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Investigating Financial Development and Its Direct and Indirect Environmental Effects in South Africa: Fresh Policy Insights

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Abstract

Results on the connection between financial development and CO2 emissions are presented in contradicting ways in earlier research. In order to solve this conundrum, the Environmental Kuznets Curve (EKC) framework is used in this study to examine both the direct and indirect effects of financial development on environmental degradation. Our empirical analysis is supported by the cutting-edge dynamic ARDL simulations framework for the 1960–2020 time span in South Africa. The estimated results, which are based on five separate financial development indices, corroborate South Africa's claim that the country's financial development prevents pollution. For South Africa, we also confirm the validity of the EKC theory. The results of the indirect channels demonstrate that financial development also lessens the negative impacts of income, energy usage, trade openness, and foreign direct investment (FDI) on pollution emissions. A weak financial structure is also necessary for the viability of the polluted haven hypothesis (PHH), which is examined using trade openness and FDI variables. For each of these variables, PHH vanishes at a particular point in financial development. Last but not least, increased industrial value-added increases pollution emissions, whereas increased technical innovation decreases the former. On the basis of these findings, South Africa should offer financial incentives and tax breaks to attract green FDI and encourage investments that prioritize environmental sustainability. These incentives can include grants, subsidies, and preferential tax rates for FDI projects that align with South Africa's environmental goals. Providing a favourable investment climate for green projects can stimulate sustainable economic growth and attract responsible investors.

Résumé

Les résultats sur la relation entre le développement financier et les émissions de CO2 ont étés présentés de manière contradictoire dans les recherches précédentes. Afin de résoudre ce dilemme, la courbe environnementale de Kuznets Le cadre de la Courbe de Kuznets Environnementale (EKC) sont utilisés dans cette étude pour examiner à la fois les effets directs et indirects du développement financier sur la dégradation de l'environnement. Notre analyse empirique est soutenue par le cadre de simulation ARDL dynamique de pointe pour la période 1960-2020 en Afrique du Sud. Les résultats estimés, qui sont basés sur cinq indices distincts de développement financier, corroborent l'affirmation de l'Afrique du Sud selon laquelle le développement financier du pays prévient la pollution. Pour l'Afrique du Sud, nous confirmons également la validité de la théorie de l'EKC. Les résultats indirects démontrent que le développement financier atténue également les impacts négatifs du revenu, de l'utilisation de l'énergie, de l'ouverture commerciale et de l'investissement direct étranger (IDE) sur les émissions de pollution. Une structure financière faible est également nécessaire pour la viabilité de l'hypothèse du paradis pollué (en anglais : « Polluted Heaven Hypothesis », PHH), qui est examinée à l'aide des variables d'ouverture commerciale et d'IDE. Pour chacune de ces variables, le PHH disparaît à un certain point du développement financier. Enfin et surtout, une augmentation de la valeur ajoutée industrielle augmente les émissions de pollution tandis qu'une augmentation de l'innovation technique diminue les premières. Sur la base de ces résultats, l'Afrique du Sud devrait offrir des incitations financières et des allégements fiscaux pour attirer les IDE verts et encourager les investissements qui privilégient la durabilité environnementale. Ces incitations peuvent inclure des subventions, des subventions et des taux d'imposition préférentiels pour les projets d'IDE qui s'alignent sur les objectifs environnementaux de l'Afrique du Sud. Fournir un climat d'investissement favorable pour les projets verts peut stimuler la croissance économique durable et attirer des investisseurs responsables.

Resumen

Los resultados sobre la conexión entre el desarrollo financiero y las emisiones de CO2 han sido presentados de manera contradictoria en investigaciones anteriores. Para resolver este enigma, este estudio utiliza el esquema de la Curva de Kuznets Ambiental (en ingles: “Environmental Kuznets Curce”, EKC) para examinar tanto los efectos directos como indirectos del desarrollo financiero en la degradación ambiental. Nuestro análisis empírico está respaldado por el marco de simulaciones ARDL dinámicas para el período entre 1960-2020 en Sudáfrica. Los resultados estimados, que se basan en cinco índices de desarrollo financiero separados, corroboran la afirmación de Sudáfrica de que el desarrollo financiero del país previene la contaminación. Para Sudáfrica, también confirmamos la validez de la teoría EKC. Los resultados indirectos demuestran que el desarrollo financiero también disminuye los impactos negativos del ingreso, el uso de energía, la apertura comercial y la inversión extranjera directa (IED) en las emisiones de contaminación. Una estructura financiera débil también es necesaria para la viabilidad de la hipótesis del paraíso contaminado (en inglés: “Polluted Heaven Hypothesis”, PHH), que se examina utilizando variables de apertura comercial e IED. Para cada una de estas variables, el PHH desaparece en un punto particular en el desarrollo financiero. Por último, pero no menos importante, el aumento del valor añadido industrial aumenta las emisiones de contaminación, mientras que el aumento de la innovación técnica disminuye las anteriores. En base de estos hallazgos, Sudáfrica debería ofrecer incentivos financieros y exenciones fiscales para atraer IED verde y fomentar inversiones que prioricen la sostenibilidad ambiental. Estos incentivos pueden incluir subvenciones, subsidios y tasas impositivas preferenciales para proyectos de IED que se alineen con los objetivos ambientales de Sudáfrica. Proporcionar un clima de inversión favorable para proyectos verdes puede estimular el crecimiento económico sostenible y atraer a inversores responsables.

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Data Availability

The data relevant to this research are publicly available from the World Development Indicators or obtained from the authors by making a reasonable request.

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Funding

This work is based on the research supported in part by the National Research Foundation of South Africa (Grant Number PSTD2203311300).

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Authors and Affiliations

  1. School of Economics, University of Pretoria, Hatfield Campus, Hatfield, South Africa

    Maxwell Chukwudi Udeagha & Marthinus Christoffel Breitenbach

  2. Department of Economics, University of Pretoria, Private Bag X20, Hatfield, 0028, South Africa

    Maxwell Chukwudi Udeagha

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MCU and MCB conceptualized the study idea, drafted the paper, collected data, analysed data, wrote the introduction section, organized the literature review, drafted the methodology section, interpreted the results, and provided the discussions, concluded the study with policy implications, and organized the reference list.

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Appendix

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See Figs. 13 and 14.

Fig. 13
figure 13

Plot of cumulative sum of recursive residuals (CUSUM)

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Fig. 14
figure 14

Plot of cumulative sum of squares of recursive residuals (CUSUMSQ)

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Udeagha, M.C., Breitenbach, M.C. Investigating Financial Development and Its Direct and Indirect Environmental Effects in South Africa: Fresh Policy Insights. Eur J Dev Res 36, 428–495 (2024). https://doi.org/10.1057/s41287-023-00608-7

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