This paper develops an endogenous growth model which links pollution to ineffective input-use, which can be reduced through conservation capital investment. It derives the conditions under which individual preferences for environmental quality and private investment in conservation capital can lead to non-decreasing environmental quality and balanced growth in an unregulated and in a regulated regime. In the absence of regulation, balanced growth can lead to improvement in environmental quality as long as the rate of growth is low. The extent to which the growth rate is low depends upon preference for environmental quality, interest and discount rates, productivity of conservation capital, and price of the polluting input. Under an emissions tax regime, sustainable balanced growth requires the interest rate to lie between the amenity value derived by consumers from environmental improvement and the marginal return to the firm due to the regenerative capacity of the environment. This implies that interest rate must be high enough to encourage consumers to forego consumption but low enough to constrain the productivity of conservation capital and restrain usage of the polluting input. The emissions tax is also shown to be equivalent to a pollution permit system or to a two-instrument scheme composed of a tax on polluting input and a subsidy on conservation capital investment.

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 Record created 2017-04-01, last modified 2020-10-28

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