Pollution and economic growth in a model of overlapping generations

We analyze a model of overlapping generations in which clean air, a pure public consumption good, is used as a private input into production. Although production exhibits constant returns to scale, endogenous growth can occur because the economy has tWO sectors. In a laissez-faire equilibrium, there is no market for pollution rights, and firms appropriate clean air in an arbitrary manner. Growth occurs only if the marginal propensity to save is high enough and the asymptotic share of pollution in the investment sector is zero. Firms generate quasi-rents that are the value of pollution rights. These quasi-rents crowd out investment and slow economic growth. A laissez- faire equilibrium may not support Pareto optimal allocations, but a Pigouvian tax with lump-sum distribution of the resulting revenues does. Hence, a pollution lax yields a double dividend because it can increase both the static efficiency of the economy and its growth rate. 1 fig., 20 refs