The impact of economic and financial development on environmental degradation: An empirical assessment of EKC hypothesis

The purpose of this study is to validate the impact of economic and financial development along with energy consumption on environmental degradation using dynamic panel data models for the period 1980-2010. The study uses three sub-panels constructed on the basis of income level to make panel data analysis more meaningful.

Larsson et al. panel cointegration technique, fully modified ordinary least squares and vector error correction model causality analysis are applied for empirical estimation.

Main empirical findings demonstrate that financial development reduces environmental degradation in the high-income panel and increases environmental degradation in the middle- and low-income panels. Hypothesis of the environmental Kuznets curve is accepted in all income panels. Granger causality results show the evidence of bidirectional causality between financial development and CO₂ emission in the high-income panel, and unidirectional causality from financial development to CO₂ emission in the middle- and low-income panels.

In empirical literature, only a few studies explain the effect of financial development on environment. The present study is an effort to fill this gap by exploring the effect of economic and financial development on environmental degradation.