Journal of Environmental Management 196 (2017) 627e632
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Research article
Economic growth, CO2 emissions, renewable waste and FDI relation in Pakistan: New evidences from 3SLS Khuda Bakhsh a, *, Sobia Rose b, Muhammad Faisal Ali b, Najid Ahmad c, Muhammad Shahbaz d a
Department of Management Sciences, COMSATS Institute of Information Technology, Vehari, Pakistan Institute of Agriculture and Resource Economics, University of Agriculture Faisalabad, Pakistan Dongbei University of Finance and Economics, Dalian, China d Montpellier Business School, France b c
a r t i c l e i n f o
a b s t r a c t
Article history: Received 27 August 2016 Received in revised form 16 January 2017 Accepted 11 March 2017
First attempt has been made to find the effects of foreign direct investment on environmental pollution and economic growth, in addition to finding the determinants of foreign direct investment inflows in Pakistan using the annual data set for the period of 1980e2014. Simultaneous equation model has been used to find relation between the variables of concern. Results from technique and composition effects show that increase in economic growth leads towards more pollution emissions. Scale effect shows stock of capital and labor have positive effect on the economic growth of Pakistan while pollution has negative effect on growth. In case of capital accumulation effect, economic growth and foreign direct investment have positive and significant effect on stock of capital. Although increase in economic growth increases pollution, however, economic growth declines as pollution crosses a certain limit. Foreign direct investment is also found positively related with pollution. © 2017 Elsevier Ltd. All rights reserved.
Keywords: GDP FDI Environmental pollution Labor Physical capital JEL Classification: C30 O44
1. Introduction The industrial sector in Pakistan is one of the major contributors to economic growth i.e. 25.5 percent of GDP (GOP, 2014). Raising industrial production requires increased mobilization of foreign resources, being the most important determinant for progress in this sector (Khan and Kim, 1999). Pakistan is undertaking sound macroeconomic policies along with a wide range of structural reforms and incentives for being congenial for both foreign investors and local industries (Khan, 2007, 2011; Hussain, 2009; Desbordes, 2010). Recent studies have explored the relationship between FDI inflows and its determinants [see Akhtar (2000); Afza and Khan (2009); Khan and Samad (2010); Hakro and Ghumro (2011)]. However, the relationship between pollution emissions and FDI is limited in previous work. The importance of FDI in economic
* Corresponding author. E-mail address: [email protected] (K. Bakhsh). http://dx.doi.org/10.1016/j.jenvman.2017.03.029 0301-4797/© 2017 Elsevier Ltd. All rights reserved.
growth process is increasing gradually and increasing concern regarding environmental problems. Thus, FDI role has become controversial and debatable. FDI contributes into host economy via three folds: (i) FDI stimulates hence economic development process in host economy (Alfaro et al., 2010). (ii) FDI is source of external finance (Bustos, 2007). (iii) FDI reduces the bridge between domestic savings and target investment (Ndikumana and Verick, 2008). Moreover, FDI stimulates economic activity by providing direct access to capital financing, generating positive externalities, transferring advanced technology, increasing productivity gains, etc. (Lee, 2013; Shahbaz et al., 2015). FDI helps in developing local enterprise development which further encourages employment opportunities for skilled and unskilled labor in host country. It is affirmed that FDI promotes economic growth but not free from environment cost (Shahbaz et al., 2015). The fact is that developing economies undermine environmental apprehensions via relaxed environmental regulation is named as pollution haven hypothesis (Cole and Elliott, 2003). In such circumstances, multinationals are encouraged to
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make investment in those countries which have relaxed environmental policies to enhance their production. This scenario provides opportunities to multinationals for reaping full advantage of reduced cost of production and it is termed as industrial flight hypothesis (Asghari, 2013). Anyhow, relaxed environmental policies as well as reduced cost of production are sources of environmental degradation in host country. Contrarily, FDI comes with advanced and energy efficient technology and works under better management practices that leads to improve environmental quality in host country. This is termed as pollution halo hypothesis. FDI affects economic growth which affects energy consumption and hence carbon emissions in host country (Shahbaz et al., 2015). If multinationals or foreign investors employ advanced technologies for production process then FDI declines energy intensity and lowers CO2 emissions otherwise FDI impedes environmental quality by increasing carbon emissions due to use of energy intensive technology. The relationship between FDI and carbon emissions via income or energy consumption is discussed and empirically investigated in various studies in existing literature but results are inconclusive (Omri and Kahouli, 2014; Shahbaz et al., 2015). This ambiguity in empirical evidence on FDI-emissions nexus provides rational for reinvestigating association between FDI and carbon emissions for reliable and consistent empirical analysis. In doing so, this study fills the gap by investigating the relation between FDI, CO2 emissions by incorporating role of economic growth for Pakistan. Industrial sector is a major contributor in GDP of Pakistan. The expansion in industrial sector leads energy demand which is major source of CO2 emissions (Shahbaz et al., 2015). Pollution emissions is mainly associated with industrial sector. Further, FDI inflow to Pakistan is increasing may also be a source of CO2 emissions. FDI may affect CO2 emissions via scale, technique and composition effects. Thus, this study offers the solution to check all possible channels to overcome environmental pollution for Pakistan. Beauty of the study is to decompose the total environmental effect of FDI into three techniques, namely technique, scale and composition effects. FDI affects carbon emission via income is termed as income or scale effect. FDI may affects carbon emissions via changing structure of an economy i.e. shift of economy from agriculture to industry and then industry to services is called composition effect. FDI helps host country in adopting advanced technology which may affect carbon emissions is termed as technique effect. This study is inspired by recent studies (for example, Zhang and Zhou, 2016; Shahbaz et al., 2015) to investigate the relation between CO2 emissions, economic growth and FDI for Pakistan. The spurious problem may be found due to omission of relevant variables. This issue is covered by adding additional independent variables such as stock of capital, renewable waste and labor force. For empirical analysis, we have employed three stage least square (3SLS) to solve a simultaneous equations system. The 3SLS is more efficient as compared to 2SLS as 3SLS allows correlation between unobserved disturbances across various equations to be used in the analysis. Thus, 3SLS has been used because of its advantages. Rest of the paper is structured in different sections as: Section 2 is for brief literature review, section 3 for data and method, section 4 is for results and discussion while section 5 concludes the paper policy. 2. Brief literature review There are two different arguments regarding effect of FDI on environmental quality of the host country. At one side, it is considered to have positive effect on the host country environment (Liang, 2006) on the other side, it is argued that although FDI accelerates the process of economic growth but it may also generate a negative spillover effects on environment of the host countries
(Xing and Kolstad, 2002; He, 2006; Tang and Tan, 2014). Similarly, Kivyiro and Arminen (2014) find that CO2 emissions, FDI, economic development and energy consumption move in the same direction in the long run in Sub-Sahara Africa. Omri et al. (2014) also find bidirectional causality between economic growth and FDI flows and CO2 emissions and FDI, indicating that FDI may exert adverse effect on the host economy. The studies focusing on Gulf Cooperating Council and five ASEAN countries reveal that economic growth and energy consumption are the sources of pollution emission whereas FDI flows have no role in pollution emission (Almulali and Tang, 2013; Chandran and Tang, 2013). Therefore, the effect of FDI inflows on the host country's environmental pollution has always been one of the most controversial issues till date and there is little to focus for Pakistan's economy. Developing countries deliberately underrate the environmental standards to attract foreign investors. Therefore, generally, to get benefit of the few stringent environmental policies, foreign investors shift their operations to the less developed countries (Mabey and McNally, 1999). On other hand, it is also possible that multinational corporations (MNC) use more environment friendly and advanced technologies along with better management and operational practices in the production process. Hence, FDI contributes positively in reducing the host country environmental pollution intensities (Zarsky, 1999). Existing energy economics literature discusses the relationship between environmental pollution and FDI both in cross-country and inter-country framework (Porter and Van der Linde, 1995; Eskeland and Harrison, 2003; Henderson and Millimet, 2007; Lee, 2013; Shahbaz et al., 2015). However, results remain controversial. Literature shows relationship between all these variables like a study conducted by Cole et al. (2011) in China report that there is a U-shaped relationship between per capita pollution emissions and income, economic development also lead to an increase in industrial emissions. He (2006) used panel data to test economic growthenvironment relationship by employing simultaneous equation approach by constructing five equations in a system of equations to find out the effect of FDI on pollution emissions. The decision of FDI entry depends on the economic growth of last period and stringency of the environmental regulations. The results in this study support the pollution haven hypothesis while the effect of environmental stringency affects the FDI inflows modestly. The nexus between pollution and FDI becomes more complicated when theoretical considerations are related to three economic considerations namely the scale effect, technique effect and composition effect. Basically the entry decision is mostly based on the scale of economic growth in the host country. On other hand, pollution halos hypothesis exists in the case when domestic firms are more pollution intensive as compared to multinational firms because these multinational firms use more environmental friendly technologies and cleaner and advanced production methods which result in an improved environmental management systems (Cole et al., 2008; Eskeland and Harrison, 2003). 3. Material and methods Annual data has been used for the period of 1980e2014 in the present study. Data on real GDP (US million dollar), per capita GDP (Us dollar), population density (number of persons per square km) and foreign direct investment (US million dollars) are taken from different issues of Economic Survey of Pakistan. We used two indicators of pollution due to data availability on these variables. They include CO2 emissions and renewable waste. Renewable waste comprises waste (metric tons) from energy consumption in industrial sector. Data on CO2 emissions (metric tons), renewable waste (metric tons), road and railway lengths (km) are taken from
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World Development Indicators. Data on capital stock is from the Next Generation of Penn World Table (Feenstra et al., 2013). Labor force participation rate is taken from the different issues of the Labor Force Survey of Pakistan. Human capital is measured as the percent of total population with literacy rate and this information is collected using different issues of publications of Pakistan Bureau of Statistics. All data is converted into log form to make it smooth and easy to interpret. Simultaneous equation model is used for empirical purpose. For the estimation of simultaneous equation model, 3SLS is used as it is more efficient than 2SLS. Reason is that the 3SLS allows correlation between unobserved disturbances across various equations to be used in the analysis. Three stage least squares estimates are more consistent and asymptotically normal, and, under some conditions, asymptotically more efficient than single equation estimates. Indeed it is the combination of multivariate regression and two stage regression (Zellner and Theil, 1962). Thus, 3SLS method has been adopted for the present study because of its advantages [see Bao et al. (2010) for more details]. FDI affects environment of the host country through different channels like scale effect (GDP), technique effect (tech) and composition effect (comp) [see Liang (2006)]. In the empirical analysis, we decompose pollution emissions into following three effects.
POL ¼ GDP þ TECH þ COMP
(1)
To measure scale effect, physical capital stock (KS) is used while the ratio of industrial output to GDP is used to measure composition effect. Finally, for the technique effect the ratio of total pollution emissions to the industrial output is used. In order to study the scale effect of foreign direct investment, we investigate how foreign direct investment affects economic growth via stimulating the domestic physical capital accumulation. Effect of FDI on economic scale is estimated using Equation (2):
GDP ¼ a0 þ b1 FDI þ b2 K þ b3 L þ b4 H þ b5 POL þ 3 t
(2)
Here GDP is real GDP, FDI is foreign direct investment, K is stock of capital, L is labor force, H is human capital, POL is pollution emissions. a0 is constant, b1 to b5 are the parameters to be estimated, 3 t is white noise error term. Pollution emissions coefficient is expected to have negative sign because of its damaging effect and its cost to recover the damage. FDI directly affects the economic growth (Cole et al., 2011) and indirectly, it increases the physical capital stock in the country (Zhang et al., 2004). Indirect effect of foreign direct investment on economic growth is determined by Equation (3).
K ¼ b0 þ b1 FDI þ b2 ðGDPt1 Þ þ 3 t
(3)
GDP is with one period lagged value to show how much, economic growth and economic environment imbalance affects the accumulation of capital. FDI is foreign direct investment that also influences the stock of capital of an economy. Equation (4) was used for technique effect.
TECH ¼ a0 þ b1 FDI þ b2 PD þ b3 GDP þ 3 t
(4)
Here TECH is for technique effect that is measured as a ratio between pollution emissions per unit of industrial output, FDI is foreign direct investment, GDP is GDP per capita, PD is population density. Consequently, it increases the damage cost and recovering that cost negatively affects output. As GDP per capita increases the demand for improved air quality, clean habitat and clean water also rises for maintaining a quality life. An increase in economic activity raises per capita income, causing an increase in demand for a cleaner environment. Further, a higher GDP per capita also shows
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an increased capacity of an economy to allocate its resources for the purpose of environmental protection and pollution abatement (Grossman and Krueger, 1995; Pao and Tsai, 2010). To examine this, we estimate composition effect employing Equation (5):
COMP ¼ a0 þ b1 FDI þ b2 K þ b3 GDP þ b4 road þ b5 rail þ 3 t
(5)
Ratio of industrial output to GDP is used for composition effect. Higher physical capital stock causes an increase in the industrial output that causes pollution. The effect of GDP per capita on dependent variable is twofold: first, a higher GDP per capita is a signal to show the process of industrialization in an economy and second, it also shows that people have an increased demand for a cleaner environment. Two infrastructure variables road and rail length are used to find out the contribution of infrastructure in boosting the process of industrial activities. Different factors influence FDI in a country and these factors can be time and country specific. The present study also estimates these factors affecting FDI in Pakistan. The determinants of FDI are estimated using Equation (6).
FDI ¼ a0 þ b1 FDIt1 þ b2 road þ b3 rail þ b4 POLt1 þ 3 t
(6)
To avoid the endogeneity and estimate self-accumulation of FDI, one period lag of FDI is introduced in the model. Variables road and rail are included to show infrastructure effect on FDI while POL is the amount of pollution determining the impact of decision to invest in Pakistan. Thus, to sum up, to estimate the effect of pollution on foreign direct investment the above (1e6) system of equations was developed where first Equation (1) is decomposed into three effects, namely scale effect, technique effect and composition effect. Scale effect can be seen in Equations (2) and (3) while technique and composition effect is in Equations (4) and (5) respectively. As stated above, Equation (6) serves for the determinants of FDI. There are two ways through which foreign FDI affects pollution emissions. First is the direct as shown through scale, technique and composition effects. Indirect effect is through the channel of GDP per capita and through increasing the physical capital of the host country. Then this increased physical capital again exerts an impact on pollution emissions through composition and scale effect.
4. Results and discussion For estimating the effect of FDI on economic growth and pollution emissions, we employed 3SLS. Considering empirical methods, Equation (1) is identity. Therefore, we cannot estimate it directly. We estimated five Equations (2)e(5) in the model using 3SLS to cover this issue. Scale effect results are reported in Table 1. We find that physical capital, labor force and human capital play an important role in the domestic production and hence, economic growth. In case of renewable wastes, the impact of foreign direct
Table 1 Estimates of scale effect. Variables
GDP Pollution
Renewable waste
CO2 Emissions
Constant FDI K L H POL R2
6.29 (0.06)* 0.06 (0.19) 0.11 (0.00)* 0.69 (0.26)* 1.79 (0.00)* 2.15 (0.00)* 0.89
1.08 (0.72)*** 0.26 (0.06)* 0.74 (0.05)* 0.24 (0.64) 0.91 (0.00)* 0.32 (0.00)* 0.81
9.54 (0.00)* 0.35 (0.00)* 0.66 (0.01)* 2.07 (0.00)* 0.25 (0.55) 2.16 (0.00)* 0.83
Standard errors are in parentheses. * and *** show 1 and 10% level of significance.
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investment is negative and statistically significant. Industries generating renewable waste but having no facility to recycle can cause an increase in overall pollution in the country. This increase in overall pollution causes significant reduction in economic growth of the country. Increased pollution causes environmental degradation as it has been estimated that environmental degradation costs for Pakistan's economy is more than PakRS 365 billion every year, out of this, the cost for the air pollution in urban areas is PakRS 65 billion. Some also argue that environmental degradation cost has already exceeded PakRS 450 billion (GOP, 2014). All the economic sectors especially industrial sector in Pakistan are open to FDI. There is a universal consensus on a positive relationship between economic growth of the host country and FDI. However, in case of Pakistan, weak institutional structure and less stable political scenario may be the reasons behind weak/or even negative relationship between economic growth and FDI. Besides this, there is a complimentary relationship between human capital and foreign direct investment and its effect on economic growth. So in a country with weak human capital development, FDI relation with economic growth is negative. Foreign direct investment causes an increase in economic growth in the case when host countries have some certain characteristics like improved level of education and possess skilled human resources (Zhang, 2001). Lee (2013) also provides the evidence of unidirectional causality from FDI to economic growth and from economic growth to CO2 emissions whereas on contrary Omri et al. (2014) show an evidence of a bidirectional causal link between FDI inflows and CO2 emissions and between economic growth and FDI inflows. FDI increases pollution which shows that technique effect is unable to curb CO2 emissions due to adoption of obsolete technology during production process. This incurs negative effect on economic growth in long-run (Jayanthakumaran et al., 2012). In case of renewable waste and overall pollution, the labor force shows an insignificant effect which means that in Pakistan labor force is not too skilled to influence the economic growth significantly. But, its highly negative and significant coefficient in case of CO2 emissions manifests its efficient participation in industrial sector. The variable of total pollution consists of a combined effect of both renewable wastes and CO2 emissions in Equations (2) and (3). FDI shows a negative and significant relation with the economic growth both in case of renewable wastes and CO2 emissions. Perhaps domestic institutional structure is not developed adequately and there may be the reason of unskilled labor (Ataullah and Le, 2004). Diffusion of technology associated with foreign direct investment is measured by the absorption capacity of the host country which further depends on the intensity of human capital (Fu, 2008). We measure human capital as percentage of total population with literacy rate as done by Fu (2008). Increase in CO2 emissions causes a significant increase in economic growth of the country. In developing country like Pakistan, the relationship is reverse because renewable waste serves as an input in the production process and can incur a significant effect on the economic growth of the country but in the present study, negative sign of its coefficient shows that the waste is being absorbed in the environment. This renewable waste includes liquid bio-fuels, biogases, municipal waste, charcoal, primary solid bio-fuels, and industrial waste. The variable of pollution is showing a negative and significant effect on economic growth while CO2 emissions has a positive effect on economic growth. This can be an increase in industrial sector at a fast pace making the effect of CO2 emissions on economic growth as negative. Table 2 explains the capital accumulation effect of foreign direct investment in Pakistan. In all three cases the relationship of FDI with capital accumulation is significantly positive. It
Table 2 Estimation results of capital accumulation effect. Variables
Constant FDI GDPt-1 R2
K Pollution
Renewable waste
CO2 emission
6.35 (0.00)* 0.39 (0.00)* 0.02 (0.06)* 0.91
0.67 (0.00)* 2.16 (0.00)* 13.17 (0.07)* 0.85
6.45 (0.00)* 0.39 (0.00)* 0.01 (0.05) 0.91
Standard errors are in parentheses. * show 1% level of significance.
(0.0546 þ 0.3917*0.1088 ¼ 0.013) shows the total scale effect of FDI on economic growth in case of pollution. Previous growth affects the present physical capital accumulation and to elicit this effect, lagged values of economic growth are also added. So the impact of previous year economic growth of physical capital accumulation is positive and statistically significant in Pakistan. Table 3 explains the results of technique effect. There is a positive relation between pollution emissions and flow of FDI in the host country (Lan et al., 2012). The results show that marginal pollution damage increases with an increase in FDI. While in the case of CO2 emissions, there is a negative and significant relationship between FDI and marginal pollution damage. This significant effect is because foreign investors do not follow appropriate strategies for pollution abatement. Increase in FDI causes an increase in marginal pollution damage in case of renewable wastes. The negative sign of the population density shows that marginal pollution damage increases as a result of an increase in population density which requires strict pollution regulation measures to cope with. GDP per capita shows a different impact in all three kinds of pollutants. In case of pollution as GDP per capita increases the marginal pollution damage decreases, showing with an increase in GDP per capita people become more aware about the damages of pollution and try to combat. The case of renewable wastes shows a positive impact of GDP per capita on marginal pollution damage because when an economy is at the turning point of moving completely towards industrialization it remains unaffected by the environmental damages caused by the increased economic activity (Yandle et al., 2002). While in the case of CO2 emissions the variable has positive coefficient which shows that an increase in GDP per capita causes a decrease in marginal pollution damage. This impact on CO2 makes the overall combined effect negative. Policies in Pakistan generally don't consider the effects of renewable wastes and it is assumed that it can be recycled later on. So an increase in per capita GDP causes an increase in renewable wastes without considering its detrimental effects. Table 4 illustrates the results of composition effect for pollution, CO2 emissions and renewables wastes. In case of overall pollution, an increase in foreign direct investment affects share of industrial output in overall economy positively but this relationship is insignificant. In case of CO2, this impact is significantly positive. The variable K shows an increase would lead towards a significant share of the industrial output in the overall economy because the
Table 3 Estimation results of technique effect. Variables
tech Pollution
Renewable waste
CO2 emission
Constant FDI PD GDP R2
17.23 (0.00)* 0.01 (0.72) 3.60 (0.00)* 0.02 (0.07) 0.99
0.93 (0.80) 0.46 (0.00)* 2.79 (0.00)* 1.69 (0.00)* 0.84
13.95 (0.00)* 0.09 (0.01)* 3.54 (0.00)* 0.59 (0.05)** 0.98
Standard errors are in parentheses. * show 1% level of significance.
K. Bakhsh et al. / Journal of Environmental Management 196 (2017) 627e632 Table 4 Estimation results of composition effect. Variables
Constant FDI K GDP road rail R2
Table 6 Various effects of FDI on pollution in the country.
comp
Variables
Pollution
Renewable waste
CO2 emission
2.99 (0.53)* 0.06 (0.44) 0.73 (0.01)* 1.15 (0.00)* 0.21 (0.12)** 0.55 (0.29)* 0.92
19.63 (0.02)* 0.51 (0.72) 1.19 (0.02)* 0.58 (0.00)* 1.01 (0.00)* 3.76 (0.00)* 0.96
0.53 (0.07)* 0.16 (0.00)* 0.34 (0.04)* 1.06 (0.00)* 0.16 (0.01)* 0.19 (0.14)*** 0.96
Standard errors are in parentheses. *, ** and *** show 1, 5 and 10% level of significance, respectively.
Table 5 Estimation results of the determinants of FDI. Variables
Constant FDIt-1 road rail POLt-1 R2
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FDI Pollution
Renewable waste
CO2 emission
42.60 (0.03)* 0.34 (0.03)* 0.68 (0.20)* 2.35 (0.16)* 1.45 (0.01)* 0.89
7.82 (0.07)* 0.71 (0.00)* 0.55 (0.42) 0.34 (0.86) 1.93 (0.06)* 0.90
46.78 (0.00)* 0.22 (0.06)* 0.61 (0.09)* 0.45 (0.00)* 0.00 (0.00)* 0.91
Standard errors are in parentheses. * show 1% level of significance.
industrial sector is both more pollution intensive as well as capital intensive. With the more use of imported technology in industries, the capital labor ratio would increase, resulting in more industrial output share in the overall economy (Kalim, 2001). Considering infrastructure, rail length shows a significant negative relationship with industrial output share. The road length has a significant positive effect. But, overall composition effect of FDI on industrial composition is insignificant. This shows a negative effect of an increase in FDI on industrial composition of the economy and this is mainly due to increase in pollution as FDI increases. Table 5 reveals the estimation results of the determinants of FDI. The accumulation effect of FDI due to which more foreign investors are attracted is shown through FDIt-1. This shows that the previous year's investment causes a significant increase in current year's FDI. The rail and road variables show a positive effect, describing the importance of infrastructure attracting FDI. Lagged value of pollution shows the feedback impact on FDI which is positive and significant. Table 6 is constructed using Bao et al. (2010) formulas1 where total effect, scale effect, technique effect and composition effect are determined as are shown in Table 6. The total effect shows a negative scale effect while positive technique and composition effects. The effect of capital accumulation is positive on FDI and it emphasizes the importance of capital accumulation effect, being one of the most important determinants. This coefficient shows how FDI affects capital accumulation while in return capital accumulation exerts a positive impact on economic activity through scale effect and it also affects positively on industrial output. FDI causes an increase in capital accumulation but along with this, the level of pollution also increases in the country. While on the other hand technique and composition effects show respectively that increase in the economic growth of the country leads towards more pollution emissions. Rise in per capita income leads towards increased demand for
1 To conserve the space, we did not repeat the formulas from Bao et al. (2010). However, are available on request.
Total effect Scale effect Technique effect Composition effect
FDI Pollution
Renewable waste
CO2 emission
0.47 1.02 1.01 1.47
2.88 2.25 1.02 1.79
0.95 2.14 1.63 2.56
pollution abatement as evident by technique effect. It is also confirmed through the coefficient of GDP per capita in case of composition effect. The feedback effect of pollution emissions on economic growth is shown in scale effect. It indicates its negative effect on economic growth because with increase in pollution, economic growth increases at first stage but with the passage of time the pollution abatement cost causes a decrease in economic growth. This scale effect further affects technique and composition effects and total feedback effect can be measured (see Bao et al., 2010 for details). The scale effect is always negative when a country does not consider the environmental regulations and management while progressing economically (Mahmood and Chaudhary, 2012). The negative scale effect in this study shows that in case of increase in FDI, the GDP decreases and this is exactly opposite to the results of Bao et al. (2010). The indirect effect of FDI on capital accumulation is positive but in scale effect it becomes negative due to effect of pollution on economic growth and several other factors. The direct technique effect is reported in Table 3 while Table 6 shows indirect effect. The calculation of indirect technique effect requires the knowledge of the effect of economic development on pollution emissions and the effect of FDI on economic growth. Both of these effects are measured by the effect of GDP per capita on marginal pollution damage and by the effect of FDI on GDP in scale effect. Composition effect is positive, showing that overall FDI increases the share of industrial sector in GDP. Total effect in case of overall pollution is positive. But in case of renewable waste and CO2 emissions, it is negative. It means there may be some other pollutants which contribute positively and make the overall impact positive. Scale and technique effects are positive only in case of renewable wastes. Composition effect is positive in case of CO2 emissions and overall pollution.
5. Conclusion This study finds several interesting results of impact of FDI on environmental pollution in Pakistan through the channels of scale effect, technique effect and composition effect. The overall scale effect technique shows that physical capital stock and labor have positive and significant effects on gross domestic product and effect of pollution is negative. FDI has negative and significant impact on CO2 emissions and renewable waste. In composition effect, road length and capital stock are positively related with CO2 emissions whereas GDP per capita has negative effect. The study also finds a positive relation of pollution emission to FDI, favoring existence of pollution haven hypothesis in Pakistan. The present study provides important policy implications for controlling pollution emission, particularly relating to FDI in Pakistan. Presently the Government of Pakistan provides incentives to foreign investors in order to attract FDI at the cost of environmental pollution and again there is no doubt that FDI plays an important contribution in the economy of any developing country like Pakistan. Findings of the study reveal that the host country should also consider adverse effects of FDI on environmental
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quality. Environmental degradation causes a decline in economic activities in the long-run. Thus, it is more imperative for the host country to attract investments generating more technique effects in the host country. This can help achieving objectives of growth and development of the host country. The host country like Pakistan have to strictly implement environmental rules and regulations to foreign and domestic firms, such as establishing proper waste management plants in industry and defining permits on CO2 emissions. Role of regulators needs to be strengthened by making institutions strong for proper implementation of environmental laws to curb environmental pollution in the country. Further, the host country should promote environmental friendly technology in the production process among domestic and foreign investors. Funding This research did not receive any specific grant from funding agencies in the public, commercial, or non-for-profit sectors. Acknowledgements We would like to thank Dr. Apostolos P Kyriazopoulos, and three anonymous reviewers for their constructive and valuable comments and suggestions in preparing this final version of the manuscript. Appendix A. Supplementary data Supplementary data related to this article can be found at http:// dx.doi.org/10.1016/j.jenvman.2017.03.029. References Afza, T., Khan, M.M.S., 2009. Greenfield in Pakistan: is it really green? An empirical investigation. Am. J. Sci. Res. 4, 59e71. Akhtar, M.H., 2000. The determinants of foreign direct investments in Pakistan: an econometric analysis. L. J. Econ. 5, 1e23. Alfaro, L., Chanda, A., Kalemli-Ozcan, S., Sayek, S., 2010. Does foreign direct investment promote growth? Exploring the role of financial markets on linkages. J. Dev. Econ. 91, 242e256. Al-mulali, U., Tang, C.F., 2013. Investigating the validity of pollution haven hypothesis in the gulf cooperation council (GCC) countries. Energy Policy 60, 813e819. Asghari, M., 2013. Inward FDI, growth and environmental policy. Int. J. Sci. Res. Knowl. 1, 288e298. Available online. www.ijsrpub.com/ijsrks. Ataullah, A., Le, H., 2004. Financial repression and liability of foreignness in developing countries. Appl. Econ. Lett. 9, 545e549. Bao, Q., Chen, Y., Song, L., 2010. Foreign direct investment and environmental pollution in China: a simultaneous equations estimation. Environ. Dev. Econ. 16, 71e92. Bustos, P., 2007. FDI as a Source of Finance in Imperfect Capital Markets, Firm-level Evidence from Argentina. CREI and Universitat Pompeu Fabra. Available online. http://www.cemfi.es/~bustos/FDI_and_external_finance.pdf. Chandran, V.G.R., Tang, C.F., 2013. The impacts of transport energy consumption, foreign direct investment and income on CO2 emissions in ASEAN-5 economies. Renew. Sust. Energy Rev. 24, 445e453. Cole, M.A., Elliott, R.J., Strobl, E., 2008. The environmental performance of firms: the role of foreign ownership, training, and experience. Ecol. Econ. 65, 538e546. Cole, M.A., Elliott, R.J., 2003. Determining the tradeeenvironment composition effect: the role of capital, labor and environmental regulations. J. Environ. Econ. Manag. 3, 363e383. Cole, M.A., Elliott, R.J.R., Zhang, J., 2011. Growth, foreign direct investment, and the environment: evidence from Chinese cities. J. Reg. S. C. 51, 121e138. Desbordes, R., 2010. Global and diplomatic political risks and foreign direct investment. Econ. Polit. 22, 92e125. Eskeland, G.S., Harrison, A.E., 2003. Moving to greener pastures? Multinationals and the pollution haven hypothesis. J. Dev. Econ. 1, 1e23. Feenstra, R.C., Robert, I., Marcel, P.T., 2013. The Next Generation of the Penn World Table. Fu, X., 2008. Foreign direct investment, absorptive capacity and regional innovation
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CO2 emissions, energy consumption, trade and income: a comparative analysis of China and India. Energy Policy 42, 450e460. Kalim, R., 2001. Capital intensity in the large-scale manufacturing of Pakistan. Pak. Econ. Soc. Rev. 2, 135e151. Khan, A.H., Kim, Y.H., 1999. Foreign Direct Investment in Pakistan: Policy Issues and Operational Implications. EDRC Report Series No. 66. Khan, M.A., 2007. Foreign Direct Investment and Economic Growth: the Role of Domestic Financial Sector. Pakistan Institute of Development Economics. Working Papers 18. Khan, M.A., 2011. Foreign Direct Investment in Pakistan: the Role of International Political Relations. Department of International Development, University of Oxford. TDM Working Paper No. 039. Khan, M.A., Samad, G., 2010. Intellectual property rights and foreign direct investment: analysis of 14 South and South East Asian Countries, 1970e2005. Appl. Econ. Int. Dev 10, 219e230. Kivyiro, P., Arminen, H., 2014. Carbon dioxide emissions, energy consumption, economic growth, and foreign direct investment: causality analysis for SubSaharan Africa. Energy 74, 595e606. Lan, J., Kakinakaand, M., Huang, X., 2012. Foreign direct investment, human capital and environmental pollution in China. Environ. Resour. Econ. 2, 255e275. Lee, W.J., 2013. The contribution of foreign direct investment to clean energy use, carbon emissions and economic growth. Energy Policy 55, 483e489. Liang, F.H., 2006. Does Foreign Direct Investment Harm the Host Country's Environment? Evidence from China. http://faculty.haas.berkeley.edu/fenliang/ research/pollution%26fdi/fdi_pollution.pdf. Mabey, N., McNally, R., 1999. Foreign Direct Investment and the Environment: from Pollution Havens to Sustainable Development. WWF, UK. Mahmood, H., Chaudhary, A.R., 2012. FDI, population density and carbon dioxide emissions: a case study of Pakistan. Iran. J. Energy Environ. 4, 354e360. Ndikumana, L., Verick, S., 2008. The Linkages between FDI and Domestic Investment: Unraveling the Developmental Impact of Foreign Investment in Subsaharan Africa. IZA DP N. 3296. Available online. http://ftp.iza.org/dp3296.pdf. Omri, A., Kahouli, B., 2014. Causal relationships between energy consumption, foreign direct investment and economic growth: fresh evidence from dynamic simultaneous-equations models. Energy Policy 67, 913e922. Omri, A., Nguyen, D.K., Rault, C., 2014. Causal interactions between CO2 emissions, FDI, and economic growth: evidence from dynamic simultaneous-equation models. Econ. Model 42, 382e389. Pao, H.T., Tsai, C.M., 2010. CO2 emissions, energy consumption and economic growth in BRIC countries. Energy Policy 38, 7850e7860. Porter, M.E., Van der Linde, C., 1995. Towards a new conception of the environmentcompetitiveness relationship. J. Econ. Perspect. 9, 97e118. Shahbaz, M., Nasreen, S., Abbas, F., Anis, O., 2015. 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Contents lists available at ScienceDirect
Journal of Environmental Management journal homepage: www.elsevier.com/locate/jenvman
Research article
Economic growth, CO2 emissions, renewable waste and FDI relation in Pakistan: New evidences from 3SLS Khuda Bakhsh a, *, Sobia Rose b, Muhammad Faisal Ali b, Najid Ahmad c, Muhammad Shahbaz d a
Department of Management Sciences, COMSATS Institute of Information Technology, Vehari, Pakistan Institute of Agriculture and Resource Economics, University of Agriculture Faisalabad, Pakistan Dongbei University of Finance and Economics, Dalian, China d Montpellier Business School, France b c
a r t i c l e i n f o
a b s t r a c t
Article history: Received 27 August 2016 Received in revised form 16 January 2017 Accepted 11 March 2017
First attempt has been made to find the effects of foreign direct investment on environmental pollution and economic growth, in addition to finding the determinants of foreign direct investment inflows in Pakistan using the annual data set for the period of 1980e2014. Simultaneous equation model has been used to find relation between the variables of concern. Results from technique and composition effects show that increase in economic growth leads towards more pollution emissions. Scale effect shows stock of capital and labor have positive effect on the economic growth of Pakistan while pollution has negative effect on growth. In case of capital accumulation effect, economic growth and foreign direct investment have positive and significant effect on stock of capital. Although increase in economic growth increases pollution, however, economic growth declines as pollution crosses a certain limit. Foreign direct investment is also found positively related with pollution. © 2017 Elsevier Ltd. All rights reserved.
Keywords: GDP FDI Environmental pollution Labor Physical capital JEL Classification: C30 O44
1. Introduction The industrial sector in Pakistan is one of the major contributors to economic growth i.e. 25.5 percent of GDP (GOP, 2014). Raising industrial production requires increased mobilization of foreign resources, being the most important determinant for progress in this sector (Khan and Kim, 1999). Pakistan is undertaking sound macroeconomic policies along with a wide range of structural reforms and incentives for being congenial for both foreign investors and local industries (Khan, 2007, 2011; Hussain, 2009; Desbordes, 2010). Recent studies have explored the relationship between FDI inflows and its determinants [see Akhtar (2000); Afza and Khan (2009); Khan and Samad (2010); Hakro and Ghumro (2011)]. However, the relationship between pollution emissions and FDI is limited in previous work. The importance of FDI in economic
* Corresponding author. E-mail address: [email protected] (K. Bakhsh). http://dx.doi.org/10.1016/j.jenvman.2017.03.029 0301-4797/© 2017 Elsevier Ltd. All rights reserved.
growth process is increasing gradually and increasing concern regarding environmental problems. Thus, FDI role has become controversial and debatable. FDI contributes into host economy via three folds: (i) FDI stimulates hence economic development process in host economy (Alfaro et al., 2010). (ii) FDI is source of external finance (Bustos, 2007). (iii) FDI reduces the bridge between domestic savings and target investment (Ndikumana and Verick, 2008). Moreover, FDI stimulates economic activity by providing direct access to capital financing, generating positive externalities, transferring advanced technology, increasing productivity gains, etc. (Lee, 2013; Shahbaz et al., 2015). FDI helps in developing local enterprise development which further encourages employment opportunities for skilled and unskilled labor in host country. It is affirmed that FDI promotes economic growth but not free from environment cost (Shahbaz et al., 2015). The fact is that developing economies undermine environmental apprehensions via relaxed environmental regulation is named as pollution haven hypothesis (Cole and Elliott, 2003). In such circumstances, multinationals are encouraged to
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make investment in those countries which have relaxed environmental policies to enhance their production. This scenario provides opportunities to multinationals for reaping full advantage of reduced cost of production and it is termed as industrial flight hypothesis (Asghari, 2013). Anyhow, relaxed environmental policies as well as reduced cost of production are sources of environmental degradation in host country. Contrarily, FDI comes with advanced and energy efficient technology and works under better management practices that leads to improve environmental quality in host country. This is termed as pollution halo hypothesis. FDI affects economic growth which affects energy consumption and hence carbon emissions in host country (Shahbaz et al., 2015). If multinationals or foreign investors employ advanced technologies for production process then FDI declines energy intensity and lowers CO2 emissions otherwise FDI impedes environmental quality by increasing carbon emissions due to use of energy intensive technology. The relationship between FDI and carbon emissions via income or energy consumption is discussed and empirically investigated in various studies in existing literature but results are inconclusive (Omri and Kahouli, 2014; Shahbaz et al., 2015). This ambiguity in empirical evidence on FDI-emissions nexus provides rational for reinvestigating association between FDI and carbon emissions for reliable and consistent empirical analysis. In doing so, this study fills the gap by investigating the relation between FDI, CO2 emissions by incorporating role of economic growth for Pakistan. Industrial sector is a major contributor in GDP of Pakistan. The expansion in industrial sector leads energy demand which is major source of CO2 emissions (Shahbaz et al., 2015). Pollution emissions is mainly associated with industrial sector. Further, FDI inflow to Pakistan is increasing may also be a source of CO2 emissions. FDI may affect CO2 emissions via scale, technique and composition effects. Thus, this study offers the solution to check all possible channels to overcome environmental pollution for Pakistan. Beauty of the study is to decompose the total environmental effect of FDI into three techniques, namely technique, scale and composition effects. FDI affects carbon emission via income is termed as income or scale effect. FDI may affects carbon emissions via changing structure of an economy i.e. shift of economy from agriculture to industry and then industry to services is called composition effect. FDI helps host country in adopting advanced technology which may affect carbon emissions is termed as technique effect. This study is inspired by recent studies (for example, Zhang and Zhou, 2016; Shahbaz et al., 2015) to investigate the relation between CO2 emissions, economic growth and FDI for Pakistan. The spurious problem may be found due to omission of relevant variables. This issue is covered by adding additional independent variables such as stock of capital, renewable waste and labor force. For empirical analysis, we have employed three stage least square (3SLS) to solve a simultaneous equations system. The 3SLS is more efficient as compared to 2SLS as 3SLS allows correlation between unobserved disturbances across various equations to be used in the analysis. Thus, 3SLS has been used because of its advantages. Rest of the paper is structured in different sections as: Section 2 is for brief literature review, section 3 for data and method, section 4 is for results and discussion while section 5 concludes the paper policy. 2. Brief literature review There are two different arguments regarding effect of FDI on environmental quality of the host country. At one side, it is considered to have positive effect on the host country environment (Liang, 2006) on the other side, it is argued that although FDI accelerates the process of economic growth but it may also generate a negative spillover effects on environment of the host countries
(Xing and Kolstad, 2002; He, 2006; Tang and Tan, 2014). Similarly, Kivyiro and Arminen (2014) find that CO2 emissions, FDI, economic development and energy consumption move in the same direction in the long run in Sub-Sahara Africa. Omri et al. (2014) also find bidirectional causality between economic growth and FDI flows and CO2 emissions and FDI, indicating that FDI may exert adverse effect on the host economy. The studies focusing on Gulf Cooperating Council and five ASEAN countries reveal that economic growth and energy consumption are the sources of pollution emission whereas FDI flows have no role in pollution emission (Almulali and Tang, 2013; Chandran and Tang, 2013). Therefore, the effect of FDI inflows on the host country's environmental pollution has always been one of the most controversial issues till date and there is little to focus for Pakistan's economy. Developing countries deliberately underrate the environmental standards to attract foreign investors. Therefore, generally, to get benefit of the few stringent environmental policies, foreign investors shift their operations to the less developed countries (Mabey and McNally, 1999). On other hand, it is also possible that multinational corporations (MNC) use more environment friendly and advanced technologies along with better management and operational practices in the production process. Hence, FDI contributes positively in reducing the host country environmental pollution intensities (Zarsky, 1999). Existing energy economics literature discusses the relationship between environmental pollution and FDI both in cross-country and inter-country framework (Porter and Van der Linde, 1995; Eskeland and Harrison, 2003; Henderson and Millimet, 2007; Lee, 2013; Shahbaz et al., 2015). However, results remain controversial. Literature shows relationship between all these variables like a study conducted by Cole et al. (2011) in China report that there is a U-shaped relationship between per capita pollution emissions and income, economic development also lead to an increase in industrial emissions. He (2006) used panel data to test economic growthenvironment relationship by employing simultaneous equation approach by constructing five equations in a system of equations to find out the effect of FDI on pollution emissions. The decision of FDI entry depends on the economic growth of last period and stringency of the environmental regulations. The results in this study support the pollution haven hypothesis while the effect of environmental stringency affects the FDI inflows modestly. The nexus between pollution and FDI becomes more complicated when theoretical considerations are related to three economic considerations namely the scale effect, technique effect and composition effect. Basically the entry decision is mostly based on the scale of economic growth in the host country. On other hand, pollution halos hypothesis exists in the case when domestic firms are more pollution intensive as compared to multinational firms because these multinational firms use more environmental friendly technologies and cleaner and advanced production methods which result in an improved environmental management systems (Cole et al., 2008; Eskeland and Harrison, 2003). 3. Material and methods Annual data has been used for the period of 1980e2014 in the present study. Data on real GDP (US million dollar), per capita GDP (Us dollar), population density (number of persons per square km) and foreign direct investment (US million dollars) are taken from different issues of Economic Survey of Pakistan. We used two indicators of pollution due to data availability on these variables. They include CO2 emissions and renewable waste. Renewable waste comprises waste (metric tons) from energy consumption in industrial sector. Data on CO2 emissions (metric tons), renewable waste (metric tons), road and railway lengths (km) are taken from
K. Bakhsh et al. / Journal of Environmental Management 196 (2017) 627e632
World Development Indicators. Data on capital stock is from the Next Generation of Penn World Table (Feenstra et al., 2013). Labor force participation rate is taken from the different issues of the Labor Force Survey of Pakistan. Human capital is measured as the percent of total population with literacy rate and this information is collected using different issues of publications of Pakistan Bureau of Statistics. All data is converted into log form to make it smooth and easy to interpret. Simultaneous equation model is used for empirical purpose. For the estimation of simultaneous equation model, 3SLS is used as it is more efficient than 2SLS. Reason is that the 3SLS allows correlation between unobserved disturbances across various equations to be used in the analysis. Three stage least squares estimates are more consistent and asymptotically normal, and, under some conditions, asymptotically more efficient than single equation estimates. Indeed it is the combination of multivariate regression and two stage regression (Zellner and Theil, 1962). Thus, 3SLS method has been adopted for the present study because of its advantages [see Bao et al. (2010) for more details]. FDI affects environment of the host country through different channels like scale effect (GDP), technique effect (tech) and composition effect (comp) [see Liang (2006)]. In the empirical analysis, we decompose pollution emissions into following three effects.
POL ¼ GDP þ TECH þ COMP
(1)
To measure scale effect, physical capital stock (KS) is used while the ratio of industrial output to GDP is used to measure composition effect. Finally, for the technique effect the ratio of total pollution emissions to the industrial output is used. In order to study the scale effect of foreign direct investment, we investigate how foreign direct investment affects economic growth via stimulating the domestic physical capital accumulation. Effect of FDI on economic scale is estimated using Equation (2):
GDP ¼ a0 þ b1 FDI þ b2 K þ b3 L þ b4 H þ b5 POL þ 3 t
(2)
Here GDP is real GDP, FDI is foreign direct investment, K is stock of capital, L is labor force, H is human capital, POL is pollution emissions. a0 is constant, b1 to b5 are the parameters to be estimated, 3 t is white noise error term. Pollution emissions coefficient is expected to have negative sign because of its damaging effect and its cost to recover the damage. FDI directly affects the economic growth (Cole et al., 2011) and indirectly, it increases the physical capital stock in the country (Zhang et al., 2004). Indirect effect of foreign direct investment on economic growth is determined by Equation (3).
K ¼ b0 þ b1 FDI þ b2 ðGDPt1 Þ þ 3 t
(3)
GDP is with one period lagged value to show how much, economic growth and economic environment imbalance affects the accumulation of capital. FDI is foreign direct investment that also influences the stock of capital of an economy. Equation (4) was used for technique effect.
TECH ¼ a0 þ b1 FDI þ b2 PD þ b3 GDP þ 3 t
(4)
Here TECH is for technique effect that is measured as a ratio between pollution emissions per unit of industrial output, FDI is foreign direct investment, GDP is GDP per capita, PD is population density. Consequently, it increases the damage cost and recovering that cost negatively affects output. As GDP per capita increases the demand for improved air quality, clean habitat and clean water also rises for maintaining a quality life. An increase in economic activity raises per capita income, causing an increase in demand for a cleaner environment. Further, a higher GDP per capita also shows
629
an increased capacity of an economy to allocate its resources for the purpose of environmental protection and pollution abatement (Grossman and Krueger, 1995; Pao and Tsai, 2010). To examine this, we estimate composition effect employing Equation (5):
COMP ¼ a0 þ b1 FDI þ b2 K þ b3 GDP þ b4 road þ b5 rail þ 3 t
(5)
Ratio of industrial output to GDP is used for composition effect. Higher physical capital stock causes an increase in the industrial output that causes pollution. The effect of GDP per capita on dependent variable is twofold: first, a higher GDP per capita is a signal to show the process of industrialization in an economy and second, it also shows that people have an increased demand for a cleaner environment. Two infrastructure variables road and rail length are used to find out the contribution of infrastructure in boosting the process of industrial activities. Different factors influence FDI in a country and these factors can be time and country specific. The present study also estimates these factors affecting FDI in Pakistan. The determinants of FDI are estimated using Equation (6).
FDI ¼ a0 þ b1 FDIt1 þ b2 road þ b3 rail þ b4 POLt1 þ 3 t
(6)
To avoid the endogeneity and estimate self-accumulation of FDI, one period lag of FDI is introduced in the model. Variables road and rail are included to show infrastructure effect on FDI while POL is the amount of pollution determining the impact of decision to invest in Pakistan. Thus, to sum up, to estimate the effect of pollution on foreign direct investment the above (1e6) system of equations was developed where first Equation (1) is decomposed into three effects, namely scale effect, technique effect and composition effect. Scale effect can be seen in Equations (2) and (3) while technique and composition effect is in Equations (4) and (5) respectively. As stated above, Equation (6) serves for the determinants of FDI. There are two ways through which foreign FDI affects pollution emissions. First is the direct as shown through scale, technique and composition effects. Indirect effect is through the channel of GDP per capita and through increasing the physical capital of the host country. Then this increased physical capital again exerts an impact on pollution emissions through composition and scale effect.
4. Results and discussion For estimating the effect of FDI on economic growth and pollution emissions, we employed 3SLS. Considering empirical methods, Equation (1) is identity. Therefore, we cannot estimate it directly. We estimated five Equations (2)e(5) in the model using 3SLS to cover this issue. Scale effect results are reported in Table 1. We find that physical capital, labor force and human capital play an important role in the domestic production and hence, economic growth. In case of renewable wastes, the impact of foreign direct
Table 1 Estimates of scale effect. Variables
GDP Pollution
Renewable waste
CO2 Emissions
Constant FDI K L H POL R2
6.29 (0.06)* 0.06 (0.19) 0.11 (0.00)* 0.69 (0.26)* 1.79 (0.00)* 2.15 (0.00)* 0.89
1.08 (0.72)*** 0.26 (0.06)* 0.74 (0.05)* 0.24 (0.64) 0.91 (0.00)* 0.32 (0.00)* 0.81
9.54 (0.00)* 0.35 (0.00)* 0.66 (0.01)* 2.07 (0.00)* 0.25 (0.55) 2.16 (0.00)* 0.83
Standard errors are in parentheses. * and *** show 1 and 10% level of significance.
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investment is negative and statistically significant. Industries generating renewable waste but having no facility to recycle can cause an increase in overall pollution in the country. This increase in overall pollution causes significant reduction in economic growth of the country. Increased pollution causes environmental degradation as it has been estimated that environmental degradation costs for Pakistan's economy is more than PakRS 365 billion every year, out of this, the cost for the air pollution in urban areas is PakRS 65 billion. Some also argue that environmental degradation cost has already exceeded PakRS 450 billion (GOP, 2014). All the economic sectors especially industrial sector in Pakistan are open to FDI. There is a universal consensus on a positive relationship between economic growth of the host country and FDI. However, in case of Pakistan, weak institutional structure and less stable political scenario may be the reasons behind weak/or even negative relationship between economic growth and FDI. Besides this, there is a complimentary relationship between human capital and foreign direct investment and its effect on economic growth. So in a country with weak human capital development, FDI relation with economic growth is negative. Foreign direct investment causes an increase in economic growth in the case when host countries have some certain characteristics like improved level of education and possess skilled human resources (Zhang, 2001). Lee (2013) also provides the evidence of unidirectional causality from FDI to economic growth and from economic growth to CO2 emissions whereas on contrary Omri et al. (2014) show an evidence of a bidirectional causal link between FDI inflows and CO2 emissions and between economic growth and FDI inflows. FDI increases pollution which shows that technique effect is unable to curb CO2 emissions due to adoption of obsolete technology during production process. This incurs negative effect on economic growth in long-run (Jayanthakumaran et al., 2012). In case of renewable waste and overall pollution, the labor force shows an insignificant effect which means that in Pakistan labor force is not too skilled to influence the economic growth significantly. But, its highly negative and significant coefficient in case of CO2 emissions manifests its efficient participation in industrial sector. The variable of total pollution consists of a combined effect of both renewable wastes and CO2 emissions in Equations (2) and (3). FDI shows a negative and significant relation with the economic growth both in case of renewable wastes and CO2 emissions. Perhaps domestic institutional structure is not developed adequately and there may be the reason of unskilled labor (Ataullah and Le, 2004). Diffusion of technology associated with foreign direct investment is measured by the absorption capacity of the host country which further depends on the intensity of human capital (Fu, 2008). We measure human capital as percentage of total population with literacy rate as done by Fu (2008). Increase in CO2 emissions causes a significant increase in economic growth of the country. In developing country like Pakistan, the relationship is reverse because renewable waste serves as an input in the production process and can incur a significant effect on the economic growth of the country but in the present study, negative sign of its coefficient shows that the waste is being absorbed in the environment. This renewable waste includes liquid bio-fuels, biogases, municipal waste, charcoal, primary solid bio-fuels, and industrial waste. The variable of pollution is showing a negative and significant effect on economic growth while CO2 emissions has a positive effect on economic growth. This can be an increase in industrial sector at a fast pace making the effect of CO2 emissions on economic growth as negative. Table 2 explains the capital accumulation effect of foreign direct investment in Pakistan. In all three cases the relationship of FDI with capital accumulation is significantly positive. It
Table 2 Estimation results of capital accumulation effect. Variables
Constant FDI GDPt-1 R2
K Pollution
Renewable waste
CO2 emission
6.35 (0.00)* 0.39 (0.00)* 0.02 (0.06)* 0.91
0.67 (0.00)* 2.16 (0.00)* 13.17 (0.07)* 0.85
6.45 (0.00)* 0.39 (0.00)* 0.01 (0.05) 0.91
Standard errors are in parentheses. * show 1% level of significance.
(0.0546 þ 0.3917*0.1088 ¼ 0.013) shows the total scale effect of FDI on economic growth in case of pollution. Previous growth affects the present physical capital accumulation and to elicit this effect, lagged values of economic growth are also added. So the impact of previous year economic growth of physical capital accumulation is positive and statistically significant in Pakistan. Table 3 explains the results of technique effect. There is a positive relation between pollution emissions and flow of FDI in the host country (Lan et al., 2012). The results show that marginal pollution damage increases with an increase in FDI. While in the case of CO2 emissions, there is a negative and significant relationship between FDI and marginal pollution damage. This significant effect is because foreign investors do not follow appropriate strategies for pollution abatement. Increase in FDI causes an increase in marginal pollution damage in case of renewable wastes. The negative sign of the population density shows that marginal pollution damage increases as a result of an increase in population density which requires strict pollution regulation measures to cope with. GDP per capita shows a different impact in all three kinds of pollutants. In case of pollution as GDP per capita increases the marginal pollution damage decreases, showing with an increase in GDP per capita people become more aware about the damages of pollution and try to combat. The case of renewable wastes shows a positive impact of GDP per capita on marginal pollution damage because when an economy is at the turning point of moving completely towards industrialization it remains unaffected by the environmental damages caused by the increased economic activity (Yandle et al., 2002). While in the case of CO2 emissions the variable has positive coefficient which shows that an increase in GDP per capita causes a decrease in marginal pollution damage. This impact on CO2 makes the overall combined effect negative. Policies in Pakistan generally don't consider the effects of renewable wastes and it is assumed that it can be recycled later on. So an increase in per capita GDP causes an increase in renewable wastes without considering its detrimental effects. Table 4 illustrates the results of composition effect for pollution, CO2 emissions and renewables wastes. In case of overall pollution, an increase in foreign direct investment affects share of industrial output in overall economy positively but this relationship is insignificant. In case of CO2, this impact is significantly positive. The variable K shows an increase would lead towards a significant share of the industrial output in the overall economy because the
Table 3 Estimation results of technique effect. Variables
tech Pollution
Renewable waste
CO2 emission
Constant FDI PD GDP R2
17.23 (0.00)* 0.01 (0.72) 3.60 (0.00)* 0.02 (0.07) 0.99
0.93 (0.80) 0.46 (0.00)* 2.79 (0.00)* 1.69 (0.00)* 0.84
13.95 (0.00)* 0.09 (0.01)* 3.54 (0.00)* 0.59 (0.05)** 0.98
Standard errors are in parentheses. * show 1% level of significance.
K. Bakhsh et al. / Journal of Environmental Management 196 (2017) 627e632 Table 4 Estimation results of composition effect. Variables
Constant FDI K GDP road rail R2
Table 6 Various effects of FDI on pollution in the country.
comp
Variables
Pollution
Renewable waste
CO2 emission
2.99 (0.53)* 0.06 (0.44) 0.73 (0.01)* 1.15 (0.00)* 0.21 (0.12)** 0.55 (0.29)* 0.92
19.63 (0.02)* 0.51 (0.72) 1.19 (0.02)* 0.58 (0.00)* 1.01 (0.00)* 3.76 (0.00)* 0.96
0.53 (0.07)* 0.16 (0.00)* 0.34 (0.04)* 1.06 (0.00)* 0.16 (0.01)* 0.19 (0.14)*** 0.96
Standard errors are in parentheses. *, ** and *** show 1, 5 and 10% level of significance, respectively.
Table 5 Estimation results of the determinants of FDI. Variables
Constant FDIt-1 road rail POLt-1 R2
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FDI Pollution
Renewable waste
CO2 emission
42.60 (0.03)* 0.34 (0.03)* 0.68 (0.20)* 2.35 (0.16)* 1.45 (0.01)* 0.89
7.82 (0.07)* 0.71 (0.00)* 0.55 (0.42) 0.34 (0.86) 1.93 (0.06)* 0.90
46.78 (0.00)* 0.22 (0.06)* 0.61 (0.09)* 0.45 (0.00)* 0.00 (0.00)* 0.91
Standard errors are in parentheses. * show 1% level of significance.
industrial sector is both more pollution intensive as well as capital intensive. With the more use of imported technology in industries, the capital labor ratio would increase, resulting in more industrial output share in the overall economy (Kalim, 2001). Considering infrastructure, rail length shows a significant negative relationship with industrial output share. The road length has a significant positive effect. But, overall composition effect of FDI on industrial composition is insignificant. This shows a negative effect of an increase in FDI on industrial composition of the economy and this is mainly due to increase in pollution as FDI increases. Table 5 reveals the estimation results of the determinants of FDI. The accumulation effect of FDI due to which more foreign investors are attracted is shown through FDIt-1. This shows that the previous year's investment causes a significant increase in current year's FDI. The rail and road variables show a positive effect, describing the importance of infrastructure attracting FDI. Lagged value of pollution shows the feedback impact on FDI which is positive and significant. Table 6 is constructed using Bao et al. (2010) formulas1 where total effect, scale effect, technique effect and composition effect are determined as are shown in Table 6. The total effect shows a negative scale effect while positive technique and composition effects. The effect of capital accumulation is positive on FDI and it emphasizes the importance of capital accumulation effect, being one of the most important determinants. This coefficient shows how FDI affects capital accumulation while in return capital accumulation exerts a positive impact on economic activity through scale effect and it also affects positively on industrial output. FDI causes an increase in capital accumulation but along with this, the level of pollution also increases in the country. While on the other hand technique and composition effects show respectively that increase in the economic growth of the country leads towards more pollution emissions. Rise in per capita income leads towards increased demand for
1 To conserve the space, we did not repeat the formulas from Bao et al. (2010). However, are available on request.
Total effect Scale effect Technique effect Composition effect
FDI Pollution
Renewable waste
CO2 emission
0.47 1.02 1.01 1.47
2.88 2.25 1.02 1.79
0.95 2.14 1.63 2.56
pollution abatement as evident by technique effect. It is also confirmed through the coefficient of GDP per capita in case of composition effect. The feedback effect of pollution emissions on economic growth is shown in scale effect. It indicates its negative effect on economic growth because with increase in pollution, economic growth increases at first stage but with the passage of time the pollution abatement cost causes a decrease in economic growth. This scale effect further affects technique and composition effects and total feedback effect can be measured (see Bao et al., 2010 for details). The scale effect is always negative when a country does not consider the environmental regulations and management while progressing economically (Mahmood and Chaudhary, 2012). The negative scale effect in this study shows that in case of increase in FDI, the GDP decreases and this is exactly opposite to the results of Bao et al. (2010). The indirect effect of FDI on capital accumulation is positive but in scale effect it becomes negative due to effect of pollution on economic growth and several other factors. The direct technique effect is reported in Table 3 while Table 6 shows indirect effect. The calculation of indirect technique effect requires the knowledge of the effect of economic development on pollution emissions and the effect of FDI on economic growth. Both of these effects are measured by the effect of GDP per capita on marginal pollution damage and by the effect of FDI on GDP in scale effect. Composition effect is positive, showing that overall FDI increases the share of industrial sector in GDP. Total effect in case of overall pollution is positive. But in case of renewable waste and CO2 emissions, it is negative. It means there may be some other pollutants which contribute positively and make the overall impact positive. Scale and technique effects are positive only in case of renewable wastes. Composition effect is positive in case of CO2 emissions and overall pollution.
5. Conclusion This study finds several interesting results of impact of FDI on environmental pollution in Pakistan through the channels of scale effect, technique effect and composition effect. The overall scale effect technique shows that physical capital stock and labor have positive and significant effects on gross domestic product and effect of pollution is negative. FDI has negative and significant impact on CO2 emissions and renewable waste. In composition effect, road length and capital stock are positively related with CO2 emissions whereas GDP per capita has negative effect. The study also finds a positive relation of pollution emission to FDI, favoring existence of pollution haven hypothesis in Pakistan. The present study provides important policy implications for controlling pollution emission, particularly relating to FDI in Pakistan. Presently the Government of Pakistan provides incentives to foreign investors in order to attract FDI at the cost of environmental pollution and again there is no doubt that FDI plays an important contribution in the economy of any developing country like Pakistan. Findings of the study reveal that the host country should also consider adverse effects of FDI on environmental
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quality. Environmental degradation causes a decline in economic activities in the long-run. Thus, it is more imperative for the host country to attract investments generating more technique effects in the host country. This can help achieving objectives of growth and development of the host country. The host country like Pakistan have to strictly implement environmental rules and regulations to foreign and domestic firms, such as establishing proper waste management plants in industry and defining permits on CO2 emissions. Role of regulators needs to be strengthened by making institutions strong for proper implementation of environmental laws to curb environmental pollution in the country. Further, the host country should promote environmental friendly technology in the production process among domestic and foreign investors. Funding This research did not receive any specific grant from funding agencies in the public, commercial, or non-for-profit sectors. Acknowledgements We would like to thank Dr. Apostolos P Kyriazopoulos, and three anonymous reviewers for their constructive and valuable comments and suggestions in preparing this final version of the manuscript. Appendix A. Supplementary data Supplementary data related to this article can be found at http:// dx.doi.org/10.1016/j.jenvman.2017.03.029. References Afza, T., Khan, M.M.S., 2009. Greenfield in Pakistan: is it really green? An empirical investigation. Am. J. Sci. Res. 4, 59e71. Akhtar, M.H., 2000. The determinants of foreign direct investments in Pakistan: an econometric analysis. L. J. Econ. 5, 1e23. Alfaro, L., Chanda, A., Kalemli-Ozcan, S., Sayek, S., 2010. Does foreign direct investment promote growth? Exploring the role of financial markets on linkages. J. Dev. Econ. 91, 242e256. Al-mulali, U., Tang, C.F., 2013. Investigating the validity of pollution haven hypothesis in the gulf cooperation council (GCC) countries. Energy Policy 60, 813e819. Asghari, M., 2013. Inward FDI, growth and environmental policy. Int. J. Sci. Res. Knowl. 1, 288e298. Available online. www.ijsrpub.com/ijsrks. Ataullah, A., Le, H., 2004. Financial repression and liability of foreignness in developing countries. Appl. Econ. Lett. 9, 545e549. Bao, Q., Chen, Y., Song, L., 2010. Foreign direct investment and environmental pollution in China: a simultaneous equations estimation. Environ. Dev. Econ. 16, 71e92. Bustos, P., 2007. FDI as a Source of Finance in Imperfect Capital Markets, Firm-level Evidence from Argentina. CREI and Universitat Pompeu Fabra. Available online. http://www.cemfi.es/~bustos/FDI_and_external_finance.pdf. Chandran, V.G.R., Tang, C.F., 2013. The impacts of transport energy consumption, foreign direct investment and income on CO2 emissions in ASEAN-5 economies. Renew. Sust. Energy Rev. 24, 445e453. Cole, M.A., Elliott, R.J., Strobl, E., 2008. The environmental performance of firms: the role of foreign ownership, training, and experience. Ecol. Econ. 65, 538e546. Cole, M.A., Elliott, R.J., 2003. Determining the tradeeenvironment composition effect: the role of capital, labor and environmental regulations. J. Environ. Econ. Manag. 3, 363e383. Cole, M.A., Elliott, R.J.R., Zhang, J., 2011. Growth, foreign direct investment, and the environment: evidence from Chinese cities. J. Reg. S. C. 51, 121e138. Desbordes, R., 2010. Global and diplomatic political risks and foreign direct investment. Econ. Polit. 22, 92e125. Eskeland, G.S., Harrison, A.E., 2003. Moving to greener pastures? Multinationals and the pollution haven hypothesis. J. Dev. Econ. 1, 1e23. Feenstra, R.C., Robert, I., Marcel, P.T., 2013. The Next Generation of the Penn World Table. Fu, X., 2008. Foreign direct investment, absorptive capacity and regional innovation
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