthur, 1989). In this paper we have shown that, in fact, we can retain the
celebrated idea that the polluter should pay as the cornerstone of environmental
policy. The single proviso is that its definition should be modified according to the
suggested way of calculating.

Acknowledgements

The author is indebted to Faye Duchin, Steven Keuning and Roberto Scazzieri
for very welcome comments on the ideas contained in this paper. Earlier versions
of the paper were presented at seminars at the University of Bologna (Department
of Economics), the Massachusetts Institute of Technology (Department of Urban
Studies and Planning), the University of Cambridge (Clare Hall), and at the
Twelfth International Conference on Input–Output Techniques, New York, 18–22
May, 1998.

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