Environmental adjustment of the EU27 GDP: an econometric quantitative model

The use of natural resources as an input to economic growth and the interactions between economic and ecological systems have resulted in an accumulation of environmental externalities. This accumulation can negatively affect future levels of welfare and economic growth. In this paper, such dynamics are assessed and quantified by introducing explicit environmental externality variables in a production function. This is performed in an endogenous growth model where cumulative environmental externalities interact with economic growth. Using efficiency analysis, a dynamic econometric model is estimated showing the significance of a negative influence of past levels of use of natural resources on GDP over a broad range of stochastic frontier analysis estimations. The results are applied to propose an alternative specification to the production function of a modelling tool used by the European Commission for the assessment of climate policies in the European Union. The findings show that observed GDP is overestimated when environmental externalities are not considered.