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The Role of Financial Development in Climate Change Mitigation: Fresh Policy Insights from South Africa

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Abstract

The present research on the relationship between financial development and CO2 emissions has shown conflicting, inconsistent results. This study resolves this problem by examining the direct and indirect effects of financial development on CO2 emissions using the Environmental Kuznets Curve (EKC) analytical framework. Our scientific work for South Africa between 1960 and 2020 is built on the cutting-edge dynamic autoregressive distributed lag simulations technique. The findings, which were based on five different financial development metrics, show that financial development both temporarily and permanently lowers CO2 emissions. We further support the EKC theory’s applicability in the case of South Africa. More significantly, the results of the indirect channels show that financial development reduces the deleterious effects of economic growth, trade openness, and foreign direct investment on CO2 emissions while strengthening the role that energy utilization plays in promoting carbon emissions. Additionally, the pollution haven hypothesis (PHH), which is explored by employing trade openness and foreign direct investment variables, is predicated on the existence of an inefficient financial framework. When financial development reaches certain levels, PHH for both of these factors vanishes. Finally, technological innovation reduces CO2 emissions even when industrial value addition fuels them. In light of our empirical findings, this research offers some critical policy suggestions and novel viewpoints for South Africa as it implements national interventions to cut CO2 emissions and achieve its net-zero emission goals.

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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.

Notes

  1. Why were these four variables—energy consumption, economic growth, trade openness, and foreign direct investment—selected above others? First, the growth of financial services leads to an increase in energy requirements (Khan and Ozturk 2021); as a consequence, it is anticipated that financial development will have a positive impact on the process of energy utilization, which in turn influences CO2 emissions. Second, it is well known that, with very few exceptions, financial development often leads to faster economic growth and higher carbon emissions in the nations concerned (Khan and Ozturk 2021). Indeed, it is widely acknowledged that financial development is essential for economic growth and that reaching a high rate of economic growth, which results in environmental deterioration, is a need for such development (Chen et al. 2019). Economic expansion thus becomes a crucial pathway for financial development to raise CO2 emissions. Third, through trade route, the impact of financial development on CO2 emissions may also be seen. When trade liberalization goes beyond a specified point, labor begins to move to peripheral regions while capital stays concentrated in the core nations (Candou 2013). Capital transfers from the core to the periphery can only occur when the periphery has stable financial systems (Jalil and Feridun 2011). Fourth, a stable financial system makes it possible for banks to extend some loans to foreign enterprises. As a result, foreign direct investment (FDI) enters the nation, which is associated with technological improvements and a decrease in pollutant emissions (Katircioğlu and Taşpinar 2017). According to Hermes and Lensink (2003), a strong financial system is a requirement for the spread of technology brought about by FDI. Regarding these latter two indirect routes (trade openness and FDI), it is important to note that some prior research suggests that trade openness and FDI have a deleterious impact on the environmental quality of poor nations because of the pollution heaven hypothesis (PHH). In spite of the conflicting empirical evidence supporting PHH's validity (Solarin et al., 2017), our article explores whether financial development may help developing nations like South Africa solve the empirical conundrum of PHH theory.

  2. In this study, we have utilized CO2 emissions as a stand-in for environmental quality because of the following reasons: First, since CO2 emissions account for the largest portion of greenhouse gas (GHG) emissions and are the easiest to measure and collect data for, many researchers have favored them in analyses of environmental quality (Aljadani 2022; Dagar et al. 2022; Islam 2022; Jahanger 2022). Second, there are now more CO2 emissions in the atmosphere, which has far-reaching effects including increased droughts, flooding, severe storms, melting glaciers, and rising sea levels (UNFCCC, 2017). Finally, because fossil fuel emissions of CO2 significantly contribute to global warming, our analysis employs CO2 emissions as a proxy for environmental quality.

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Funding

This study was not funded by any organization.

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Authors and Affiliations

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

    Maxwell Chukwudi Udeagha & Marthinus Christoffel Breitenbach

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  1. Maxwell Chukwudi Udeagha
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  2. Marthinus Christoffel Breitenbach
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Contributions

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

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Correspondence to Maxwell Chukwudi Udeagha.

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Appendix

Appendix

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. The Role of Financial Development in Climate Change Mitigation: Fresh Policy Insights from South Africa. Biophys Econ Sust 8, 1 (2023). https://doi.org/10.1007/s41247-023-00110-y

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  • DOI: https://doi.org/10.1007/s41247-023-00110-y

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