The Impact of Sub-Sector of Economic Activity and Financial Development on Environmental Degradation: New Evidence Using Dynamic Heterogeneous Panel

Abstract

While many recent studies have used the ecological footprint as a comprehensive indicator of environmental degradation instead of CO2 emission, these were mainly focused on consumer responsibility. This study, however, aims to cover both aspects of consumption and production to elicit a more comprehensive understanding. Furthermore, this study addresses another information gap by analyzing the effect of aggregated and disaggregated economic activities on the environment. Panel data were used and sourced from 92 countries classified by income group spanning 1992 to 2015. Comprehensive financial development indicators, energy structure, energy intensity, trade openness, and urbanization were considered in examining their impacts on environmental degradation. The pooled mean group estimation was adopted in examining the long-run and short-run relationship between variables. The main findings suggest that financial development promotes green investment in high-income and upper-middle-income countries but increases degradation in lower-middle and lower-income countries. Renewable energy improves the environment in general, and energy intensity is a crucial factor in environmental modeling across all groups. Most importantly, a U-shape relationship is found on both the consumption and the production side for all income groups except for lower-income countries (inverse U-shape) on the production side. Interestingly, a U-shape relationship was found in high-income and upper-middle-income countries in the industrial sector, but a monotonic relationship in the service sector. A U-shape relationship was found for the industrial and service sectors in lower-middle-income and lower-income countries, but an inverse U-shape for agriculture outputs in lower-middle-income countries. This finding suggests the need to shift from fast-growth strategies to strategic growth planning that considers the nature of the relationship between economic sectors and the environment while diversifying the economic structure to allow for the recovery of natural capital.