1. Introduction
The early literature on growth has generally only addressed the impact of capital, labor and technological progress on economic growth. However, theoretical developments over the last 20 years have shown that financial factors and environmental resources also play an important role in modern economic growth. Although research in this area has attracted growing attention in recent years, the empirical investigation of the relationships between the three within a unified framework is still largely absent.
Based on the existing literature, studies on the relationship between economic growth and environmental quality used to focus on the influence of economic growth on environmental quality. For example, Shafik and Bandyopadhyay [
1] use eight indicators that measure environmental quality to investigate the relationship between economic growth and environmental quality, finding that income growth initially causes the deterioration of environmental quality, but with a continuously rising income, environmental quality begins to improve. Grossman and Krueger [
2] study the relationship between environmental quality and economic development based on cross-nation data; their econometric results show that there is an “inverted U-shaped” relationship between the deterioration of environmental quality and economic development,
i.e., the early development of an economy leads to the deterioration of environmental quality, but after reaching a turning point, sustained economic development improves the environmental quality of the country. The above-described “inverted U-shaped” relationship between economic development and environmental quality has also been designated as the environmental Kuznets curve (EKC). Subsequently, many scholars, such as Selden and Song [
3], De Bruyn
et al. [
4] and Friedl and Getzner [
5], have used various parameters that measure the quality of environmental quality to conduct empirical studies on the “inverted U-shaped” relationship between economic growth and environmental quality. Selden and Song [
3] use different pollutants like SO
2, NO
x, CO to investigate the “inverted U-shaped” relationship between economic growth and environmental conditions. The empirical results indicate that economic growth leads to an initial degradation of the environmental conditions, and after a certain point, it leads to an improvement in the quality of environment. De Bruyn
et al. [
4] use three environmental quality indicators (CO
2, NO
2 and SO
2) in four countries (the Netherlands, the U.K., the U.S. and West Germany) to conduct an empirical study on the relationship between economic growth and emissions, and the results show that there is a positive correlation between economic growth and pollution emissions; meanwhile, the changes in the economic structure and technological progress help reduce environmental pollution. In another econometric analysis, Friedl and Getzner [
5] found that the relationship between Austria’s economic growth in the period 1960–1999 and CO
2 emissions is in line with the EKC theory, with the “turning point” occurring in the mid-1970s mainly as a result of the rise in oil prices. Through econometric analysis, Jalil and Feridun [
6] find that the EKC theory also applies to China. Similarly, in an econometric analysis on South Africa, Muhammad
et al. [
7] also show that the relationship between economic development and environmental quality displays a significant “inverted U-shaped” relationship. In a recent study, Li and Ma [
8] employed panel data analysis to study the relationships among the urbanization rate, economic development and environmental change in China. Their results reveal a remarkable inverted-U-shaped relationship between the urbanization rate and changes in regional environmental quality, which not only further confirm the “environmental Kuznets curve hypothesis”, but also expand it in that the inverted-U-shaped evolving relationship between environmental quality and economic growth (urbanization) seems to be universally applicable.
Literature regarding the relationship between financial development and environmental quality is limited. Tadesse [
9] asserts that financial development should prompt technological innovation and thus improve environmental quality. Kumbaroğlu
et al. [
10] also show that, in a country with a well-developed financial system, active technological innovation typically produces a significant reduction in pollution emissions. In a similar vein, Stijn and Feijen [
11] find that the development of financial institutions can reduce the cost of investments that are related to environmental protection projects, thus helping to improve the quality of the environment. Tamazian
et al. [
12] use panel data of the BRIC (Brazil, Russia, India and China) countries from the period 1992–2004 to study the relationship between environmental quality and financial development, and they find that the level of financial development is an important determinant of a country's environmental quality: the higher the level of the country’s financial development, the higher the level of the country’s environmental quality. After an econometric analysis of the panel data of 24 economies from the period 1993–2004, Tamazian and Rao [
13] found that the development of the banking system and capital markets, in addition to direct foreign investment, are all beneficial in reducing per capita carbon dioxide emissions. Based on the panel data of the 12 Middle East and North Africa (MENA) countries from the period 1990–2011, Omri
et al. [
14] study the causal relationships among carbon dioxide emissions, financial development, trade and economic growth, and their findings show that a reduction in environmental quality generates negative external effects on economic growth through affecting human health and that high levels of financial development and trade openness stimulate technological innovation, therefore helping to reduce pollution emissions. Although these studies tend to show that there is a positive correlation between financial development and environmental quality, some empirical studies have found that there is a negative correlation between financial development and environmental quality or that financial development has no significant effect on environmental quality. For example, based on the analysis of the panel data of 22 countries from the period 1990–2006, Sadorsky [
15] demonstrates that the development of financial markets increases consumer demand for energy and therefore is not conducive to improving environmental quality. Zhang [
16] also finds that there is a positive relationship between financial development and carbon emissions in China. In a study on Turkey, Ozturk and Acaravci [
17] find that, in the long run, financial development has no significant impact on per capita carbon dioxide emissions. In the case of Indonesia, Shahbaz
et al. [
18] analyze the linkages among economic growth, energy consumption, financial development, trade openness and CO
2 emissions over the period of 1975–2011. The empirical findings indicate that economic growth and energy consumption increase CO
2 emissions, while financial development and trade openness decrease energy pollutants. In a similar vein, Leitão [
19] evaluates the relationship between energy consumption and foreign direct investment (FDI) in Portugal over the period of 1990–2011. The empirical results illustrate a positive association between income per capita and energy consumption, which validates the hypothesis of the EKC model. In a recent study, Shahbaz
et al. [
20] find that there exists a long-run relation among energy consumption, economic growth, international trade, urbanization and carbon emissions in Portugal. Meanwhile, the EKC hypothesis has also been tested by applying the ARDL (Autoregressive distributed lag) model in the study of Shahbaz
et al. [
20].
Overall, the existing literature on financial development, environmental quality and economic growth exhibits the following deficiencies: First, most of these studies only investigate the impact of financial development or economic growth on environmental quality, but do not perform an analysis by integrating the three into a unified framework. Second, most of the studies only address the impact of financial development or economic growth on environmental quality in one direction, while neglecting the question of whether environmental quality in turn impacts economic growth, and if so, in what ways.
In this context, the present study, which is based on the dynamic panel data of 102 countries from the period 1980–2010, performs an econometric analysis of the relationships among financial development, environmental quality and economic growth using the dynamic generalized method of moments (GMM) estimation. Compared with the existing studies, the theoretical contributions of this study are as follows: First, through incorporating financial development and environmental quality into the economic growth model, the effect of financial development and environmental quality on economic growth is systematically analyzed, which extends the traditional theory concerning environmental quality and economic growth; second, the question of how financial development and environmental quality impact economic growth through interactions is addressed; based on which, the impact of financial development and environmental quality on the marginal outputs formed by labor and capital are investigated, which helps to partially fill the gaps that exist in the current literature on these subjects.
The rest of this paper is organized as follows: the second section introduces the empirical methodology and data; the third section presents the systematic econometric analysis on the impact of financial development and environmental quality on economic growth; the final section summarizes.
4. Conclusions
Based on the dynamic panel data of 102 countries from the period 1980–2010, the relationships among financial development, environmental quality and economic growth were studied using the GMM estimation. The econometric results show that there was a robust and significant “inverted U-shaped” relationship between financial development and economic growth, i.e., by increasing the level of financial development, economic growth first increased and then decreased, which is consistent with the results reported in the standard literature. Meanwhile, there was also a robust and significant “inverted U-shaped” relationship between carbon dioxide emissions and economic growth, indicating that there existed a critical point in exchanging for economic growth at the expense of environmental quality; after crossing the critical point, the deterioration of environmental quality will lead to a significant slowdown in economic growth.
In addition to the basic conclusions described above, the econometric analysis in this paper also shows that there was a mutually promoting and strengthening relationship between financial development and environmental quality. Specifically, the degree of financial development can further strengthen the promoting effect of environmental quality on economic growth; meanwhile, an improvement in environmental quality can also strengthen the promoting effect of financial development on economic growth. In addition, financial development and environmental quality could influence economic growth through strengthening the marginal product effects of capital and labor, which further indicates that both financial and environmental factors play an important role in modern economic development. In this regard, both financial development and environmental quality should be included in the production function of the economic growth model as important variables.
Apart from the main conclusions described above, it is also found that the degree of industrialization, the development of the service sector, capital account openness, the deposit insurance system and the lease of mobile cellular wireless telephone communication systems remained significantly positive in all of the equations, while the inflation rate and the deposit rate in all equations remained significantly negative. These results indicate that the deepening of industrialization, the development of the service sector, the enhancement of capital account openness and the establishment of explicit deposit insurance had positive effects on economic growth, while the increases in inflation and interest rate seem to have a negative impact on economic growth. Overall, these results are not only consistent with intuition and experience, but also in accordance with the predictions based on the classical economic theory.
There are four policy implications that can be drawn from our analysis:
First, to achieve sustainable economic growth, an appropriate level of financial development should be pursued, since neither an underdeveloped financial system nor an overdeveloped financial system is conducive to economic growth. In fact, a naive financial system is usually associated with financial repression, while an overdeveloped financial system may have a crowding-out effect on the real economy by attracting too much resources, both of which are harmful for economic growth.
Second, the “inverted U-shaped” relationship between carbon dioxide emissions and economic growth means that although in the early stages of economic development, the strategy of pursuing economic growth by sacrificing environmental quality might be economically acceptable, in the long run, it will definitely result in serious environmental problems and, thus, have a significant negative impact on economic growth. Therefore, from the perspective of long-term and sustainable economic growth, environmental protection is of crucial importance for every country.
Third, considering that there exist wide interactive relationships among financial development, environmental quality and other production factors in the process of economic growth, a complete blueprint for sustainable economic development must take these interactions into account by effectively exploring the benefits of these interactions while avoiding their harmful effects.
Finally, according to our econometric results, apart from financial development and environmental quality, there are also a wide variety of factors that are helpful for economic growth, such as the development of the secondary industry and the service sector, the opening of capital account, the establishment of deposit insurance system and the construction of wireless telephone communication systems. This means that the upgrading of economic structure, the increase in openness, the setup of financial institutions and the development of social infrastructure are all conducive to economic growth.