UNIVERSITY OF ECONOMICS INSTITUTE OF SOCIAL STUDIES HO CHI MINH CITY THE HAGUE VIETNAM THE NETHERLANDS VIETNAM - NETHERLANDS PROGRAMME FOR M.A IN DEVELOPMENT ECONOMICS The impact of foreign direct investment and economic growth on CO2 emissions: Empirical study in ASIA A thesis submitted in partial fulfilment of the requirements for the degree of MASTER OF ARTS IN DEVELOPMENT ECONOMICS By DO DANG NGOC GIAU Academic Supervisor: Dr PHAM KHANH NAM HO CHI MINH CITY, NOVEMBER 2015 DECLARATION ―I certify that the substance of this thesis has not already been submitted for any degree and have not been currently submitted for any other degree I certify that to the best of my knowledge and help received in preparing this thesis and all sources used have been acknowledged in this thesis.‖ HCMC, November 2015 Signature DO DANG NGOC GIAU ACKNOWLEDGEMENTS This process of writing a thesis is a collaborative experience involving the support and helps from many people I want to express my gratitude to those who give me the tremendous support to complete this thesis I greatly express my special thanks to my supervisor Dr Pham Khanh Nam for all his academic recommendations through finishing this process I would like to express my deepest gratitude to Dr Truong Dang Thuy for his suggestion which help me handle some problems in this thesis I wish to express my heartfelt gratitude to Dr Vo Hong Duc who gives me some logical ways in order to present confidently in this thesis During my time at VNP, I receive a great encouragement and help from some friends, so I am grateful to Mr.Vo Van Hung, Mr.Trinh Hoang Viet and Ms Vo Tan Thanh Diep, for motivating me to overcome all difficulties in the process of thesis Especially, I greatly thanks to Mr Pham Ngoc Thach and Mr Nguyen Son Kien for their help and sharing of their econometric knowledge ABSTRACT This paper is to investigate the effects of foreign direct investment (FDI) inflows and economic growth on CO2 emissions in Asian countries over period from 1991 to 2013 Under the complexity between these variables, this paper applied panel analysis method and structural equation model (SEM) to explore the influence of FDI, economic growth on CO2 emissions The result indicates that FDI inflows contribute to reduce CO2 emission (improve environmental quality) while economic growth make CO2 emissions level increase Moreover, the result shows the two-way linkages occur between CO2 emissions and FDI inflows, CO2 emissions and economic growth In addition, the unidirectional nexus exists from economic growth to FDI inflows Keywords: Foreign direct investment; economic growth; CO2 emissions; SEM; Asian countries ABBREVIATIONS GDP: Gross Domestic Product FDI: Foreign Direct Investment CO2: Carbon Dioxide SEM: Structural Equation Modeling FEM: Fixed Effects Model REM: Random Effects Model OLS: Ordinary Least Squares PHH: Pollution Haven Hypothesis EKC: Environment Kuznets Curve TABLE OF CONTENTS CHAPTER INTRODUCTION 1.1 Problem statement 1.2 Research Objectives 10 1.3 Research Questions 10 1.4 Research Scope and Methodology 10 1.5 Thesis Structure 11 CHAPTER LITERATURE REVIEW 12 2.1 Pollution Haven Hypothesis 12 2.2 Pollution Halos Hypothesis 14 2.3 Environmental Kuznets Curve Hypothesis (Theory of economic growth – environmental quality) 15 2.4 Empirical studies related to Pollution Haven Hypothesis 16 2.5 Empirical studies related to Pollution Halos Hypothesis 18 2.6 Empirical studies on the impact of FDI, economic growth on CO2 emissions 19 2.7 Empirical studies on the three-way linkages between FDI-economic growth-CO2 emissions 22 CHAPTER RESEARCH METHODOLOGY 25 3.1 Analytical framework 25 3.2 Model specification 27 3.3 Data and Defining Variables 32 3.3.1 Data 32 3.3.2 Defining Variables 34 3.4 Econometric methodology 37 3.4.1 Panel analysis 37 3.4.2 Structural equation modeling 43 CHAPTER EMPIRICAL RESULT 46 4.1 Overview about CO2 emissions, economic growth and FDI in Asia 46 4.2 Descriptive statistics 48 4.3 Regression diagnostic 49 4.4 Regression results 51 4.4.1 Regression result from panel method 51 4.4.2 Regression result from structural equation model 53 CHAPTER CONCLUSIONS AND POLICY IMPLICATIONS 59 5.1 Conclusion 59 5.2 Policy implications 60 CHAPTER INTRODUCTION 1.1 Problem statement In recent years, climate change and environmental degradation are the major concerns toward many countries all over the world, especially in ASIA These problems cause many difficulties in poverty reduction and economic development (World Bank, 2015) Moreover, human health is threatened as well as cost for health-care sector is increased by environmental degradation Neria (2014) suggested that approximately million people worldwide die every year by environmental pollution Many researchers found that one of major factors, which causes the climate change and environmental degradation is carbon dioxide (CO2 emissions) (Pittock, 2003; Solomon et al., 2007) They has pointed out that the surge of CO2 emissions level pushes greenhouse gases in atmosphere and leads to climate change threats to socio-economic systems As a matter of fact, environmental degradation is caused by human activities such as industrialization, burning of fossils fuel and deforestation Human activities are operated to develop economy and improve life quality Under enormous pressure of sustainable economic development goal, many countries increase extraction, production and especially industrialization Consequently, these activities cause high pollution level It goes to show that economic growth is one of the main reasons of environmental degradation (Dell et al 2008) The effects of economic growth on environmental quality (CO2 emissions) are analyzed by many previous studies The link of emissions and economic growth is closely related to the context of Environment Kuznets Curve (EKC) hypothesis The EKC theory suggests that the emission level increases with a rising in per capita growth of GDP, and it declines after reaching at ―turning point‖ (sustainable income level) From above discussions, this thesis will emphasize on analyzing the impact of economic growth on CO2 emissions Furthermore, the impacts of Foreign Direct Investments (FDI) on environmental quality are discussed by many researches The study of Smarzynska (2001) suggested that FDI would be considered as main determinant of environmental quality Even though FDI contributes to promote economic growth, it reduces the environmental quality According to Pollution Haven Hypothesis, FDI leads to the decline in environmental quality since most of polluting industries from developed countries tend to move to developing countries in order to avoid abatement cost from stringent environmental legislation Thus, pollution may increase together with the rising in FDI at recipient countries On the contrary, Pollution Halos Hypothesis claims that FDI may improve environmental quality in host countries via transferring superior technology and ―green‖ input products Moreover, recipient countries obtain more chances to learn the skills of environmental management system from foreign countries In both points of view, there are two possible impacts of FDI on environmental quality This thesis will examine the impact of FDI on CO2 emission base on two theories In 2014, Asia was one of regions which received the highest amount of FDI in comparison with the rest of the world, accounting for 30 percent global FDI inflows (UNCTAD, World Investment Report 2014) More importantly, FDI is considered as vital resource of economic growth toward Asian countries The increasing of FDI into Asia leads to promote economic growth in many Asian countries In addition, environmental degradation is one of the main concerns in many ASIAN countries According to the statistic of World Health Organization in 2013, Asia has the highest number of polluted cities As such, this pollution causes many damages to human health Therefore, pollution becomes enormous pressure toward Asian countries Until now, there are many studies of the relationship between environmental quality, economic growth and FDI The empirical results of these studies are ambiguous Therefore, this thesis attempts to answer the question whether FDI and economic growth have influence on CO2 emissions for Asian countries The finding from this thesis will provide evidence support the current literature related to the impact of FDI, economic growth on CO2 emissions Moreover, this study gives several suggestions for policy maker in order to achieve the goal of reducing CO2 emissions as well as improving environmental quality in Asian countries 1.2 Research Objectives This thesis is to understand the impact of foreign direct investments (FDI) on environmental quality in the context of Asian countries, based on argument of Pollution Haven Hypothesis and Pollution Halos Hypothesis In addition, this thesis attempts to investigate the relationship between economic growth and environment quality The results would provide research evidences on the general relationship between FDI, economic growth and environmental quality This knowledge would be a contribution to the literature on the linkages between the economy and environment 1.3 Research Questions In order to achieve the research objectives, this thesis attempt to the answer these following questions:  Does foreign direct investment lead to increase CO2 emissions in ASIA?  Does economic growth cause an increase in CO2 emission in ASIA? 1.4 Research Scope and Methodology This thesis investigates the influence of FDI, economic growth and other determinants (trade openness, level of democracy and scale of economic activity) on CO2 emissions by using Asian countries sample The data is collected from 1991 to 2013 due to its availability Since the possibility of endogeneity between CO2 emissions, economic growth and FDI (based on suggestion from previous studies that will present in empirical studies), this thesis applies Structural Equation Model (SEM) to estimate the simultaneous equation model which presents the effects of economic growth and FDI on CO2 emissions 10 0.19%, it implies that a 1% increase in FDI net inflows decrease level CO2 emissions by 0.19% for ASIA It goes to show that FDI contributes to reduce the CO2 emissions volume and improves environment quality in ASIA In addition, it seems to be that FDI flows is invested into electricity generation, tourism, education or real estate in ASIAN countries which release lowly pollution level On the other hands, FDI may bring high technology and ―green‖ input that make reduce CO2 emissions in Asian countries According to a report of United Nations Conference on Trade and Development in 2013, total capital of the foreign direct investment which was invested into ASIA increases and focuses on trade, service or real estate in recent years In addition, East Asia, Southeast Asia and South Asia receive the most FDI Moreover, this result advocates the suggestion of Zarsky (1999) which FDI is a vehicle to diffuse the ―best practice‖ This may reflect the fact that the clean technology, inputs for production with lower pollution and environmentally-friendly is transferred into recipient countries via FDI inflows In addition, the estimation result gives strong evidence that FDI contribute to increase the environmental demand and decrease environmental degradation Mabey and McNally (1999) also found the same result Obviously, FDI contributes to increase income, thus the demand environmental quality will be increase According EKC hypothesis, the environmental degradation tends to decrease when income rise peach at stable point With negative relationship between FDI and CO2 emissions, the results are also consistent with Pollution Halos Hypothesis and a part of Environment Kuznets Curve indirectly In sum of, FDI does not only harm to environment quality but also get involve in increase income for recipient countries in ASIA Regarding the impact of economic growth in environmental quality, the result has found that coefficient of GDP growth is positive and statistically significance at 1% This result finds a positive impact of GDP growth on CO2 emissions with the coefficient for GDP growth is 1.402 This implies that a 1% increase in economic growth result in a 1.402% increasing CO2 emissions for ASIAN countries According to Environment Kuznets Curve, an increasing in income is associated with increasing of CO2 emissions 55 This result is a part of Kuznets Curve present This finding is similar to the other studies report by Farhani and Shahbaz (2013), Bernauer and Koubi (2009) This result may reflect the fact that a rising in GDP growth indicates the increase of production, energy consumption and extraction As a consequence, number of CO2 emissions goes up As regards to Polity, according to the estimation result, the regression coefficient for Polity is negative and strongly significant at 1% As presented in the definition of variable, Polity is as a proxy for level of democracy Thus, the result indicates that high level of democracy may cause a decrease in CO2 emissions This reflects policy makers or policy regimes are operating efficiently and may help to control level of CO2emissions in Asian countries The result is consistent with the conclusion of Li and Reuveny(2006) that provided evidence support for argument that democracy may reduce environmental degradation Congelton (1992) holds the view that environmental regulation in democracy countries is better than in non-democracy countries Obviously, level of emissions and pollution are reduced by controlling of stricter environment regulation in democracy regime The result has proved for Congelton’s recommendation This may be confirmed that Polity variable contributes to reduce number of CO2 in ASIA From the table the paper may verify that trade openness has positive impact on CO2 emissions at 5% level The result illustrates an increase in trade leads to increase CO2 emissions in ASIAN countries Perhaps, trade in ASIAN countries is a catalyst in transfering pollution goods among countries In other words, benefit and pressure competition of market trade are factors which stimulate importing the products and technology that are not friendly to the environment Cole (2004) also found the same result that increase of CO2 emissions is result in growth of trade In addition, Activity variable has significant effects on CO2 emission with the confidence is approximately (-) 0.34 This result implies the increase of scale of economic activity may help to reduce CO2 emissions in Asia Although the analysis aims to investigate the environmental consequences of FDI, the bidirectional relationship between FDI, economic growth and CO2 emissions are also 56 presented through the Structural equation model This result comes from equation and in table The estimate result report the bidirectional casual between FDI-CO2 emissions and GDP-CO2 emissions Moreover, the unidirectional causal link from GDP to FDI is also indicated To be more specific, in the equation the result interprets strongly evidence about the feedback effects of CO2 on FDI There is a positive effect of CO2 emissions on FDI This result implies FDI inflows will increase if CO2 emissions increase It seems to be that most of countries in ASIA are developing or industrial country, and therefore volume of CO2 is high According to Pollution Haven Hypothesis, this is signal of low environmental regulation and then foreign firm of FDI including both of ―dirty‖ and ―clean‖ firms will be attracted into Asian countries In the abroad scale, CO2 emissions causes not only affect FDI but also holding back the economic growth In a little more detail, FDI have a part in create income and develop economic If FDI is brake by rising of pollution, economic growth will be affected to a greater or less degree In this case, the result give a strongly evidence for the negative effects of CO2 emissions with a significantly statistic at 1% level The coefficient of CO2 mission in equation indicates that economic growth decreases 0.289% if CO2 emissions increase 1% The estimate result is consistent with the finding of Omri, Nguyen and Rault (2014) Regarding the relationship between FDI and GDP, the undirectional from GDP to FDI is statistic significant at 1% level This result indicated that a 1% increase of GDP helps to increase 0.73% in FDI for Asian countries Unfortunately, the feedback effect of FDI on GDP is insignificant in this analysis It is probably to say that economic growth help to remain the FDI attraction toward ASIAN countries In the fact that, higher level of economic growth is usually associated with a rise in the profits of corporations, this is a good development potential to make the belief for foreign investor Golber (1989) also hold the same view, it is not surprising that a high rate of growth of GDP is thought to be an indicator of market opportunity or a good development potential in the future In 57 addition, the Structural equation model indicates significantly statistic of capital stock at 1% of level toward impact on GDP except for FDI Trade has positive effects on FDI and significant at 1% level 58 CHAPTER CONCLUSIONS AND POLICY IMPLICATIONS 5.1 Conclusion This thesis attempts to examine the effects of economic growth, FDI inflows on CO2 emissions in Asian countries over period from 1991 to 2013 Previous empirical findings had indicated three –way linkages between CO2 emissions, economic growth and FDI Therefore, the common estimation methods are no longer appreciated This study use the technique of simultaneous equation modeling developed from CobbDouglas production function to investigate these complex linkages The finding of this study indicated that FDI inflows reduce CO2 emissions in Asian countries; it implies that environmental quality might be improved by the increasing volume of FDI inflows In addition, the result finds a bidirectional causal relationship between two series This means FDI inflows makes CO2 emissions decline, and however, high level of CO2 emissions lead to a rising in FDI inflows The empirical result also provides evidence that economic growth has positive effects on CO2 emissions and vice versa This implies that high level of economic growth lead to high level of CO2 emissions Therefore, a decline in environmental quality (or an increase in CO2 emissions level) cause many problems which affect human health as well as production productivity, and thereby it may decrease economic growth in the long run Moreover, this study also suggests that there is unidirectional causal relationship from economic growth to FDI inflows without feedback Hence, it may reflect the fact that high level of economic growth plays a vital factor to attract FDI into nation The effects of economic growth and FDI on CO2 emissions are present in figure1 59 Figure Relationship among CO2, Economic Growth and FDI CO2 – – + + + Growth FDI Source: Author’s summary 5.2 Policy implications According to empirical result, this study has some implications for policymaker First, since the reducing of CO2 emissions by an increase in FDI inflows, policymaker in Asian countries should attract more FDI inflows but it is necessary to consider and choose carefully the source of FDI so that avoid the pollution industries For instance, recipient countries could choose the suitable technology and relevant ―green‖ energy to be used in production from FDI Moreover, design policy as long as minimize pollution level from foreign firms of FDI It may decide the standard for pollution emissions, in particularly CO2 emissions Second, economic growth is reported as determinant which cause CO2 emissions increase; otherwise, increase CO2 emission also prevent the economic growth However, Omri (2013) suggested that ―the decline in economic growth may put strong pressure on the public finances and employment‖ Therefore, policymaker should encourage foreign enterprise in using pure energy (solar, wind…) or applying superior technology to reduce polluted environment (including CO2 emissions) and promote economic simultaneously 60 5.3 Limitations and recommendations for future researches There are several limitations in this study which offer possibilities for further researches  This thesis cannot access to the data proxy for environmental regulation such as environmental tax, environmental abatement cost in each countries Hence, this thesis use Polity variable to measure for stringent of regulation (QuanLi, 2006)  Asian countries include 53 countries but this thesis just estimate in 35 countries as the insufficiency data for all year in several countries Therefore, this thesis get some trouble when divide two groups of countries (developing and developed countries) in order to consider the possibly different effects of economic growth and FDI on CO2 emissions  Kuznet Curve 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Retrieved http://www.yomiuri.co.jp/adv/wol/dy/opinion/international_090914.html 69 from ... between CO2 emissions and FDI inflows, CO2 emissions and economic growth In addition, the unidirectional nexus exists from economic growth to FDI inflows Keywords: Foreign direct investment; economic. .. about the relationship between the CO2 emissions and economic growth, indicating that arise of CO2 emissions causes economic growth declines and without feedback effects from economic growth on CO2. .. relationship This mean that the relationship between three couple of CO2 emissions economic growth, CO2 emissions FDI and economic growth – FDI working in both directions, including unidirectional