Financial Development and Environmental Quality: Differences in Renewable Energy Use and Economic Growth

Abstract

This paper uses feasible generalized least squares (FGLS) to empirically investigate the effect of financial development on environmental quality via carbon dioxide (CO2) emissions for 148 countries from 1990 to 2019. The advantage of FGLS is overcoming the heteroskedasticity and serial and crosssectional correlations and giving more efficient results than the Ordinary least squares estimate. Research innovations include the development of general regression models that establish the links among financial liberalization, renewable energy use, and economic development, which has been largely neglected in previous research. Initial findings indicate that the total effect of financial development on CO2 emissions depends on economic growth and consumption of renewable energy. Notably, while the use of renewable energy may reduce the emissions-increasing effect of economic growth, economic growth may exacerbate the problem of environmental degradation caused by economic growth. The magnitude of the effect varies by income group. The role of renewable energy consumption holds true in countries with high and middle incomes but not in countries with low incomes. Regarding the effect of economic growth, research finds that economic growth may worsen (improve) the impact of financial development on environmental quality among high- and middle-income groups (low-income groups). The findings are robust across financial development dimensions (including the financial institution and the financial market). Thus, the implications are that governments in high- and middle-income countries should promote green credit policies and focus on technology related to environmentally friendly technological innovations to improve environmental quality.