Economic growth, energy consumption, financial development, international trade and CO2 emissions in Indonesia

TLDR: In this article, the authors examined the linkages among economic growth, energy consumption, financial development, trade openness and CO2 emissions over the period of 1975Q1-2011Q4 in the case of Indonesia.

Abstract: This study examines the linkages among economic growth, energy consumption, financial development, trade openness and CO2 emissions over the period of 1975Q1-2011Q4 in the case of Indonesia. The stationary analysis is performed by using Zivot-Andrews structural break unit root test and the ARDL bounds testing approach for a long run relationship between the series in the presence of structural breaks. The causal relation between the concerned variable is examined by the VECM Granger causality technique and robustness of causal analysis is tested by innovative accounting approach (IAA). Our results confirm that the variables are cointegrated; it means that the long run relationship exists in the presence of structural break stemming in the series. The empirical findings indicate that economic growth and energy consumption increases CO2 emissions, while financial development and trade openness compact it. The VECM causality analysis has shown the feedback hypothesis between energy consumption and CO2 emissions. Economic growth and CO2 emissions are also interrelated i.e. bidirectional causality. Financial development Granger causes CO2 emissions. The study opens up a new policy insights to control the environment from degradation by using energy efficient technologies. Financial development and trade openness can also play their role in improving the environmental quality.

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Munich Personal RePEc Archive
Economic Growth, Energy Consumption,
Financial Development, International
Trade and CO2 Emissions, in Indonesia
Muhammad, Shahbaz and Qazi Muhammad Adnan, Hye and
Aviral Kumar, Tiwari
COMSATS Institude of Information Technology, Lahore, Pakistan,
University of Malaya, Malaysia, ICFAI University Tripura, India
3 December 2013
Online at https://mpra.ub.uni-muenchen.de/43272/
MPRA Paper No. 43272, posted 17 Dec 2012 17:39 UTC

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Economic Growth, Energy Consumption, Financial Development, International Trade and
CO
2
Emissions, in Indonesia
Muhammad Shahbaz
Department of Management Sciences,
COMSATS Institute of Information Technology,
Lahore, Pakistan. Email:
shahbazmohd@live.com
www.ciitlahore.edu.pk, UAN: 0092-42-111-001-007,
Fax: 0092-42-99203100, Mobile: +92334-3664-657
Qazi Muhammad Adnan Hye
Economics Department,
Faculty of Economics and Administration,
University of Malaya, Malaysia
E-mail:
adnan.economist@yahoo.com
Aviral Kumar Tiwari*
Faculty of Applied Economics,
Faculty of Management, ICFAI University Tripura,
Kamalghat, Sadar, West Tripura, Pin-799210, India
E-mail:
aviral.eco@gmail.com, aviral.kr.tiwari@gamil.com
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Abstract: This study examines the linkages among economic growth, energy consumption,
financial development, trade openness and CO
2
emissions over the period of 1975Q
1
-2011Q
4
in
the case of Indonesia. The stationary analysis is performed by using Zivot-Andrews structural
break unit root test and the ARDL bounds testing approach for a long run relationship between
the series in the presence of structural breaks. The causal relation between the concerned variable
is examined by the VECM Granger causality technique and robustness of causal analysis is
tested by innovative accounting approach (IAA). Our results confirm that the variables are
cointegrated; it means that the long run relationship exists in the presence of structural break
stemming in the series. The empirical findings indicate that economic growth and energy
consumption increases CO
2
emissions, while financial development and trade openness compact
it. The VECM causality analysis has shown the feedback hypothesis between energy
consumption and CO
2
emissions. Economic growth and CO
2
emissions are also interrelated i.e.
bidirectional causality. Financial development Granger causes CO
2
emissions. The study opens
up a new policy insights to control the environment from degradation by using energy efficient
technologies. Financial development and trade openness can also play their role in improving the
environmental quality.
Keywords: Growth, Energy, Financial Development, CO
2
Emissions.
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1. Introduction
The international trend indicates that various countries have resisted in attaining economic
growth exclusive of parallel observing a boost in CO
2
emissions. On the other hand, there has
been rising apprehension over the technique of ‘low carbon and green growth’. Specifically, the
inquiry of whether it truly is feasible to reach constant economic growth not including growing
energy consumption or greenhouse gases has circled into a topic of particular consideration.
Developing and underdeveloped countries have disagreed that some constraints on carbon
energy would hinder economic expansion and recommended that industrial countries should
increase funds to alleviate global warming, which is extensively measured as a result of
emissions by industrial countries. This issue is moderately connected to post-Kyoto discussions
over climate change, and therefore, it is vital to observe the association between the environment
and economic growth by using empirical analysis tools.
In recent times, a few readings have investigated the causal association between energy
consumption, CO
2
emissions, and economic growth. Though, these empirical investigations have
shown mixed results, which calls for additional study to elucidate this association. Incidentally,
the current investigation gives an empirical analysis of this multivariate Ganger causality
affiliation by considering the case of Indonesia. Indonesia is the fourth largest populous country
on the earth. The main energy consumption in Indonesia increases by 50% in the period of 2000-
2010. The current study probes the association among economic growth, energy consumption,
financial development, trade openness and CO
2
emissions using the quarter frequency data of the
Indonesian economy over the period of 1975-2011. Due to our imperfect knowledge, this study
may be a comprehensive effort on this topic for the economy of Indonesia and it has fivefold
contribution to the energy literature by applying: (i) Zivot-Andrews [107] structural break unit

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root test; (ii), the ARDL bounds testing approach to cointegration for long run relationship
between the variables in the presence of structural breaks; (iii), OLS and ECM for long run and
short run impacts (iv) the VECM Granger causality approach for causal relationship and (v)
innovative accounting approach (IAA) to test the robustness of causality analysis.
Our empirical findings show that cointegration is found in the long run relationship among
the variables such as; economic growth, energy consumption, financial development, trade
openness and CO
2
emissions in case of Indonesia. A rise in energy consumption, economic
growth, financial development (trade openness) increase (condenses) CO
2
emissions. The
causality analysis reveals that the bidirectional causal relationship is found between energy
consumption and CO
2
emissions. Financial development Granger causes CO
2
emissions,
economic growth and trade openness. The feedback hypothesis are validated between trade
openness and CO
2
emissions and, same inference is drawn between economic growth and energy
consumption. Bidirectional causality is found between trade openness and energy consumption
while economic growth is cause of trade openness and same inference is for trade openness.
These results may provide new avenues for policy makers to design a comprehensive economic,
financial, trade and environmental policy to sustain economic growth in Indonesia.
2. Literature Review
The first strand of existing energy literature deals with a wide range of mixed result studies about
energy consumption and economic growth nexus. Now a days, energy-growth relation has been
empirically investigated extensively since the original study accomplished by Kraft and Kraft
[47] . The empirical findings of the existing energy literature are not unambiguous due to the
use of various econometric approaches such as; correlation analysis, simple regressions, bivariate

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causality, unit root tests, multivariate cointegration, panel cointegration, vector error correction
modeling (VECM) and innovative accounting approach to detect the direction of causality
between economic growth and energy consumption (Chontanawat et al. [17]; Shahbaz and Lean
[87]. These inconclusive empirical evidences could not help economic policy planners in lucid a
wide-ranging energy plan to prolong long run economic growth (Ozturk and Acaravci [67],
Payne [74] ). Hossain and Saeki [107] tested the relationship between electricity consumption
and economic growth. They used the data of 76 countries, and divided these countries in five
panels (high income, upper middle income, lower middle income, low income). On the basis of
the panel conintegration approach found cointegration only in case of high income, upper middle
income and global panels.With the appropriate knowledge about the direction of causality
between energy consumption and economic growth is very essential regarding theoretical and
policy point of view (Ghali and El-Sakka [31]).
In recent studies, Payne [74] and Ozturk [66] reviewed the existing literature that
linking energy consumption and economic growth nexus and provided four empirical competing
hypotheses for said issue: (i) growth hypothesis i.e. energy consumption Granger causes
economic growth implies that energy reduction policies should be discouraged and new sources
of energy must be explored, (ii) if causality is running from economic growth to energy
consumption then energy reduction policies would not have adverse effect on economic growth
because economic growth of the country does not seem to be dependent on energy, (iii) feedback
hypothesis implies the interdependence of energy consumption and economic growth. A rise in
economic growth leads to increase in energy demand, which in return stimulates economic
growth. In such a situation, energy conservation policies are detrimental to economic growth and
(iv) no causality between energy consumption and economic growth infers neutrality hypothesis

Frequently asked questions

Q1. What contributions have the authors mentioned in the paper "Economic growth, energy consumption, financial development, international trade and co2 emissions, in indonesia" ?

In this paper, the authors investigated the relationship between economic growth, energy consumption, financial development, trade openness and CO2 emissions in the case of Indonesian economy over the period of 1975-2011. 

Q2. What are the future works in "Economic growth, energy consumption, financial development, international trade and co2 emissions, in indonesia" ?

The present study can be augmented for future research by investigating the relationship between renewable energy consumption, nonrenewable energy consumption, economic growth and carbon emissions following ( Tiwari [ 97, 98 ], Shahbaz et al. [ 88 ] ). Other variables may also be included in model as potential determinants of carbon emissions such as urbanization, ( Hossain [ 40 ] ) ; foreign direct investment, ( Pao and Tsai [ 71 ] ) ; exchange rate / terms of trade, ( Jalil and Feridun [ 43 ] ) ; interest rate, ( Karanfil [ 46 ] ) ; population or population density, ( Himayatullah et al. [ 39 ] ) and industrialization, ( Zhang [ 106 ] ) to examine the relationship between economic growth, energy intensity and CO2 emissions in case of Indonesia. 

Q3. What is the null hypothesis of unit root break date?

The null hypothesis of unit root break date is 0c which indicates that the series is not stationary with a drift not having information about structural break point while 0c hypothesis implies that the variable is found to be trend-stationary with one unknown time break. 

Q4. What is the way to examine the causality between the variables?

The vector error correction method (VECM) is appropriate to examine causality between the variables once series are found to be cointegrated and then causality must be found at least from one direction. 

Q5. What is the t-statistic of the estimate of lagged error term?

The t-statistic of the estimate of lagged error term i.e. 1tECT with negative sign is used to test the long run casual relation and the joint 2 statistical significance of the estimates of the first difference lagged independent variables is used to investigate short run causality. 

Q6. What is the effect of trade openness on the environment?

Trade openness improves environmental quality as response in CO2 emissions following standard shocks occurring in trade openness. 

Q7. What is the main advantage of the generalized forecast error variance decomposition method?

The authors have implemented the generalized forecast error variance decomposition method using vector autoregressive (VAR) system to test the strength of causal relationship between economic growth, energy consumption, financial development, trade openness and CO2 emissions in case of Indonesia. 

Q8. What is the pre-requisite to apply the ARDL bounds testing?

Before applying the ARDL bounds testing, there is a pre-requisite to choose the appropriate lag order of the variables to compute suitable the ARDL F-statistic and to test whether cointegration exists between the variables or not. 

Q9. What is the way to investigate cointegration between the variables?

In such an environment, an error correction method is an easy and suitable way to investigate cointegration between the variables. 

Q10. What is the VECM method used to test cointegration between the series?

Pesaran et al. [76] generated two asymptotic critical values i.e. upper critical bound (UCB) and lower critical bound (LCB), are used to take decisions whether cointegration exists or not between the series. 

Q11. What is the effect of the VECM Granger causality analysis?

In the case of South Africa, Menyah and Wolde-Rufael [56] concluded that energy consumption Granger causes CO2 emissions and resulting in economic growth is being Granger caused by CO2 emissions. 

Q12. What is the share of economic growth and financial development to contribute in trade openness?

The share of economic growth and financial development to contribute in trade openness is negligible i.e. 3.73 and 2.32 per cent and, a 54.41 percent portion of trade openness is contributed by its own standard shocks. 

Q13. What is the relationship between economic growth and trade openness?

CO2 emissions and energy consumption attribute economic growth positive but trade openness contributes negatively to economic growth. 

Q14. What is the main reason why Halicioglu added trade openness to the study?

Halicioglu [35] added trade openness to explore the relationship between economic growth, CO2 emissions and energy consumption in Turkey. 

Q15. What is the causality between energy consumption and economic growth?

In such a situation, energy conservation policies are detrimental to economic growth and (iv) no causality between energy consumption and economic growth infers neutrality hypothesis  5    indicating that energy and growth are not interdependent. 

Q16. What is the effect of trade openness on economic growth?

The response in trade openness is fluctuating due to standard shock in CO2 emissions and same inference is drawn for economic growth and trade openness. 

Q17. What is the way to examine the causality between the series?

On the same lines, Granger [33] argued that vector error correction method (VECM) is more appropriate to examine the causality between the series if the variables are integrated at me (1).