International Research Journal of Finance and Economics ISSN 1450-2887 Issue 67 (2011) EuroJournals Publishing, Inc. 2011 http://www.eurojournals.com/finance.

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Carbon Dioxide Emissions and Economic Growth: An Econometric Analysis

Karnjana Sanglimsuwan Economics Department, Bangkok University, Bangkok, Thailand E-mail: karnjana.s@bu.ac.th Tel: +668-3-9774443; Fax: +66-2-350-3690 Abstract This study examines the relationship between CO2 emission and gross domestic product per capita whether an inverted-U relationship exists between them. Since most of previous literatures have used cross sectional data, this study uses panel data with fixed effects specification which allows this study to control unobserved country heterogeneity and the associated omitted variable bias. Empirical results using data for 63 countries in 1990, 1995, 2000 suggest that the inverted-U shaped relationship appears only in the short run. Once per capita GDP reaches at $26,448.76 and $25,735.91 in the basic model and in the extended model respectively, however, the relationship between per capita GDP and CO2 emission becomes positive again. Against EKC hypothesis, clean environment cannot be achieved only by promoting economic growth. Hence, policy makers should integrate environmental protection into economic development policies

Keywords: Environmental Quality; Economic Growth; CO2 Emissions; Fixed Effects Specification; Enrivornmental Kuznets Curve

1. Introduction
This study focuses on the relationships between economic growth and environmental variables in cross-sections of countries with widely varied levels of development. In recent years, there has been increased concern in environmental degradation, both in term of quality and quantity. Deforestation, soil degradation, and loss of biological diversity have become part of everyday issues. Moreover, increasing in both air and water pollution and global warming are fairly well known as the result of increased and uncontrolled human activities at different stages of economic development such as agriculture, industries, transportation, and energy generation. More specifically, CO2 emissions have recently been under spotlight since some scientists have suggested that global warming is caused by the emission of green houses gases. 72% of totally emitted green house gases are CO2, therefore, CO2 is the major cause of global warming. In fact, CO2 is emitted in a number of ways such as burning of oil, coal, gas, petrol including deforestation. CO2 emissions have been dramatically increased within the last 50 years and are still increasing each year (See Figure I).

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Figure 1: CO2 emissions world-wide by year

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Source: Carbon Dioxide Information Analysis Center, Environmental Sciences Division, Oak Ridge National Laboratory, Tennessee, United States.

As described by Environmental Kuznets Curve (EKC) hypothesis, the take-off stage of development and industrialization progress can lead to increased environmental damage due to greater use of natural resources, more emission of pollutants, the operation of less efficient and relatively dirty technologies, and disregard for the environmental consequences of growth. However, as economic growth continues, the heavy industries are shifted to knowledge-based and service industries which are cleaner (Shafik & Bandyopadhyaya, 1992). Moreover, at higher levels of development, there are increased environmental awareness and enforcement of environmental regulation that can lead to gradual decline of environmental degradation (Stern, Common and Barbier, 1996). Because of the shape of the graphical plot, the EKC relationship is sometimes referred to as an inverted-U relationship (see Figure 2)
Figure 2: Environmental Kuznets Curve Hypothesis

The Environmental Kuznets Curve : EKC

Per Capita GDP

The EKC is named after Simon Kuznets who discovered that income inequality first increases and then decreases with economic development. In the early 1990s, this concept was transferred to the income-pollution relationship and labeled as the EKC. There are numerous empirical studies support EKC hypothesis (Grossman & Krueger,1991; Shafik & Bandyopadhyay, 1992; Selden & Song ,1994).

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Besides the traditional inverted-U shape relationship, an N shape relationship, which indicates that pollution increases as a country develops, decreases once the threshold GDP is reached, and then begin increasing as national income continues to increase, has been found in some studies (Grossman & Krueger (1993); Shafik (1994); Grossman (1995), Torras and Boyce (1998); Galetotti, Manera, & Lanza (2009). However, there are some empirical studies that found no evidence of EKC (Cole, Rayner, & Bates, 1997; Horvath (1997); Koop & Tole (1999)) Although there are largely analyzed related to EKC study, the results are still inconsistent. Hence, this study tests whether there is EKC for CO2 emission. Moreover, most of the past EKC studies focus either within one country or a single year or one-one relationship which excludes other factors that affect environment situation such as government policy. To fill the gap, this study is designed to investigate the relationship between CO2 and GDP per capita with panel data. This study is compiled a panel dataset and carefully tested to identify the most appropriate econometric model, including fixed and random effects. Advantages of panel data over time series data or cross-section data is more degrees of freedom, less multicollinearity, and more variation in the data that results in more efficiency of the estimators (Baltagi, 2007). More specifically, fixed effects regression can control for all possible characteristics of the individuals in the study. In addition, government effectiveness index is used in this study to show whether environmental quality is affected by including political control variable. Section 2 of this study discusses about data and model specification. Results and discussion are given in Section 3 which is followed by a conclusion in the last Section.

2. Model Specification
The relationship between CO2 and economic growth is analyzed using panel data. Based on EKC hypothesis and literature, the empirical approach postulates that environmental degradation, Eit, is related to per capita income Xit , its squared term and its cubic term (if it is significant). In addition, unobserved factor control variable are represented in term of time specific () and country specific () effects while i = 1,., n (country) and t = 1,., T (years). The basic model is, therefore; (1) Eit = f (Xit,; , ) or E it = i + 1 x it + 2 x2it + 3 x3it + it (2) Next, additional explanatory variables such as other socioeconomic variable (Sit) are added in extended model. The extended model allows this study to determine what happens to the EKC after explanatory variables which might capture cross-country characteristics are added. The roles of other explanatory variables are also identified to see whether those variables have influence on environmental status. The extended model is, therefore; Eit = f (Xit, Sit,; , ) (3) or E it = i + 1 x it + 2 x2it + 3 x3it + Sit + it (4) The turning point income, where emissions or concentrations are at a maximum, is given by:
63 for equation (2) and (4) or T = - 1 / 2 2 T= 2 2 4 22 12 1 3 )

(6)

3. Data
The study sample consists of a total 63 countries for the period 1990, 1995, 2000.

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3.1. Carbon dioxide Emissions (CO2)

CO2 (kt per capita) is used as the measurement of environmental degradation in this study. CO2 emissions are defined as those stemming from the burning of fossil fuels and the manufacture of cement. They include carbon dioxide produced during consumption of solid, liquid, and gas fuels and gas flaring. Data source is from Carbon Dioxide Information Analysis Center, Environmental Sciences Division, Oak Ridge National Laboratory, Tennessee, USA.

3.2. Explanatory Variable 3.2.1. GDP per capita Since CO2 emissions is the results of economic growth at different level, GDP per capita, its quadratic term and its cubic term are specified for the EKC relationship. GDP per capita is the total annual output of a countrys economy in constant 2000 US. Dollar per capita which allow for the comparison of GDP across years without interference from the effects of inflation on prices. The data source is the World Development Indicator Database 2010. 3.2.2. Population Density Population can be a driving force behind the increase in emissions. Population density is defined by mid-year population divided by land area in square kilometers. The definition of population is all residents regardless of legal status or citizenship. Land area is a country's total area, excluding area under inland water bodies. The sources for estimates of land area and population data are the Food and Agriculture Organization (FAO) and World Bank, respectively. 3.2.3. Urban Population Density Urban population density can also influence the increase in emissions. Moore, Gould & Keary (2003) stated that urban growth is often associated with environmental degradation. Urban population density is defined by the midyear population of areas defined as percent of population that is in urban area in each country (% of total). The data source is the World Development Indicator Database 2010, which obtains this data from World Urbanization Prospects Division of the United Nations. Urban Population Density measures the degree of urbanization. 3.2.4. Government Effectiveness Index Government effectiveness can positively influence on environmental quality through higher performance on good policies, and effective implementation of policies. Government effectiveness Index is a measure of the quality of public service provision, the quality of the bureaucracy, the competence of civil servants, the independence of the civil service from political pressures, and the credibility of the government's commitment to policies. This is measured in units ranging from about 2.5 to 2.5, with higher values corresponding to better governance outcomes. The data source for this variable is from Kaufmann, Krayy & Mastruzzi (2007).

4. Econometric Models and Estimation

Following the above basic and extended model specifications, linear specification of all of the variable provides regression coefficient between CO2 per capita and explanatory variables, while the quadratic term and the cubic term of per capita GDP are tested to validate the EKC hypothesis. The coefficients of the independent variables are represented by s and the error term by it. The basic econometric model can be specified by: CO2 it = i + 1 GDP it + 2GDP2it + 3 GDP3i + it (7) The extended econometric model can be specified by: CO2 it = i + 1 GDP it + 2GDP2it + 3 GDP3i + 4 popdenitt + 5 urbanit + 5 govit + i (8) For both basic empirical model and extended empirical model, simple pooled regression, the fixed effects and the random effects specification are tested to estimate the coefficients. Hausmen test

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and LM test are applied in order to choose the most appropriate model. In this study, the fixed effects specification is the most preferred overall.

5. Results and Discussion

Descriptive statistics used in this study are given in Table 1.
Variable CO2 per capita (metric ton) GDP per capita ($1000) Population Density (person/sq.km) Urban Population (% of total) Government Effectiveness OObs 189 189 189 189 189 Mean 4.97 10.04 118.08 58.28 0.50 Std. Dev. 4.59 8.63 150.14 22.17 0.98 Min 0.03 0.29 2.22 6.30 -1.74 Max 20.01 36.08 1081.41 92.20 2.32

Table 2:

Results for EKC studies

Basic Model 0.7355** (0.1574) -0.0303** (0.0092) 0.0004** (0.0002) Extended Model 0.8028** (0.1890) -0.0336** (0.0102) 0.0005** (0.0002) 0.0050 (0.0055) 0.0420* (0.0211) -0.1988 (0.3605) 2.9483 (2.1538) 11.9322 10.08 (3,123)

Variables Per Capita GDP Per Capita GDP2 Per Capita GDP3 Population Density Urban Population Government Effectiveness Index Constant Turning Point (Max) F-statistics (df)

1.2924 0.6797 12.1366 10.08 (3, 123)

Standard Errors are in parenthesis ** significant at 0.01 level; * significant at 0.10 level

The results for EKC estimation reveal evidence for N-shaped EKC for CO2 and per capita GDP when both the basic and extended models are used. CO2 emissions increase as country with low per capita GDP grows richer. The estimated coefficient on the square term and cubic term of per capita GDP-squared are negative, and positive respectively. The estimated coefficients indicate that CO2 emissions increase as a country develops, decrease once the threshold GDP is reached, and then begin increasing as GDP continues to increase. The points at which an increase in per capita GDP affects decreased CO2 emissions are estimated to be $12,136 and $11,932 for the basic model and the extended model, respectively. The trough points are estimated to be $26,448.76 and $25,735.91 for the basic model and the extended model, respectively. An increase in per capita GDP after these trough points leads to an increase CO2 emission. In extended model, the level of urban population is seen to increase CO2 emissions with statistically significant. Population density and government effectiveness do not seem to be significant for increasing or decreasing CO2 emission. The relationship occurs mainly because higher population in urban area puts the pressure on air pollution and environment. CO2 emission is mainly caused by human activities such as deforestation and the burning of fossil fuels. From the empirical result, the EKC does not hold in the long run. The inverted-U shape curve relationship between per capita GDP and per capita CO2 would be only an initial stage of relationship. Above a certain income level, there would be a new turning point that leads to N-shape curve. This can imply that CO2 emissions would come back in higher income level. Hence, increasing in only GDP level itself cannot reduce CO2 emissions in the long run. The main policy implication from this

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empirical study is that policy maker should not draw the policy from the EKC hypothesis. The misdirected development policy based on the EKC hypothesis could have potentially irreversible impacts on the country. Good policy should enable a harmonization between economic growth and environmental quality. Besides the policy implication, this study contributes both framework and methodology that can be useful for further study in EKC hypothesis on other emissions.

Conclusion
This study investigates the existence of EKC for CO2 emissions and per capita GDP by analyzing panel data from 63 countries. Empirical results show that CO2 emission are increasing along with an increase in per capita GDP until per capita GDP reaches at $12,136 and $11,932 for the basic model and the extended model, respectively. After that, CO2 emissions are decreasing as per capita GDP increases until per capita GDP reaches $26,448.76 and $25,735.91 for the basic model and the extended model, respectively. Then, CO2 emissions begin increasing as per capita GDP continues to increase. The evidence suggests that EKC relationship between CO2 emission and per capita GDP does not exist in the long term. This result can be useful for policy makers. Policy makers should integrate emissions regulation with economic development policies.

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