Energy, Environment and Economic Growth

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Energy, environment and growth nexus in
South Asia

Data from Pakistan, India, Bangladesh, Nepal, Sri Lanka

Muhammed Zeshan,

Vaqar Ahmed

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Energy, Environment and Economic Growth

  1. 1. Energy, environment and growth nexus in South Asia Muhammad Zeshan & Vaqar Ahmed Environment, Development and Sustainability A Multidisciplinary Approach to the Theory and Practice of Sustainable Development ISSN 1387-585X Environ Dev Sustain DOI 10.1007/s10668-013-9459-8 1 23
  2. 2. Your article is protected by copyright and all rights are held exclusively by Springer Science +Business Media Dordrecht. This e-offprint is for personal use only and shall not be selfarchived in electronic repositories. If you wish to self-archive your article, please use the accepted manuscript version for posting on your own website. You may further deposit the accepted manuscript version in any repository, provided it is only made publicly available 12 months after official publication or later and provided acknowledgement is given to the original source of publication and a link is inserted to the published article on Springer's website. The link must be accompanied by the following text: "The final publication is available at link.springer.com”. 1 23
  3. 3. Author's personal copy Environ Dev Sustain DOI 10.1007/s10668-013-9459-8 REVIEW Energy, environment and growth nexus in South Asia Muhammad Zeshan • Vaqar Ahmed Received: 27 January 2013 / Accepted: 17 April 2013 Ó Springer Science+Business Media Dordrecht 2013 Abstract The present study investigates the energy, environment and growth nexus for a panel of South Asian countries including Bangladesh, India, Pakistan, Sri Lanka and Nepal. The simultaneous analysis of real GDP, energy consumption and CO2 emissions is conducted for the period 1980–2010. Levin panel unit root test and Im test panel unit root both indicate that all the variables are I (1). In addition, Kao’s panel Cointegration test specifies a stable long-term relationship between all these variables. Empirical findings show that a 1 % increase in energy consumption increases output by 0.81 % in long run whereas for the same increase in CO2 emission output falls by 0.17 % in long run. Panel Granger causality tests report short-run causality running from energy consumption to CO2 emissions and from CO2 emissions to GDP. Keywords Energy Á Environment Á Economic Growth Á South Asia 1 Introduction Rising economic growth in South Asia is escalating the energy demand, and more energy inputs are required to cater this demand. This region witnesses a positive growth trend over the last three decades, from 1981 to 2010. It is interesting to note that most of the countries are following the same growth pattern indicating a strong impact of regional policies on growth. During the period of analysis, the highest average growth rate was observed in India that was 6.2 %, whereas Pakistan observed the second highest average growth rate that was 5 %. On the other hand; Sri Lanka, Bangladesh and Nepal witnessed 4.9, 4.8 and 4.6 % growth rates, respectively (please see Fig. 1 for details). There are serious concerns about rising demand for energy inputs and the volume of greenhouse gas (GHG) emissions (Zeshan 2013, Shahbaz and Dube 2012; Shahbaz et al. 2012). M. Zeshan (&) Á V. Ahmed Sustainable Development Policy Institute, Islamabad, Pakistan e-mail: zeshan@sdpi.org; muh.zeshan@gmail.com V. Ahmed e-mail: vaqar@sdpi.org 123
  4. 4. Author's personal copy M. Zeshan, V. Ahmed Correspondingly, the countries with higher usage of energy consumption are adding more CO2 emissions in the environment. The rising energy demand has created energy crisis and environmental degradation. On the one hand, energy resources are depleting quickly, whereas on the other hand, it is causing environmental degradation. Around the globe, these problems have forced the governments to closely monitor and supervise energy markets (ECSSR 2004). At this stage, universal environment friendly energy policies are essential because the rising CO2 emissions might bleak the future prospects of the sustainable development. South Asia requires such energy efficient measures that could ensure the minimum CO2 emissions. Ozturk (2010) argues that higher energy consumption increases CO2 emissions in the environment, however, the use of efficient production technology might reduce these emissions over time (Shahbaz et al. 2010; Chang 2010). Almost all the South Asian countries follow the same pattern for energy consumption but with the exception of Bangladesh. Nonetheless, sometimes it tends to follow the same pattern but with much variation. Throughout the period of analysis, average growth rate for the energy consumption in Bangladesh was the highest, 4.5 %. India and Pakistan had the second highest, 4.3 %, whereas Nepal and Sri Lanka observed 2.8 and 2.6 %, respectively (please see Fig. 2 for details). The analysis of a causal relationship between the energy consumption, CO2 emissions and economic growth provides important findings to policy makers. In empirical literature, the long-term and short-term causal relationships have much importance for energy assessment policies. The direction of causality suggests the relevant energy policies that Fig. 1 Economic growth in South Asia 1981–2010 Fig. 2 Energy consumption in South Asia 1981–2010 123
  5. 5. Author's personal copy Energy, environment and growth might be helpful for sustained economic growth (Payne 2010; Ozturk 2010, Squalli 2007). However, most of the empirical studies have focused on the developed countries (Hossain 2011; Apergis and Payne 2009a), and a scanty literature is available for developing countries (Huang et al. 2008). The prevailing gaps in literature focusing on regional analysis especially for South Asian have motivated us in examining the causal linkages among energy consumption, CO2 emissions and GDP in South Asia. The empirical literature follows a country by country analysis which is not robust because of less number of observations, on the other hand, the panel data provide a robust analysis (Arouri et al. 2012; Wang et al. 2011). Hence, the present study plans to investigate the cointegrating relationship and the causal links among the variables in a panel framework. The causality tests between economic growth, energy consumption and CO2 emissions would be performed in three steps. First it examines order of integration in variables and employs panel unit root tests offered by Levin et al. (2002) and Im et al. (2003). Second Kao’s (1999) panel cointegration test is used to find the long-term relationship between variables. Third it applies Panel Granger causality tests to determine the direction of causality and adjustment mechanism in the system. The rest of the study is as follows. Section II provides a literature review, and Section III presents data and an account of the econometric methodology. Section IV discusses the results, whereas Section V concludes the study and provides policy recommendations. 2 Literature review Over the last few decades, extensive efforts are directed to discover the impact of energy consumption and CO2 emissions on the economic growth. It works through two wellestablished directions of empirical literature. One of them discusses the relationship between CO2 emissions and economic growth discussed in the context of Environmental Kuznet curve (EKC) hypothesis. In this scenario, an initial rise in income causes environmental degradation. However, when income level reaches a specific point, people become more conscious about their environmental responsibilities and environmental degradation starts falling (Fodha and Zaghdoud 2010; Shahbaz et al. 2010). In contrast, Dinda (2004) argues that these findings are not universal because the direction of causality is not a like for each country. If CO2 emissions are causing economic growth, then CO2 emissions might be the result of the production process. On the other hand, the seminal work of Kraft and Kraft (1978) provides important insights into energy consumption and economic growth. It finds a unidirectional causal relationship between the energy consumption and economic growth; the direction of causality was from economic growth to energy consumption. This piece of work paved the way for voluminous literature on finding causal linkages between energy consumption and economic growth (Abosedra and Baghestani 1989; Bentzen and Engsted 1993). The literature on energy consumption and economic growth is extended under four different hypotheses that are based on direction of causality. First one is growth hypothesis which argues that energy consumption is imperative for economic development. Energy inputs facilitate production process and are complements to factors of production. An economy would be energy dependent if higher economic growth is obvious in response to rising energy consumption. To be more specific, it suggests unidirectional causality running from energy consumption to economic growth (Akarca and Long 1980). Second one is known as conservation hypothesis which specifies that a country should adopt conservation policy if higher energy consumption is unable to boost the economic 123
  6. 6. Author's personal copy M. Zeshan, V. Ahmed growth. In this case, direction of causality is from economic growth to energy consumption showing rising energy consumption owing to higher income level. For Taiwan, Cheng and Lai (1997) applied cointegration method to examine the interaction between economic growth and energy consumption. It took data for the period 1955–1993 and confirmed the conservation hypothesis. Using the same methodology, Wietze and Van Montfort (2007) worked for Turkey and ended with the same conclusion. Third one is neutrality hypothesis which asserts no causal relationship between energy consumption and economic growth. In this case, energy conservation policies would not be harmful for sustainable economic growth (Akarca and Long 1980). Finally, the fourth one is feedback hypothesis. It presumes the bidirectional causal relationship between energy consumption and economic growth, in this case both might be considered as complements. It implies that any change in energy policies might cause significant effect on economic growth and vice versa (Yang 2000; Paul and Bhattacharya 2004). The following table provides the brief literature summary which considers two criterion. First as most of the recent economic studies are working with panel data because it provide robust results as compared to time series data (Lee and Chang 2008; Apergis and Payne 2009b) that is why present study has focused mainly on panel data studies. However, some important time series studies are also reviewed. Second keeping in view the objectives of the present study, it analyzes the collective relationship between energy consumption, CO2 emissions and economic growth (see Table 1). 3 Methodology and data Levin panel unit root test operates under the null of a collective unit root in all the variables in panel against the collective stationary. It is as follows, Dxi;t ¼ ai þ di t þ #t þ qi xi;tÀ1 þ ei;t ; i ¼ 1; 2; 3; . . .; N; t ¼ 1; 2; 3; . . .; T ð1Þ It captures cross-sectional fixed affects with the help of a, whereas unit-specific time trend is denoted with #. As the equation carries lagged dependent variable which presumes slope homogeneity for all the units, it becomes important to capture unit-specific fixed effects. Null of this test is specifies qi = 0 (for each i) against the alternative of qi = q0. It develops a correction factor to produce standard distribution of pooled OLS estimates. The assumption of collective stationarity of all variables is the major shortcoming of this test. Having all the variables integrated or stationary is not a necessary condition in econometrics, a fraction of variables might be integrated, while other might be stationary. Im panel unit root test overcomes this problem and it discusses heterogeneity in qi under different hypothesis. For Eq. (1), its works under the following null and alternative hypotheses; HA : qi 0; H0 : qi ¼ 08i i ¼ 1; 2; . . .; N1; i ¼ N1 þ 1; N1 þ 2; . . .; N: In this scenario, null assumes that all the variables are non-stationary against the alternative that a part of variables are stationary. If each variable in hand is non-stationary, but there exits such a linear combination between the variables that make the system stationary then the set of variables must be cointegrated. Using modified Dickey-Fuller (DF) type and Augmented Dickey-Fuller (ADF) type tests, it employs Kao’s (1999) panel cointegration test for finding a unique cointegrating vector. Given that all the variables are I (1), this test is investigates long-run relationship between the variables. It is as follows, 123
  7. 7. Authors Huang et al. (2008) Apergis and Payne (2009a) Apergis and Payne (2010) Al-Mulali (2011) Hossain (2011) Niu et al. (2011) Wang et al. (2011) Arouri et al. (2012) 2 3 4 5 6 7 8 9 Soytas et al. (2007) Ang (2007) Soytas and Sari (2009) 11 10 Section II Time series studies Coondoo and Dinda (2002) 1 Section I Panel studies S. No. 12 1960–2000 960–2004 1960–2000 1981–2005 1995–2007 1971–2005 1971–2007 1980–2009 1992–2004 1971–2004 1972–2002 1960–1990 Time period Granger causality test Granger causality test Cointegration, VECM, Granger causality test Bootstrap Panel Cointegration Panel Cointegration, Panel VECM Panel Granger causality test Panel cointegration Granger causality test Cointegration test, Granger causality Panel VECM Panel Cointegration, VECM, Granger causality test Panel GMM, Panel VAR model Panel Granger causality test Methodology Table 1 Literature review for energy, environment and growth nexus Turkey United States France MENA countries 28 provinces in China Asia–Pacific countries Newly industrialized countries MENA countries Panel of common wealth independent states Central America Panel of 82 countries, Low income group Middle-income group High-income group Panel North America, Western Europe and Eastern Europe Countries Panel of Central American, South American, Japan and Oceania Panel of Asian and African countries Countries CO2 ? E Y = CO2 E ? CO2 Y ? E, CO2 E?Y E ? CO2 CO2 ? E GDP ? E E ? CO2 Y ? CO2, E E, CO2$Y E ? Y, CO2 E$Y Short-run: E ? Y, CO2 Long-run: E$Y, CO2 E = CO2 Y?C Y?E CO2 ? Y Y ? CO2 CO2$Y Results Author's personal copy Energy, environment and growth 123
  8. 8. Authors Zhang and Cheng (2009) Chang (2010) Fodha and Zaghdoud (2010) Shahbaz et al. (2010) Shahbaz et al. (2012) S. No. 13 14 15 16 17 Table 1 continued 123 1971–2009 1971–2009 1961–2004 1981–2006 1960–2007 Time period Cointegration, granger causality Granger causality test Cointegration, causality test Granger causality tests VECM, Granger causality Test Methodology Pakistan Tunisia China China Countries Y ? CO2 E ? CO2 Y ? CO2 E ? CO2 Y ? CO2 Y ? E, CO2 Y?E E ? CO2 Results Author's personal copy M. Zeshan, V. Ahmed
  9. 9. Author's personal copy Energy, environment and growth yit ¼ ai þ xit b þ uit ð2Þ where ai indicates country-specific constant term, b is slope of parameter, uit specifies stationary error term, yit and xit both are unit root processes such that I (1). Both the DF type test and ADF type test can be conducted in the following from: ^ ^ uit ¼ q uitÀ1 þ vit ð3Þ and uit ¼ q uitÀ1 þ ^ ^ p X u D uitÀ1 þ vit ^ ð4Þ j¼1 ^ where residuals uit can be retained from Eq. (2); null and alternative hypotheses can be specified as; H0 : q ¼ 1; HA : q1. Kao (1999) suggested different DF tests which are based on the assumption of exogeneity of regressor. It also suggested its extended version similar to ADF type test. All these tests work with nuisance parameters of long-run conditional variance X. Asymptotic distribution of these tests converges to standard normal distribution as N ? ? and T ? ?. After specifying the long-term relationship between the variables, present study aspires to investigate the direction of causality between the variables. If two integrated variables are cointegrated, dynamic error correction mechanism can be utilized to discover the direction of causality. Technically speaking, it is specified in the form of traditional vector autoregression (VAR) framework augmented with one time period lagged error term recovered from cointegrated vector. It is as follows, X X h DGDPi tÀp þ h DECi tÀp þ DGDPit ¼ c1i þ p 11 ip p 12 ip X ð5Þ Â h DCO2i tÀp þ l1i ECTi tÀ1 þ e1t p 13 ip X X DECit ¼ c2i þ h21 ip DGDPi tÀp þ h DECi tÀp þ p p 22 ip X ð6Þ Â h DCO2i tÀp þ l2i ECTi tÀ1 þ e2t p 23 ip X X DCO2it ¼ c3i þ h DGDPi tÀp þ h DECi tÀp þ p 31 ip p 32 ip X ð7Þ Â h33 ip DCO2i tÀp þ l3i ECTi tÀ1 þ e3t p where D is first difference operator, ECT is error correction term and p specifies lag length. ECTit is the estimated residual derived from long run Eq. (2), lit shows the speed of convergence parameter for each variable in the system. To measure granger causality, it takes the help of F-test with a collective null that all the coefficients of another variable are zero against the alternative of at least one of the coefficients in nonzero one by one for each variable. A stable system requires at least one significant coefficient for all the error correction terms in the system. It measures the speed of convergence if there is some exogenous shock in the system. The present study uses annual panel data that cover the period 1980–2010. The panel of South Asian countries comprises Bangladesh, India, Pakistan, Sri Lanka and Nepal. Following Al-mulali (2011) and Chang (2010), it uses three variables approach including GDP (real GDP, constant 2005 international $), EC (energy consumption, constant 2005 kt of oil equivalent) and CO2 (CO2 Emissions, kg per 2005 PPP $ of GDP). All the variables 123
  10. 10. Author's personal copy M. Zeshan, V. Ahmed Table 2 Results of panel unit root tests Name of variable Levin and Lin test (see foot note 1) Im–Pesaran–Shin test Level Level Unadjusted t-statistic Adjusted t-statistic First difference w-t-bar statistic GDP -0.90 1.24 3.05 -3.28*** EC -3.77 1.15 1.26 -1.44* CO2 -3.23 0.88 2.27 -3.51*** *** and * indicate 1 and 10 % level of significance are transformed in natural logarithm. Our data source is World Development Indicators (WDI). 4 Results Standard econometric techniques require the stationary data for empirical analysis. If a variable is non-stationary, first difference makes it stationary, but this procedure wipes out long-run information in the data. Kao’s (1999) panel cointegration technique preserves the long-run information in data and provides robust results. Levin and Im both tests indicate that all the three variables in this regression are integrated at levels (see Table 2 below). Furthermore, first difference of all the three variables makes them stationary specifying that all these series are I (1).1 Kao’s (1999) panel cointegration test portrays a unique cointegrating relationship between the variables. As all the variables are in natural logarithms, so estimated coefficients represent elasticities. Long-run energy consumption elasticity of income is 0.81 indicating that a 1 % increase in energy consumption will bring 0.81 percent increase in GDP in long run (See Table 3 below). It signifies that higher energy consumption might contribute to economic growth significantly in emerging economies. On the other hand, higher CO2 emissions are also affecting economic growth significantly. A 1 % increase in CO2 emission reduces the GDP growth by 0.17 % in the long run. It indicates that CO2 emissions are much more detrimental for the South Asia because of its deteriorating implications. There is a need for regional policy making to address this issue of rising CO2 emission. VECM tests unearth the direction of short-term and long-term causality in the system. Results illustrate that short-term causality runs from energy consumption to CO2 emissions specifying that higher energy consumption results in more CO2 emissions, this fact is also consistent with the Fig. 1. On the other hand, the short-term causality is running from CO2 emissions to GDP indicating that these emissions are detrimental for the sustained economic development in the short run. The absence of any causal relationship between energy consumption and economic growth assures the presence of neutrality hypothesis in South Asia. Zeshan (2013) argues that if energy does not granger cause economic growth, it implies that energy is operating at sub-optimal level. In such a situation, conservation policies can bring the society back to the 1 As Levin panel unit root test requires strongly balanced panel data so it is unable to operate with first difference. 123
  11. 11. Author's personal copy Energy, environment and growth Table 3 Results of Kao’s panel cointegration test ADF t-statistics p value -3.75** 0.03 Long-run coefficients: (GDP is dependent variable) EC -0.17*** Intercept *** and ** indicate 1 and 5 % significance level, respectively 0.81*** CO2 0.33 Table 4 Results of causality tests Dependent variable Short-run causality DGDP DEC Long-run causality DCO2 DGDP – 1.15 2.71* -0.55 DEC 0.32 – 1.18 2.14** DCO2 1.96 6.37** – 2.14** ** and * indicate 5 and 10 % significance level, respectively optimal path. It implies that South Asia should adopt the conservation policies which would also reduce the CO2 emissions in environment without impeding the economic growth. Finally, the coefficients of error correction terms associated with the variables DEC and DCO2 portray that the system is convergent in long run. The long-run causality indicates that all the short-term disturbances in the system are corrected by adjusting the energy consumption and CO2 emissions. However, GDP is unable to response in short run and one possible factor might be inertia in GDP (please see last column of Table 4 for details). 5 Conclusion Increasing energy demand is causing not only the energy crisis but is also depleting the energy resources. Higher energy consumption escalates the proportion of CO2 emissions in environment which causes pollution. Over the globe, governments are closely monitoring this CO2 emission and are trying to supervise energy markets, same is the situation in South Asia. In the policy making process, causal linkages between the macro-social indicators are very important. The information about long-run and short-run causality between energy consumption, CO2 emission and economic growth is much helpful in devising energy policies. For this purpose, the present study has focused on a panel of South Asian countries that include Bangladesh, India, Pakistan, Sri Lanka and Nepal. It employs real GDP, energy consumption CO2 emissions for the period of 1980–2010. Both Levin and Im panel unit root tests specify that all the variables are I (1). In this situation, the use of panel cointegration would be beneficial because it preserves the longrun information in data. Kao’s panel cointegration test finds a stable long-run relationship between the variables. It illustrates that CO2 emissions are affecting South Asia significantly and a 1 % increase in carbon emission might reduce GDP growth by 0.17 % in the long run. However, energy consumption positively affects the economic growth and a 1 % increase in energy consumption escalated the economic growth by 0.81 % in the long run. 123
  12. 12. Author's personal copy M. Zeshan, V. Ahmed Panel Granger causality tests report short-run causality running from energy consumption to CO2 emissions which shows that higher energy consumption results in more CO2 emissions in South Asia. Furthermore, it indicates that casualty is running from CO2 emissions to GDP indicating that CO2 emissions are detrimental to economic growth. Moreover, the absence of any causal relationship between the energy consumption and economic growth assures the evidence of neutrality hypothesis. Error correction coefficients portray that the system is convergent in long run and energy consumption and CO2 emissions would adjust them to rectify any short-run disturbance in the system. 6 Policy implications • The CO2 emissions are adversely affecting the economic growth, and there is a need to invest in environment friendly technologies. • The South Asian countries should set regional environment protection targets to overcome the increasing pollution in the region. • The South Asian countries should meet at least once a year to discuss the devastating impact of rising CO2 emissions in the region and also to devise strategies to cope with these environmental challenges. • The absence of any causal relationship between energy consumption and economic growth assures the presence of neutrality hypothesis. The adoption of conservation policies might reduce CO2 emission without impeding the economic growth. • The South Asian countries use obsolete energy production technologies that are less economic and are impeding the economic growth. It should gradually move to the environment friendly technologies which are more efficient. • The idea of regional energy market and open regional trade between the South Asian countries would result in economies of scale and also more secure energy supplies. • This regional interdependency will also reduce the hostile tendency of conflict which is impeding the regional economic growth. References Abosedra, S., & Baghestani, H. (1989). New evidence on the causal relationship between United States energy consumption and Gross National Product. Journal of Energy and Development, 14, 285–392. Akarca, A. T., & Long, T. V. (1980). On the relationship between energy and GNP: a reexamination. Journal of Energy and Development, 5, 326–331. Al-Mulali, U. (2011). Oil Consumption, CO Emission and Economic Growth in MENA Countries. Energy, 36(10), 6165–6171. Ang, J. B. (2007). CO2 emissions, energy consumption, and output in France. Energy Policy, 35(10), 4772–4778. Apergis, N., & Payne, J. E. (2009a). CO2 emissions, energy usage and output in Central America. Energy Policy, 37(8), 3282–3286. Apergis, N., & Payne, J. E. (2009b). Energy consumption and economic growth in Central America: evidence from a panel cointegration and error correction model. Energy Economics, 31, 211–216. Apergis, N., & Payne, J. E. (2010). The emissions, energy consumption, and growth nexus: Evidence from the commonwealth of independent states. Energy Policy, 38(1), 650–655. Arouri, M.H., Ben Youssef, A., M’Henni, H., & Rault, C. (2012). Energy consumption, economic growth and CO2 emissions in Middle East and North African Countries. CESifo Group Munich, Working Paper Series, 3726. Bentzen, J., & Engsted, T. (1993). Short- and long-run elasticities in energy demand : a Cointegration approach. Energy Economics, 15, 9–16. 123
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