Analyzing which economic variables are helping the most
There is much criticism and controversy about what the most capitalist countries do and how they protect the environment. Some of those ideas are misguided or have inherent prejudices. Some others make focus in particular issues such as CO2 emissions or how centrally-based policies can help to achieve a greater success factor, overlooking the big picture.
However, take into consideration the property rights. Everyone who pollutes the air, conditions our right to live in a cleaner environment which in some cases is our shared property. It shall be noticed that there is always interested parts protecting the places where they lives, starting from their personal space and their belongings. Even if it has been commented briefly, “the tragedy of the commons” is outside the scope of this article.
On the other hand, it’s natural to our human condition to seek ways of living better everyday, increasing our standards and development factors. This simple fact presents a trade off with the environment, development is always counteracting with the ecology preservation. Only rich nations (and individuals) have a tendency to consume goods which has a less impact in nature since they can easily spend a few more based in this criteria… or do they try to save every penny? Let’s find it out.
Correlating the Environment with the Free Market Economies
Every year the Yale University releases the Environmental Performance Index (EPI), it provides a data-driven summary of the state of sustainability around the world. Using 32 performance indicators across 11 issue categories, the EPI ranks 180 countries on environmental health and ecosystem vitality. These indicators provide a gauge at a national scale of how close countries are to established environmental policy targets.
At the same time, the Heritage Foundation provides a ranking of Economic Freedom, based in 12 freedoms — from property rights to financial freedom — in 186 countries. The principles of economic freedom that have fueled the human progress are measured in the Index of Economic Freedom, aiming to provide helpful insights to foster the development process and preserve it all around the globe.
Let’s take a look at how these two indexes correlate together.
The positive impact of economic freedom to the environment is noticeable. It can be observed a J or (check mark) shape in the scatter distribution. It’s usual to have a relatively high environmental performance for extremely low development rates. However, as soon as this is more intensive the performance drops: the priority is the economic growth rate rather than the environment. Finally, when countries (and individuals) reach a certain development grade, they try to seek a better environment quality, paying a little more for a healthier place to live. In these terms, the environment behaves as a luxury good, the result is that as the personal income increases, the environment benefits more than proportionally.
Below is a table describing the technical factors of the previous correlation. Even though the slope of the curve is positive, the correlation is not strong enough.
This result may be counter-intuitive, but to have a deeper understanding, we should discuss some particular factors and drill down which aspects are weighing more in the Economic Freedom Index (EFI).
Which EFI factors correlates the most?
To have a clearer picture is better to find the variables composing the EFI which correlates the most with the Environmental Performance Index. Unfortunately the picture is quite large, it correlates many factors and they cannot be appreciated at a glance. A darker blue represents a higher positive correlation, whereas a yellowish color a negative one. The lighter blue represents all the values in the middle without correlation. You can access the full resolution picture here.
From all of this, we’re interested in how they correlate with the EPI. The overall EFI performance will be used as a threshold, some factors which are in the neighborhood had been also chosen. As a result, the variables with more impact are:
- Property Rights
- Government Integrity
- Trade Freedom
- Financial Freedom
- Tax Burden % of GDP
- GDP per Capita (PPP)
All of these variables, correlates positively with the EPI, thus, the more they increase, the higher the environmental index. The next big question is: if we consider a model including only these variables, which weight have to have each of them to achieve the best fit possible?
A model including the most relevant factors
To first compare the variables, we have to standardize them. In this way, we can contrast side by side GDP per Capita and Trade Freedom which range in significantly different intervals as an e.g. Also, the standardization process equalizes the sample deviation and eliminates the biases, centering the values to the mean. The interdependence between variables is out of this article scope.
A multi-variable linear regression have been applied to gather the weight of each coefficient. The variables or predictors with higher coefficients are the ones adding more to the EPI. The bar plot at the left depicts the coefficients results.
The following table compares the results of our first model using only the overall EFI performance and the results considering only the factors which correlates the most with the EPI. Our new model with the selected variables, shows a significant performance increase in the environment index prediction.
The relative tax burden per GDP appears as the most important factor. This lead us to think that a higher government presence helps us to achieve a healthier environment. However, if we analyze the methodology used to construct the tax burden EFI indicator, we will see a slightly negative correlation of -0.4 with the EPI. The complete tax burden indicator considers the following equally weighed predictors:
- The top marginal tax rate on individual income.
- The top marginal tax rate on corporate income.
- The total tax burden as a percentage of GDP.
It will be useful to consider how the different governments are taxing and spending these resources to help preserve the environment. This is, which policies are helping the most to save the planet, such as the ones linked to CO2 emissions.
As mentioned before, the GDP per capita give us a good estimator of how each individual is willing to spend a few more to help preserve the environment. In this way, their preferences shifts towards companies which have greener policies and that reduce their activity impacts, at the expense of paying a bit more.
Corruption erodes environmental metrics by introducing insecurity and coercion into the property rights. Of greatest concern is the systemic corruption of government institutions and decision-making by such practices as bribery, extortion, nepotism, cronyism, patronage, embezzlement, and graft. The lack of government integrity caused by such practices reduces public trust and environmental vitality. The Government Integrity score weighs equally the following factors:
- Irregular payments and bribes.
- Transparency of government policymaking.
- Absence of corruption.
- Perceptions of corruption.
- Governmental and civil service transparency.
Another important factors are trade and financial freedom. A government which implements many trade barriers and inhibits their inhabitants to access environmental friendly goods at competitive prices, harms their citizens not only economically but at the same time, erodes their habitat. In the other hand, if the financial sectors have government interference which may lead to inefficient or highly focused sectors, there may be a negative impact in greener initiatives, as we can observe from the results.
Despite the property rights not weighing too much in the equation, their definition is crucial: they have to be measurable in order to be traded after. The rule of law ought to be implemented by a government that shall be highly isolated from corruption. It shall also establish the legal framework to restrict or enable the before mentioned rights. It must also penalize the environmental damages, guarantee the contracts observance and their applications. In this way, the care of the habitat will be considered as a tradable asset instead of a passive.
Free markets enable better environment care, it’s been demonstrated that developed countries are not jeopardizing the habitat. Indeed they have more resources: their citizens, companies and government consider expending an extra amount of money in greener solutions. There are several factors which are pretty important such as the tax burden, the government integrity and the property rights, that boost the environmental performance of a country. As well as the tax burden, it is also important to check how the taxes are being spent in the habitat care. That’s a good kick start for another article.
If you’re interested in the graphics and further details presented in the post, please visit the github repository.
Capitalism and Environment Through Multiple Linear Regression was originally published in Towards Data Science on Medium, where people are continuing the conversation by highlighting and responding to this story.