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Do Economic and Financial Development Increase Carbon Emission in Pakistan: Empirical Analysis through ARDL Cointegration and VECM Causality

Shahzad, Syed Jawad Hussain and Rehman, Mobeen Ur and Hurr, Maryam and Zakaria, Muhammad (2014): Do Economic and Financial Development Increase Carbon Emission in Pakistan: Empirical Analysis through ARDL Cointegration and VECM Causality.

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This empirical study is an effort to establish cointegration and causality between carbon emissions, economic growth, energy consumption, financial development and trade openness in Pakistan. Lack of environmental protection laws, energy crises and resulting lower economic growth make Pakistan a unique setting to study the country specific reactions among the variables. The annual data after the separation of Bangladesh from 1973 to 2011 is used for the empirical work. The stationarity of the variables with structural breaks is analyzed. The Auto-regressive Bound Testing (ARDL) approach to cointegration is used to determine the cointegration relation. Fully Modified Ordinary Least Square (FMOLS) and Dynamic OLS (DLOS) cointegration equations are applied to estimate long run co-efficients. Short run relationship is determined through Vector Error Correction (VEC) based Granger causality, Variance Decomposition Analysis (VDA) and Impulse Response Function (IRF). After confirmation of cointegration between the variables, long term estimations confirm that economic growth and energy consumption increase the carbon emissions. Economic growth, energy consumption and trade openness Granger cause carbon emission in short run. There is unidirectional causality running from financial development and energy consumption to economic growth. Financial development is caused by carbon emissions and trade openness. Trade openness also Granger causes energy consumption. There is a bi-directional causality between financial development and energy consumption in Pakistan. Hence, the efforts to overcome energy crises and foster the economic growth require considerable attention to the carbon emissions; the best policy is to improve the situation through alternate energy resources i.e. Coal, Liquefied Petroleum Gas (LPG) and Liquefied Natural Gas (LNG). There is a need to introduce conservation policies so that wastage and spillovers of energy resources can be minimize. Efficient use of scarce energy resources will not only reduce the environment degradation but will also help to foster the economic growth. The environmental protection laws require proper enforcement.

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