Foreign finance, economic growth and CO2 emissions Nexus in OECD countries

Abstract

Purpose This study aims to examine the relationship between foreign finance, economic growth and CO2 to investigate if the environmental Kuznets curve (EKC) exists as an empirical evidence in 32 selected Organization for Economic Co-operation and Development (OECD) countries. Design/methodology/approach This study used quantitative analysis to test two main hypotheses: H1 is the U-shape relationship between foreign finance and environment, and H2 is the N-shaped association between economic growth and environment. In doing so, this study used panel data techniques. The panel set contained 32 countries over the period from 1990 to 2015, with 27 observations for each country. This study applied a panel OLS estimator via fixed-effects control to address heterogeneity and mitigate endogeneity. Generalized method of moments (GMM) with fixed effects-instrumental variables (FE-IV) and diagnostic tests were also used. Findings The results showed that foreign finance and environmental quality have an inverted U-shaped association. The three proxies’ foreign investment, foreign assets and remittance in the first stages contribute significantly to CO2 emissions, but after the threshold point is reached, these proxies become “environmentally friendly” by their contribution to reducing CO2 emissions. Also, a non-linear relationship denotes that foreign investment in OECD countries enhances the importance, as a proxy of foreign finance has greater environmental quality than foreign assets. Additionally, empirical results show that remittances received is linked to the highest polluted levels until a threshold point is reached, at which point it then helps reduce CO2 emissions. The GMM and FE-IV results provide robust evidence on inverse U-shaped relationship, while the N-shaped relationship explains that economic growth produces more CO2 emissions at the first phase of growth, but the quadratic term confirms this effect is negative after a specific level of GDP is reached. Then, this economic growth makes the environment deteriorate. These results are robust even after controlling for the omitted variable issue. The IV-FE results indicate an N-shaped relationship in the OECD countries. Practical implications Most studies have used different economic indicators as proxies to show the effects of these indicators on the environment, but they are flawed and outdated regarding the large social challenges facing contemporary, socio-financial economic systems. To overcome these disadvantages, the social, institutional and environmental aspects of economic development should also be considered. Hence, this study aims to explain this issue as a relationship with several proxies in regard to environmental, foreign finance and economic aspects. Originality/value This paper uses updated data sets for analyzing the relationship between foreign finance and economic growth as a new proxy for pollution. Also, this study simulates the financial and environmental future to show their effect on investments in different OECD countries. While this study enhances the literature by establishing an innovative control during analysis, this will increase to add value. This study is among the few studies that empirically investigate the non-linear relationship between finance and environmental degradation.