Understanding the interaction between Carbon emissions and the components of financial development is of great importance in order to formulate proper sustainable development policies. More importantly, the assessment whether the status of financial development in Malaysia is green or not. The current study is different from the previous study in this area where this study taking into account 3 different types of financial development, i.e., foreign investment, domestic investment and private investment. Henceforth, the current study utilises quadratic model and F-bounds assessment based on the ARDL context to Malaysian Carbon emissions, foreign direct investment, domestic investment, and domestic credit to private sector time series over the period 1970-2018. Results from the F-bound co-integration analysis confirmed the existence of a significant U-shape inversion via quadratic correlation between the emissions of carbon and domestic investment in the long run; however, the role of other financial development indicators was found insignificant. These results imply that Malaysia is moving towards green financial development with the existence of technological effect on the development of Malaysia domestic investment in the near future.
Keywords: Carbon emissionsfinancial developmentARDLsustainable development
Sustainable development is an important issue highlighted in the current era. According to the Brundland Commission Report produced in 1987, sustainable development is referring to development that meets the needs of the present generation as well as those of future generations (Bekhet & Latif, 2018; Jalil, 2010). Relatively, green development is a subset of sustainable development where one of the possible ways to being green is by narrowing the gap between the development of the economy and environmental pollutions. However, due to several reasons, Malaysia faces a few challenges to achieve green development as well as “reducing 45% GHG emissions intensity of GDP by year 2030 relative to the emissions intensity of GDP in 2005" (United Nations Framework Convention on Climate Change, 2015). First, because Malaysia is an energy-dependent country and almost 99% of its energy comes from highly polluted fossil fuels whereas the remaining 1% comes from renewable energy sources (Bekhet & Othman, 2017). Second, Malaysia has considerably changed itself from a country that mostly grounded on agriculture to manufacturing and modern services, which are relatively high-energy-intensive (Bekhet & Othman, 2017). Without any innovation or action, the environmental quality is expected to worsen from time to time and will affect people's lives.
Undoubtedly, fiscal growth is essential to many countries, especially to emerging countries like Malaysia. Its function on economic growth was undeniably received a great attention with the advent of the endogenous growth theory (Nasreen & Anwar, 2015). The importance of finance in economic activities was first explore by Schumpeter (1911), and then the study on finance-economic relationship stimulated after the seminal paper of King and Levine (1993). Past literatures suggested a number of ways on how financial development can influence economic activities and environmental quality. First, efficient and affluent financial institutions improve the process of obtaining loans, which may help people to buy domestic equipment such as automobiles, air conditioners, washing machine, houses refrigerators, and many more. Consequently, this will increase energy consumption, as well as, increase carbon emissions (Javid & Sharif, 2016). Second, financial development can provide efficient financial services to foreign banking markets and attract foreign direct investment (FDI) (Kahouli & Omri, 2017). The FDI permits unindustrialized nations the required prospect and motivation in improving worldwide and local ecological endurability via new technology, clean and environmentally friendly production gained from foreign firms / investment (Acheampong, 2019; Nasreen & Anwar, 2015). Third, financial development may generally encourage research and development (R&D) activities that will improve economic activities and quality of environment (Acheampong, 2019; Shahbaz, Solarin, et al., 2013). The motivation for this study stems from the desire to explore the links between the emissions of carbon and financial progress in Malaysia that can be considered in the infant stage.
Albeit the world’s extensive focus on the connection between financial development and the environment, previously observed studies on the link between financial development and environmental quality is quite limited. Jensen (1996) reported that the financial development served as an engine to industrialisation, which increase industrial pollution and damage the environmental quality.
Insofar, in Malaysia, the relationship study between these two variables is still at the infant stage. Specifically, the research of how financial development influences the environmental pollution is still ongoing. The motivation for this study stems from the desire to explore the links between carbon emissions and financial development.
Does co-integration relationship exist between financial development and environmental pollution?
Does “Environmental Kuznet Curve (EKC)” hypothesis apply to Malaysia’s financial development and carbon emissions?
Purpose of the Study
In relation to the above matters, the aim of this study is to examine the existence of co-integration correlation between financial development and environmental pollution, as well as to inspect the presence of “Environmental Kuznet Curve (EKC)” hypothesis via quadratic relationship between financial development and carbon emissions. With the presence of EKC hypothesis between aforesaid variables, it means the Malaysia financial development can be considered as green with the occurrence of technological effect [for detail read EKC hypothesis written by Grossman & Krueger (1991)]. This study offers a good understanding and bridges the gap between financial development and carbon emissions by taking into account the role of foreign direct investment, domestic investment, and national credit to private investors as components of financial development that are separated into 3 models. Furthermore, this study utilizes the theory of demand with the intention to deliver a complete comprehension of the impact of financial development on environmental pollution. Likewise, this study serves as a significant recommendation to policy makers in Malaysia’s pursuit of transitioning into a lower carbon nation.
In order to assess the connection between the emissions of carbon and financial development, the yearly data of the carbon emissions from “solid fuel consumption (C)”, “domestic investment (K)”, “foreign direct investment (F)”, “domestic credit to private sector (D)”, and “gross domestic product (Y)” are employed. All data are obtained from “World Development Indicator (WDI)”, issued by the “World Bank” which covers the years from 1970 to 2018 and its detail was present in Table
To remove the impact of the variable’s factor to stimulate the stationary process (Narayan & Smyth, 2005; Lau et al., 2014), and to decrease the likelihood of heteroscedasticity and existence of autocorrelation (Bekhet & Othman, 2014), natural logarithms are applied to all data. Then, the following quadratic multivariate models in econometrics form are used to evaluate the status of financial development in Malaysia whether it is green or not (Bekhet & Othman, 2017):
Where LC, LK, LF, LD and LY are carbon emissions, domestic investment, foreign investment, private investment and GDP after taking the natural logarithm, respectively. µt signifies the random error term; with the assumption of a normal distribution. The relationship coefficients are interpreted as elasticities of carbon emissions as a change in independent variables [see Ivy-Yap & Bekhet (2015)].
Respectively, the squared term of financial development component is included to inspect the status of nonlinear relationship between financial development and carbon emissions; either is inversed U-shape or not. To put it differently, there is a technological effect that is able to transform the positive relationship between financial development and the emissions of carbon to an inverse relationship among aforesaid variables and then change the status of financial development from non-green to green financial development.
The role of financial development indicators whether they are able to improve environmental quality or not can be measured through the signage of the above mention coefficients. This study anticipates the , as indication to the inverted U-shaped relationship between Carbon emissions and financial development’s components. Conversely, if , a U-shaped relationship between carbon emissions and financial development’s components exists which mean there could be technology obsolescence at the middle stage of financial development that worsen the environmental pollution condition.
Next, the econometric procedures are used to test the hypothesis and to achieve the objectives of this study as shown in Figure
ADF test is utilized to measure the stationarity level. The results are presented in Table
Due to the combination of I (0) and I (1) level of stationarity, with the sample size being quite small (n=49), the most appropriate method to measure co-integration relationship is the F-bounds assessment. Nevertheless, prior to proceeding with the co-integration assessment, it is essential to ascertain the optimum lag extent to be applied in the F-bounds assessment (Matar & Bekhet, 2015; Sugiawan & Managi, 2016). Utilizing the “Akaike information criterion (AIC)”, the optimum lag extent for these models is 1 (refer to the Table
In relation to the above finding, the error correction model has been formulated to measure the long run elasticities via quadratic relationship between carbon emissions and financial development. The results are demonstrated in Figure
The coefficient of LK and LK2 are found to be significantly positive and negative respectively at a 5% level of significance and it maintained the inversed U-shape correlation between the emissions of carbon and domestic investment in due course. As suggested by the evidence, the emissions of carbon intensify during the early phase of development in domestic investment. However, at certain level of development of domestic investment, the carbon emission starts to decrease. This implies that domestic investment promotes typical environmental supervision procedures, as well as ecologically-friendly advancement into Malaysia’s economy, thus reducing the emissions of carbon. In essence, Malaysia’s domestic investment can be categorized as green.
To the contrary, the coefficient of LD and LD2 are found to be insignificantly positive and negative respectively, which rejected the existence of the inversed U-shape connection between the emissions of carbon and private investment in due course. The result is not consistent with Acheampong (2019), Al-Mulali et al. (2016), and Tamazian et al.’s (2009), but in line with Seetanah et al. (2019), indicating that private investment does not show any curvilinear impact on the emissions of carbon in Malaysia
The current study aims to measure the status of financial development in Malaysia, either it is green or not. To do so, the quadratic model and F-bounds assessment based on the ARDL context to Malaysian carbon emissions and financial development indicators are utilised for 1970-2018 period. It is different from the previous study in this area where this study taking into account 3 different types of financial development, i.e., foreign investment, domestic investment and private investment. Results from the F-bound co-integration analysis confirmed the existence of the significant inversed U-shape via quadratic connection between the emissions of carbon and domestic investment in due course, however, the role of other financial development indicators was found insignificant. These results imply that Malaysia’s domestic investment is moving towards green financial development with the existence of technological effect on its development in the near future.
Since 2010, Malaysia has been recorded almost 80% of the approved investment projects is coming from domestic investment, while the remaining 20% of the approved investment projects is coming from foreign investment (Hanif & Jalaluddin, 2013). The contribution of service sector to GDP increased from 51.2% in year 2010 to 55.5% in year 2018, and it was targeted to increase to 58% in year 2020 make a service sector as the largest contributor of approved investment (www.mida.gov.my). Judging from this, Malaysia has enormous amount of investment projects and the allocation of these project is moving towards green investment.
As for policy implication, policy maker has to continuously stay on this path by highlighting more energy efficient and renewable energy components in all the investment process starting from its approval process until the implementation of the project. Through this, the policy makers either it in the public or private sector able to support government mission and vision to ensure that the country is protected against any possible environmental pollution. However, this study did not measure the forecast threshold level via at which the carbon emissions start to decrease as a result of development of domestic investment. Due to this, future researchers are to measure the threshold level and explore more potential factor that can influence the environmental quality in Malaysia.
The authors would like to acknowledge IRMC UNITEN for awarding internal grant (UNIIG2018) for funding this research.
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Othman, N. S., Bekhet, H. A., Ibrahim, D., Harun, N. H., & Bakar, S. (2020). Is Financial Development in Malaysia Green? An Empirical Assessment of EKC Hypothesis. In N. S. Othman, A. H. B. Jaaffar, N. H. B. Harun, S. B. Buniamin, N. E. A. B. Mohamad, I. B. M. Ali, N. H. B. A. Razali, & S. L. B. M. Hashim (Eds.), Driving Sustainability through Business-Technology Synergy, vol 100. European Proceedings of Social and Behavioural Sciences (pp. 513-523). European Publisher. https://doi.org/10.15405/epsbs.2020.12.05.55