The Effects of Energy Consumption, Economic Growth and Financial Development on CO2 Emissions in China: A VECM Approach

Abstract

As one of the largest energy consumers and the greatest emitter of CO2 in the world, China now confronts the dual challenge of reducing energy use while continuing to foster economic growth. To overcome this issue, there is a need of comprehensive economic, financial, and energy policy reforms to promote sustainable development. The objective of this paper is to examine the effects of economic growth, financial development and energy consumption on carbon dioxide emission (CO2) in China from 1982 to 2017. The study applies Johansen cointegration test and vector error correction model (VECM) to investigate the long-term equilibrium and short-term causality relationship among the four variables. The causality is also checked by using the innovative accounting approach (IAA). The empirical results show the long-term cointegration relationship between them. Evidence shows that a unidirectional Granger causality running from energy consumption to financial development. Financial development and energy consumption have a statistically significant positive impact on CO2 emissions. In the long run, economic growth can curb CO2 emissions. Hence, financial innovation should be encouraged in the country to meet the demand of sustainable development. Nevertheless, optimizing energy structure and increasing the efficiency of energy utilization can never be left out from the process of development. We add light to policy makers with the construction of carbon trading to effectively address greenhouse effects in China.