An Empirical Study of the Relationships between CO2 Emissions, Economic Growth and Openness

Transcription

1 DISCUSSION PAPER SERIES IZA DP No An Empirical Sudy of he Relaionships beween CO2 Emissions, Economic Growh and Openness Eunho Choi Almas Heshmai Yongsung Cho November 2010 Forschungsinsiu zur Zukunf der Arbei Insiue for he Sudy of Labor

2 An Empirical Sudy of he Relaionships beween CO2 Emissions, Economic Growh and Openness Eunho Choi Korea Universiy Almas Heshmai Korea Universiy and IZA Yongsung Cho Korea Universiy Discussion Paper No November 2010 IZA P.O. Box Bonn Germany Phone: Fax: Any opinions expressed here are hose of he auhor(s) and no hose of IZA. Research published in his series may include views on policy, bu he insiue iself akes no insiuional policy posiions. The Insiue for he Sudy of Labor (IZA) in Bonn is a local and virual inernaional research cener and a place of communicaion beween science, poliics and business. IZA is an independen nonprofi organizaion suppored by Deusche Pos Foundaion. The cener is associaed wih he Universiy of Bonn and offers a simulaing research environmen hrough is inernaional nework, workshops and conferences, daa service, projec suppor, research visis and docoral program. IZA engages in (i) original and inernaionally compeiive research in all fields of labor economics, (ii) developmen of policy conceps, and (iii) disseminaion of research resuls and conceps o he ineresed public. IZA Discussion Papers ofen represen preliminary work and are circulaed o encourage discussion. Ciaion of such a paper should accoun for is provisional characer. A revised version may be available direcly from he auhor.

3 IZA Discussion Paper No November 2010 ABSTRACT An Empirical Sudy of he Relaionships beween CO2 Emissions, Economic Growh and Openness This paper invesigaes he exisence of he environmenal Kuznes curve (EKC) for carbon dioxide (CO2) emissions and is causal relaionships wih economic growh and openness by using ime series daa ( ) from China (an emerging marke), Korea (a newly indusrialized counry), and Japan (a developed counry). The sample counries span a whole range of developmen sages from indusrialized o newly indusrialized and emerging marke economies. The environmenal consequences according o openness and economic growh do no show uniform resuls across he counries. Depending on he naional characerisics, he esimaed EKC show differen emporal paerns. China shows an N-shaped curve while Japan has a U-shaped curve. Such dissimilariies are also found in he relaionship beween CO2 emissions and openness. In he case of Korea and Japan i represens an invered U- shaped curve, while China shows a U-shaped curve. We also analyze he dynamic relaionships beween he variables by adoping a vecor auo regression or a vecor error correcion model. These models hrough he impulse response funcions allow for analysis of he causal variable s influence on he dynamic response of emission variables and i adops a variance decomposiion o explain he magniude of he forecas error variance deermined by he shocks o each of he causal variables over ime. Resuls show evidence of large heerogeneiy among he counries and variables impacs. JEL Classificaion: C32, F18, F43, N55, O13, Q56 Keywords: carbon dioxide (CO2), environmenal Kuznes curve (EKC), economic growh, free rade, developmen Corresponding auhor: Almas Heshmai Deparmen of Food and Resource Economics College of Life Sciences and Bioechnology Korea Universiy Eas Building, Room 217 Anam-dong Seongbuk-gu Seoul, Korea heshmai@korea.ac.kr

4 1. Inroducion Improvemens in economic growh and welfare can affec he ypes of echnological and financial opporuniies used o avoid and manage environmenal problems. In his siuaion, i is ineresing o know wheher economic growh and environmenal preservaion can coincide or no. In general, environmenal goods and heir qualiy are normally good, denoing ha increased earnings from free rade would increase an individual s demand for higher environmenal qualiy. In he early sage of economic developmen, a small porion of excess income is ypically allocaed for environmenal problems, and hus, a his sage, he indusrializaion process is likely o be accompanied by environmenal problems. When GDP per capia increases and exceeds a cerain hreshold, he level of polluion ypically decreases. This combined effec can resul in an invered U-shaped relaionship beween GDP per capia and he level of polluion. This invered U-shaped relaionship beween GDP per capia and various indicaors of polluion is referred o as he environmenal Kuznes curve (EKC), which was inroduced by Kuznes (1955). This hypohesis, which suggess a U-shaped or invered U-shaped relaionship beween wo variables, implies a non-linear relaionship ha is applicable o many areas. A number of sudies have examined he environmenal consequences of rade liberalizaion and economic growh in recen decades. Furhermore, he climae change phenomenon, which has been an imporan research opic in recen years, has been considered o be one of he mos imporan consequences of he global energy sysem and use. Carbon dioxide (CO2) accouns for he larges porion of greenhouse gas emissions and is a major source of environmenal problems. Thus, i is meaningful o examine he causal relaionships beween environmenal polluion, rade liberalizaion, and economic growh. By applying EKC heory, previous sudies have provided a beer undersanding of he environmenal consequences of inernaional rade and suggesed ha economic growh can improve he environmen and ha economic growh is necessary for mainaining or improving he qualiy of he environmen. However, mos of he previous sudies have no aken ino accoun he differen levels of income across counries. In his regard his sudy is an aemp o remedy his limiaion by focusing on comparing he relaionships beween CO2, rade liberalizaion and economic growh by accouning for level of developmen. According o he EKC concep, CO2 emissions are expeced o have a posiive relaionship wih he level of income or rade liberalizaion before he EKC hreshold and hen a negaive relaionship beyond he hreshold. For example, if here is a negaive relaionship beween CO2 emissions and free rade, hen GHG emissions are likely o decrease as he counry becomes more exposed o open markes. Similarly, if here is a posiive relaionship beween CO2 emissions and free rade, hen he counry is no likely o have experienced is opimal level of rade liberalizaion. The EKC framework implies he exisence of an invered U-shaped relaionship beween GDP per capia and environmenal degradaion o be a local polluan. However, he exisence of he EKC for he global polluan, for example carbon dioxide emissions resuling in problems of inernaional scale, has no been agreed. There are differen views relaing o EKC. Galeoi e al. (2006) explained ha empirical sudies for he EKC hypohesis for CO2 emissions are a bes mixed. Even hough we canno find an 2

5 EKC curve for CO2 emissions being evidence of susainable developmen, we can find anoher way of susainable developmen hrough inernaional cooperaion. Munasinghe (2008) suggesed ha he hypohesis of susainomics can be he key o green growh and insised ha developing counries can achieve heir arge economic growh while mainaining a lower polluion level. Figure 1 illusraes he posiion of counries a differen sages of heir developmen on he EKC. Figure 1: Tunneling hrough he EKC using inernaional cooperaion and susainable policies. Munasinghe (2008) insised on he usefulness of he unnel effec, which may enable developing counries o aain heir arge economic growh while mainaining a lower level of polluion. Suppose ha developing counries lie on Poin B in Figure 1, hen hese counries can move o Poin C by using clean echnologies and developing and implemening susainable developmen policies. Alhough i is difficul o faciliae he global polluan o follow his pahway, we can expec a lower rae of increase han from poin B o F. Furher, if developed counries no only provide financial suppor o emerging markes and newly indusrialized counries o help hem cope wih environmenal degradaion, bu also ransfer heir environmen-friendly echnologies o hose counries, he poorer counries may be able o shif from Poin D o Poin E, which is he basic concep behind he unnel. The empirical resuls of his sudy are based on daa from China, Korea and Japan. These counries, represening he Norheas Asian region, reflec differen levels of economic developmen and have achieved considerable economic developmen. In addiion o invesigaing he exisence of EKC relaionships, his sudy examines he dynamics relaionships among hree variables CO2 emissions, openness, and GDP per capia by using vecor auo regression (VAR) and vecor error correcion model (VECM). These models, which use impulse response ess and variance decomposiion funcions, allow for he analysis of he inerrelaionships among various variables and enable he deerminaion of he variables wih sronger effecs. This sudy is unique in ha i esimaes he EKC by aking he evaluaion and policy perspecives for an ineresing sample of counries. The uniqueness of his sudy is ha i esimaes he environmenal Kuznes curve, from evaluaion and policy perspecives, 3

6 for an ineresing sample of counries. I focuses on he rend of CO2 emissions of each counry and ries o analyze is relaionships wih openness and GDP per capia condiional on specific, growh, openness and oher characerisics. Such a mehod allows for he posiioning of counries on he EKC. The resuls indicaing heir posiion before and afer he urning poin have imporan implicaions for heir growh and environmenal policy. Deermining he exisence of he EKC for CO2 as a global polluan is imporan. If developed counries have an invered U-shaped curve, i is likely ha he global polluan can be reduced hrough inernaional cooperaion and financial suppor. Therefore, his sudy focuses on he exisence of he EKC for China, Korea, and Japan. Figure 1 illusraes he hree counries economic developmen levels and heir posiions on he EKC. Noe ha China, Korea, and Japan represen an emerging marke, a newly indusrialized counry, and a developed counry, respecively, which reflecs he characerisics of he above hypohesis. The resuls of his case sudy have useful implicaions for developing and implemening appropriae policies for realizing he unnel effec. The res of his paper is organized as follows. Secion 2 provides a brief review of previous research on he EKC, and Secion 3 presens he daa. Secions 4 and 5 specify he relaionships beween environmenal qualiy, economic growh, and openness by considering counry characerisics and echnologies. Secion 6 presens he dynamic esimaion resuls obained using he VAR and VECM mehods and he resuls of a number of ess ha examined he properies of he daa and model specificaions, and Secion 7 provides some appropriae policy recommendaions based on he empirical resuls and concludes. 2. The Lieraure on he Environmenal Kuznes Curve An analysis of susainable economic growh and developmen requires careful consideraion of he environmenal consequences of such developmen. Previous sudies examining he nexus causal relaionships beween he environmen, rade liberalizaion, and economic growh have sressed he need for furher research in his area. We now provide a brief review of he growing body of lieraure invesigaing his opic. 2 Grossman and Krueger (1993) analyzed he relaionship beween environmenal qualiy and GDP per capia by focusing on he level of urban air polluion o esimae he urning poin for he amospheric concenraion of suspended paricular maer (SPM) and sulfur dioxide (SO2). They proposed ha air polluion can improve when GDP per capia increases o sufficien levels. They esimaed he urning poin o be $4,000~5,000 (in 1985 U.S. dollars). This is he poin a which people ypically become concerned abou he qualiy of heir environmen. If GDP per capia is approximaely $10,000, people may become involved in a number of aciviies o improve heir environmen, and hus, he qualiy of heir environmen is likely o improve considerably. Seldon and Song (1994) analyzed he relaionship beween income and air polluans by using fixed and random effec models wih panel daa. In conras o 2 The mehodology has been exended o oher ypes of causal relaionships such as GDP growh, inequaliy and povery (e.g. Heshmai, 2006). 4

7 Grossman and Krueger s urning poin (i.e., $5,000 or less for SPM and SO2), heir urning poin for hese polluans is greaer han $8,000. They found ha nirogen oxides (NOx) and sulfur dioxide (SO2) have a Kuznes curve represening he exisence of a relaionship beween naional oupu and environmenal qualiy. Copeland and Taylor (1994) invesigaed he relaionship beween free rade and environmen qualiy and suggesed ha free rade has hree ypes of effecs on counries. The firs is he echnology effec in which increases in income increase he consumpion of environmenal goods. Free rade induces people s ineres in and undersanding of environmenal issues and people require effecive polluion conrol and managemen policies. Thus, he echnology effec hrough free rade is likely o improve he environmen. The second is he scale effec. Free rade can lead o increases in world rade volume, and each counry increases is oupu, which can in urn deeriorae he environmen. The hird is he composiion effec. Developing counries end o arac polluion-inensive indusries, and developed counries are likely o avoid such indusries o arac foreign direc invesmen. A decrease in polluion depends on he relaive size of he echnology and composiion effecs. Cole e al. (1997) invesigaed he relaionship beween GDP per capia and a wide range of indicaors by using cross-counry panel daa and suggesed ha meaningful EKCs exis only for local polluans. More global or indirec environmenal effecs end o increase monoonically wih income, which implies ha i is easier o improve urban air polluion han o reduce naional air polluion. They also suggesed ha concenraions of local polluans end o reach a urning poin a a lower level of GDP per capia and ha global air polluans are likely o reach a urning poin a a higher level of GDP per capia. A noeworhy sudy by Moomaw and Unruh (1997) examined he relaionship beween CO2 and he level of income in developed counries. They seleced 16 OECD member counries o invesigae he EKC. Mos of he counries showed an invered U-shaped rend, and heir urning poin occurred beween 1970 and Furhermore, by applying he cubic model specificaion o he 16 counries, hey deermined ha he N- shaped curves for all he esimaed coefficiens were saisically significan. The firs and second hreshold poins were beween $12,810 and $18,330. Friedl and Gezner s (2003) sudy showed ha boh linear and quadraic models were no suiable for analyzing he case of Ausria bu he cubic model can represen i more appropriaely. The relaionship beween GDP and CO2 emissions followed an N-shaped curve beween 1960 and Galeoi and Lanza (2003) verified he invered U-shape curve for he relaionship beween CO2 emissions and GDP. Huang e al. (2008) considered economic developmen and greenhouse gas (GHG) emissions, which have been he focus of he Kyoo Proocol. The Proocol aemps o limi increases in GHG emissions among developed counries. They analyzed singlecounry ime series and GDP daa and found ha mos of he Annex Ⅱ counries do no provide evidence supporing he EKC hypohesis. Akbosanci e al. (2009) invesigaed he relaionship beween income and environmenal degradaion in Turkey. By using a ime series model spanning from 1968 o 2003, hey found ha CO2 emissions and income end o have a monoonically increasing relaionship in he long run. This monoonically increasing relaionship implies ha he EKC hypohesis does no hold in his case. Galeoi e al. (2009) explained ha EKC is no found a all he imes relaing o CO2. Furhermore his paper makes a significan conribuion o he saisical 5

8 robusness of he EKC by giving a direcion. The auhors emphasize ha heoreical and empirical invesigaion is clearly organized before he exisence and validiy of he EKC is esablished. The review of previous research indicaes ha here are subsanial differences among he counries, suggesing ha he hypohesis of he Kuznes curve has a number of weaknesses ha need o be addressed. 3. The Daa The daa is an annual ime series aimed o be used in ime series regression analysis of hree counries, namely China, Korea and Japan. The daa spanned from 1971 o 2006 and conained he key variables CO2, GDP, and Openness and some informaion on he source of CO2 emissions and he variables underlying openness. CO2 emissions, measured in meric ons, were ransformed ino a per capia measure o adjus for he populaion size of he hree counries. GDP was measured as real GDP per capia. A counry-specific GDP deflaor was used o conver he moneary values ino fixed ones. Openness, a measure of rade liberalizaion, was measured as he sum of impors and expors as a share of oal GDP in a given year. The carbon dioxide emission variables are obained from Carbon Dioxide Informaion Analysis Cener (CDIAC). The source of Real GDP per capia and openness is he Penn World Table 6.3. A number of variables (RE, FOP and energy ype shares) are added o accoun for he naure of he energy sysem. RE is he conribuion of renewable energies and energy from wase. This daa is sourced from OECD daa. The FOP daa were drawn from he 2009 BP Saisical Review of World Energy. Through his source, we obained daa on he consumpion of oil (in million ons), naural gas (in million ons of oil equivalen), and coal (in million ons of oil equivalen). These hree variables were oaled for each counry and hen divided by he oal populaion of he counry o obain FOP (fossil consumpion per capia). Table1: Definiion and descripive saisics of he variables, China Korea Japan Variables Definiion Mean Sd. Dev Mean Sd. Dev Mean Sd. Dev CO2- emission CO2 emissions in M CO2 RE FOP CO2 / Populaion (on CO2/capia) Conribuion of renewable energies (%) Fossil consumpion/ capia x GDP Real GDP per capia OPEN The degree of openness

9 A summary of saisics in he annual ime series daa is presened in Table 1. Japan s emission per capia is he highes, followed by Korea and China. A similar paern is found concerning GDP per capia. China has a much higher share of renewable energy sources in is per capia energy consumpion, while Japan has a higher share of fossil consumpion per capia. Korea, followed by China, has a relaively higher dependency on an impored primary source of energy han Japan. Figure 2 shows he developmen of CO2 over ime in level and changes for he hree counries. Figure 2.A on he lef shows he developmen of he CO2 level over ime, while Figure 2.B on he righ shows he rends in he growh rae of oal carbon dioxide emissions of individual counries normalized a 1971 values. Figure 2.A and 2.B: The rends of carbon dioxide and is growh rae Generally, CO2 emissions end o increase. In Korea, here is a declining area in relaion o he Asian Financial Crisis bu CO2 emissions were on he rise again afer 1998 and in relaion o he recovery of he economy. A he beginning he level of CO2 was close in Japan and he economic reform in China changed he siuaion dramaically and by he end of he period in China he gap had increased by more han 6-fold. China also has he fases increasing rend bu we can find a slowdown and even sligh decline afer he Tiananmen square rios. The graph shows a rapid rise in he CO2 emissions since CO2 emissions flucuaed a lo in he case of Japan; however, is rend is slowly increasing, in paricular afer The Figure 2.B displays emission rends of hree sample counries joinly in he same graph normalized a 1971 values. The objecive is o enable a comparison of he level and is developmen concerning he relaive emission of each counry. Here he Figure 2.B shows ha he growh rae is much higher in Korea han in China, bu he gap has been shrinking since The growh in Japan is very low and he level is relaively consan during he enire period. 7

10 4. Empirical Analysis 4.1 Specificaion of Environmenal Kuznes curve We specify and esimae he environmenal Kuznes curve (EKC) based on CO2 emissions per capia for China, Korea and Japan o deermine wheher hese counries have an EKC. The resuls are expeced o have imporan implicaions for he counries as hey esablish environmenal arges for CO2 emissions. To verify he shape of he EKC, we specify and esimae he following muliple regression equaions for each counry: (1) (2) ln CO2 ln CO2 = α + α ln GDP + α (ln GDP ) 0 + α ln RE + α Trend + α ln FOP + ε α OPEN 2 7 = α + α ln GDP + α (ln GDP ) α OPEN + α OPEN + α ln RE + α Trend + α ln FOP + ε α (ln GDP ) α OPEN where CO2 denoes CO2 emissions per capia and is an endogenous variable ha represens beer environmenal qualiy if i is a lower level. The main exogenous variables are lngdp which is logarihm of GDP per capia and OPEN represening rade openness or rade dependence on foreign counries. To es he presence of EKC, he equaion (1) and (2) which are derived from he relaionships beween polluion levels and GDP and Openness will be used. The relaionships are esimaed as being condiional on renewable energy share, fossil energy consumpion and ime rend. Polluion levels are expeced o increase wih growing income up o a hreshold level beyond which polluion levels are expeced o decrease wih higher income levels. The combinaion of hese wo effecs, α >0 α <0 in Model (1), creaes he invered U-shaped relaionship beween per capia CO2 emissions and GDP. A represenaive invered U-shape example of an expeced EKC is shown in Figure 3.A Furhermore, we can easily es he presence of an N-shaped curve (Figure 2.B) by using cubic funcional form (α > 0) as shown in Model (2). In he EKC empirical analysis based on he SO2 polluion case, N-shaped curve is found by Torras and Boyce (1998), Lis and Galle (1999), Bradford e al. (2005), and ohers. Therefore, his paper adds a variable GDP represening a cubic model specificaion o verify he exisence of N-shaped relaionships beween carbon dioxide and economic growh. In an aemp o broaden he concep of EKC, we invesigae he relaionship beween environmenal qualiy and rade openness. This is moivaed by he fac ha a early sages of economic developmen, free rade leads o an increase in real income, and a he same ime, i increase he polluion level because environmenal qualiy is regarded as a luxury good and no a normal good. However, as he counry achieves a cerain level of GDP, he increased income from free rade encourages consumers o increase heir demand for a clean environmen and hen an aemp is made o reduce environmenal damage hrough increasing clean producion and evenually o improve environmenal qualiy (Galeoi and Lanza, 1999). Based on he paern described above, a counry ends o follow increasing polluion levels as rade openness proceeds (α >0), and hen we can find declining polluion levels a more advanced sage of free rade (α <0). We have already explained he variable of RE and FOP, so in his par, we will skip explanaions of hese condiional variables. Trend is a ime rend 4 8

11 variable used as a proxy o represen he effecs of oher exogenous ime dependen variables such as he rend in polluion abaemen, environmenal policy change and echnological change. Figure 3.A: The invered U-shaped Environmenal Kuznes Curve Figure 3.B: The N-shaped Environmenal Kuznes curve 4.2 Empirical Resuls As noed above, esimaing and quanifying he effec of free rade on income and environmenal qualiy is necessarily an empirical problem and i varies according o circumsances such as individual counries developmen sage, he degree of openness, populaion and policies of he counries. In his paper we deal wih he exogenous variables such as GDP, OPEN and oher indicaors of environmen and developmen. Through individual counries OLS esimaion resul, we can obain an esimaion of he effecs on each counry s environmen. Separae counry regressions allow for heerogeneous effecs in response o differences in level of developmen of he sample counries. Thus, in order o invesigae he relaionships beween environmenal degradaion, economic growh and rade liberalizaion, here we use simple OLS regression analysis. Table 2 repors he esimaion resuls. 9

12 Table 2 summarizes he regression resuls for each counry based on he wo model specificaions, differing wih square and cubic GDP specificaions. Since he wo models differ only by one parameer, he -es can be used o deermine he level of generaliy of he model. A maer of primary concern is he esimaed coefficiens, heir signs and significance. We are ineresed in no only quadraic Model 1, bu also cubic Model 2 o esablish he absence of EKC, invered-u or N-shaped naure of he Kuznes curve. Table 2: Resuls from OLS esimaion mehod (T=37). Consan GDP OPEN RE Trend FOP GDP GDP OPEN China Korea Japan Model 1 Model 2 Model 1 Model 2 Model 1 Model *** (3.4422) *** *** (4.9389) 2.41E-05 (0.2366) 1.97E-08* (1.9269) * ( ) * (1.9206) *** ( ) ( ) *** (3.2158) -1.52E-07*** ( ) 1.12E-11*** (3.3067) *** ( ) *** (3.4182) *** ( ) *** ( ) (1.4663) *** (6.0186) *** ( ) 1.90E-08*** (7.2172) *** (3.7144) *** ( ) (0.3283) *** ( ) *** (6.2256) (7.6471) *** ( ) 3.13E-08*** (9.4679) -2.81E-26*** ( ) ( ) 4.16E-05 (0.1723) ( ) (0.5347) *** (7.2647) *** (12.020) *** ( ) 7.99E-09*** (2.9193) (0.9852) ( ) (1.2545) (0.3776) *** ( ) ** ( ) 6.77E-08** (2.2365) -9.17E-13* ( ) (1.2134) ( ) (0.5154) ( ) ** (2.6709) *** (8.8037) *** (7.9868) R F-value DW-saisics Noe: significan a he 1% (***), 5% (**) and 10% (*) levels of significance. -values in parenhesis. In he case of Korea, GDP per capia and is square are saisically significan in Model 1, and he cubic componen in Model 2 was also saisically significan. On he oher hand unlike in Model 1 he OPEN and is square erm in Model 2 are saisically insignifican. The Durbin-Wason saisics for hese models are respecively, in Model 1 and in Model 2. The Durbin-Wason saisic is a es for firs-order serial correlaion. The DW es saisic in Model 2 rejecs he null hypohesis ha here is no posiive serial correlaion, bu he es resul for Model 1 canno rejec he null hypohesis. Therefore, hese saisics sugges ha he esimaed sandard errors and he significance of he coefficiens of he parameers in Model 1 are reliable. Therefore, Model 1 is more suiable for esimaing he EKC for Korea. In looking a he esimaed coefficien of GDP, we noice ha i is negaive and ha he GDP has a posiive sign. This shows ha economic growh does no have he expeced Kuznes effec on environmenal circumsances in Korea. A he early sage of economic growh, environmenal polluion canno be avoided, bu when reaching a 10

13 higher level, however, circumsances would gradually be improved as he level of developmen and welfare improves. The resul is in conradicion o he expeced one and hereby canno find an invered U-shaped hreshold poin. In Figure 3 we show he resuls of regressions of per capia CO2 emissions on per capia GDP. Here we can find evidence of a U-shaped EKC. The urning poin 3 is esimaed o be $8210. In he early sage, here is declining rend bu i immediaely begins o rise afer he urning poin. This resul refues he EKC hypohesis in he case of Korea. Dependence on foreign rade has a significan impac on CO2 emissions. The variables OPEN and OPEN exhibi invered U-shaped relaionships wih CO2 emissions. Similar conclusions are reached by Taskin and Zaim (2000), here is almos a common agreemen ha here exiss a U-curve ype quadraic relaionship wih he environmenal qualiy where OPEN represens a posiive coefficien and OPEN shows negaive coefficien. A he early sage of free rade, i leads o increased environmenal polluion bu when individual counries exceed cerain level of openness hen he condiions for a pollued environmen would be improved. This is because he more rade circumsances liberalize, he more people make an effor o mee inernaional environmenal sandards for inernaional rade, collaboraion and compeiion purposes. RE shows a posiive relaionship bu his variable is no saisically significan. Time rend represens he echnological change and i represens a negaive CO2 relaionship wih ime suggesing a decline in emissions as was our expecaion. As echnologies develop, i is conducive o environmenal qualiy. In he case of China, GDP per capia and CO2 emissions are shown no o be saisically significanly relaed o Model 1 bu hey are o Model 2. For his reason we find Model 2 o be more suiable o esimae he EKC in China's case. We noice he posiive coefficien of GDP, negaive coefficien of GDP and again he posiive coefficien of GDP. These ogeher sugges an N-shaped curve describing he relaionship beween polluion and GDP. The iniial deerioraion of environmenal condiions and hen economic growh causing an improvemen of he environmen, in spie of he effors of environmen-friendly developmen, environmenal circumsances canno ge beer coninually. Through he signs of he coefficien, we hink inuiively, he curve has an N-shape. However, afer depicing he graph, we can work ou ha he cubic funcion is monoonically an increasing funcion which does no have any exernal value. In cases wih such paern here is no use verifying he hreshold poin on he EKC. 3 The condiions for his o occur are for esimaed coefficien α >0,α <0, is urning poin is compued as α /2α. 11

14 Figure 4: The EKC for CO2 emission per capia in China, Korea and Japan Also in China s case, he variables relaed o free rade have a significan impac on he environmen. These openness variables represen a U-curve ype quadraic relaionship wih he CO2 emissions. I means ha here is a hreshold level of openness, bu in reversed form. RE and Trend represen negaive and by expecaion consisen relaionships. Increasing he amoun of applicaion of New and Renewable Energy sources and developing he echnology of energy efficiency can conribue o a decrease in emissions in China. In he case of Japan, i was difficul o deermine he more appropriae model. The DW es saisic was no helpful in selecing he appropriae model. In Model 1, beyond a cerain level, CO2 emissions showed an increasing rend. The esimaed urning poin 12

15 was $29,700 in erms of GDP per capia. In spie of many effors o reduce carbon dioxide emissions, i is no easy o achieve desired reducions if economic growh is based upon a premise. In Model 2, heir respecive signs sugges an inversed N-shaped curve. The relaive minimum urning poin is calculaed a $19,600 and he relaive maximum urning poin is calculaed o be $29,700. Alhough boh models are significan, his paper prefers Model 2 because i conains addiional informaion. Through his regression, we noice ha Japan has an inversed N-shaped curve which exhibis he invered U-shaped curve in he laer pars of he curve. In erms of openness, he more economy is dependen on rade, he more carbon dioxide is emied. However, if Japan exceeds a cerain level of openness, hen CO2 emissions decrease. This is inerpreed ha he rise in GDP hrough rade will in urn generae increases in demand for environmenal goods. Par of he gain is hen used o alleviae environmenal polluion. However, i is no saisically significan and hereby hard o deermine ha here exiss a decreasing par. 5. The Vecor Auoregressive and Vecor Error Correcion Models 5.1 The framework Afer having esablished he relaionship beween CO2 emissions, GDP and openness, his paper uses a vecor auo regression (VAR) o es he shor-run relaionship among he deerminans of environmenal variables. VAR has he advanage ha i is very useful by allowing all variables o inerac wih hemselves (pas values) and wih each ohers in regression analysis wihou any heoreical srucure on he esimaors. Furhermore, VAR which can conduc dynamic analysis is useful o overcome he saic disadvanage of OLS because VAR can explain he dynamic srucure of ime series beer han he saic OLS esimaion mehod bu a he expense of complexiy in inerpreaion of effecs. In ime series daa, mos of he indicaors end o have rends. To avoid his problem, non-saionary variables should be differeniaed a leas once o ransform hem ino a saionary form. Through such a ransformaion process, we can make he variables saionary, bu he differeniaion procedure may enail some loss of he long-erm characerisics of he original daa. However, Engle and Granger (1987) proposed ha even hough all he variables in he model are non-saionary, he series may be saionary if he variables have a linear combinaion. In such a case, we can consider he variables o be coinegraed. Because he use of VAR depends on he saionary condiion of he daa se, we firs briefly discuss and presen he resuls of a uni roo es he augmened Dickey-Fuller (ADF) es. Anoher es o be conduced is he adapion of he Johansen s Coinegraion es which will follow. If here exiss a long-run equilibrium relaionship, we will adop he Vecor Error Correcion Model (VECM). Through he Error Correcion Mechanism, a proporion of he disequilibrium in one period is correced in he nex period. Engle and Granger (1987) proposed ha once he variables are deermined o be coinegraed, here always exiss a corresponding error correcion represenaion, implying ha changes in he dependen variable are a funcion of he level of disequilibrium in he coinegraing relaionship capured by he error correcion erm (ECT). The ECT is 13

16 used o correc such disequilibrium, and hus, we used i o examine he shor-run and long-run relaionships beween CO2 emissions and is deerminans. 5.2 Uni roos and Coinegraion ess resuls The possibiliy of he nonsaionariy of ime series daa raises an imporan issue. A saionary series is defined as a series ha ends o reurn o is mean value and flucuae around i wihin a more or less consan range, whereas a non-saionary series is defined as a series whose means differ a differen poins in ime and variance increases wih he sample size (Harris & Sollis, 2003). If a daa se conains non-saionary series, OLS canno provide valid esimaion resuls and inerpre various relaionships. Mos pars of economic variables generally are non-saionary. To avoid his problem, nonsaionary variables should be differeniaed. The variables are differeniaed d imes and hen saionary and OLS resuls are valid in inerpreaion. The Uni roo es is conduced o es saionary. Individual variables are esed by he Augmened Dickey-Fuller (ADF) es and he resuls are shown in Table 3. Table 3: Resuls of Uni Roos Tess Tes saisics Log(CO2) Log(GDP) Log(OPEN) China Level -value The firs differences *** *** *** Korea Level -value The firs differences *** *** *** Japan Level -value The firs differences *** *** *** Noe: MacKinnon (1996) one-sided p-values, ***=p<0.01; **=p<0.05; *=p<0.1 From Table 3 we noe ha, in he case of Korea, he resul of uni roo ess show ha he -saisic of CO2 is Therefore, a null hypohesis of non-saionariy canno be rejeced. The ADF-es saisic is he -saisic for he variables of ineres. If he absolue value of he ADF-es saisic is smaller han a cerain value like 1% or 5% level of significance, we canno rejec he null hypohesis. The resuls indicae ha each of he series is non-saionary a he 1% level. Afer he firs differeniaed CO2 emission, he null hypohesis of non-saionary is clearly rejeced a he 1% significance level. As a resul, he firs-differencing he CO2 emission removes he non-saionary and any oher variables are equal. In he cases of China and Japan also he nonsaionary is removed when applying he firs differenced ransformaion of he variables. In any ime series analysis, i is imporan o deermine wheher one economic variable can help forecas anoher. For example, If x Granger-causes y bu y does no Granger cause x, hen he pas value of x is useful in predicing he curren and fuure values of y. The Granger causaliy es assumes ha he informaion is relaed o each variable. 14

17 To confirm how he variables are arranged in he vecor form, his sep applied he pairwise Granger causaliy ess. We conduced he es o deermine he direcion of causaliy and he shor-run effec of he relaionship. This process requires he use of he VAR or VEC model because he resuls obained using he model are influenced by he ordering of variables. The resul of he Granger causaliy ess show ha in he case of China, Korea and Japan, OPEN Granger-causes GDP. According o he resuls of he causaliy ess, we deermined an ordering of he variables in he following way: (3) CO = f ( CO2, OPEN, OPEN ) 2 p p where p is he number of lags in he model. Prior o finding he proper number of lag, we decided o use a VAR model. In general, SC (Schwarz Informaion Crierion), AIC (Akaike Informaion Crierion) and HQC (Hannan-Quinn Informaion Crierion) are used o deermine he opimal number of lags (p). In his paper, AIC is seleced o esimae he opimal lag because SC ends o underesimae he lag (p). Under he lag lengh selecion rule we have chosen he smalles value and his paper uses 5 lags as he maximum lag lengh. The opimal lag order lengh is seleced by he crierion, in Korea p=5, in China p=3 and in Japan p=2 (see Table 4). Table 4: Resuls of Informaion Crierion Lag AIC China Korea Japan SC HQC AIC SC HQC AIC SC * * * HQC * * * * * * Noe: * indicae lag order seleced by he crierion In he analysis of he VAR model, each variable should be saionary, and here mus be no coinegraion among he variables. To deermine wheher he variables were coinegraed, we used he Johansen coinegraion es. Through his es, we can choose among he wo VAR or VECM models. If he daa is saionary and he variables are coinegraed, a VECM model is preferred. To es for he co-inegraion relaionship, his paper uses lag lengh chosen by he informaion crieria above. The resul of he Johansen co-inegraion es is repored in Table 5. In he case of Korea, he null-hypohesis of zero and r 1 is rejeced a he 5% level of significance. On he oher hand, he null-hypohesis of r 2 canno be rejeced a any level of significance. Based on his resul, i is deermined ha hese variables have wo coinegraing vecors represening a long-run relaionship. As a resul, i is deermined ha hese variables would be analyzed by he VECM model. The resul from he Johansen and Julius (1990) mehods indicae he presence of coinegraed vecors. I suggess ha, here are long-run relaionships among variables. As a resul, he daa is non-saionary and variables are coinegraed and so he VECM model is 15

18 adoped here o he analysis of he series. In he case of China, he null-hypohesis of zero is rejeced a he 5% level so here is one coinegraing vecor. In his case we also use he VECM model. For he Japan case, all of he null-hypohesis is no rejeced a he 5% level. Hence, we can conclude ha here is no coinegraing vecor and he VAR model will be adoped for he Japanese daa. Table 5: Resuls of Johansen Coinegraion Tes Hypohesized No. of CE(s) Eigen value Trace Saisic Λ-max China None * r = 0 r= A mos 1 r 1 r= A mos 2 r 2 r= Korea None * r = 0 r= A mos 1 * r 1 r= A mos 2 r 2 r= Japan None * r = 0 r= A mos 1 * r 1 r= A mos 2 r 2 r= Noe: * Significan a he 5% level 5.3 The VAR Model The Vecor Auoregression (VAR) model suggesed by Johansen is used o invesigae he dynamic inerrelaionships beween CO2 emission, GDP and Openness. The Johansen mehod uses his model including up o k lags as follow: (4) X = u + A0 + A1 X 1 + A2 X Ak X k + u where (5) X Open = GDP CO2 and u u = u u If all variables are non-saionary, coinegraing vecors exis. Under such condiions, he Vecor Error Correcion Model (VECM) is defined as: (6) X = u + Γ1 X 1 + Γ2 X Γk 1 X k+ 1ΠX k + u where X and u are defined previously. is he difference operaor. Γ,,Γ are he coefficien marices of shor-run dynamics and Π are he marix of long-run coefficiens. Long-run impac is calculaed from marix Π= αβ (Johansen, 1988; and Johansen and Juselius, 1992). 16

19 5.4 The long-run and shor-run relaionship (VECM) in Korea and China The long-run esimaion resuls for he VECM are repored in Table 6. The coefficien of he ECT (α) which indicaes he speed-adjusmen coefficien on he long-run correcion erm and he β coefficien which means individual variables coefficien in he error correcion erm are repored. The resuls show ha, in he case of Korea, since all of he β coefficiens of he ECT s -saisics are greaer han he criical value, i is inerpreed ha GDP is significan in his equaion and OPEN is insignifican. GDP and is square have negaive signs. Therefore, GDP is found o have a posiive long-run relaionship. In China s case, he β coefficiens of he ECT of GDP have a negaive sign while OPEN has a posiive sign bu OPEN is no saisically significan. Therefore, CO2 and GDP have a posiive long-run relaionship. The resuls based on boh Korea and China no only ake ino consideraion he impac of he long-erm facors on he equilibrium bu hey also allow examinaion of he shor-run impacs facors. Table 6: Long-run Coefficien of he VECM CO2 GDP OPEN China β coef iciens of he ECT * (sandard errors) ( ) ( ) Coefficien on he ECT(α) * * (sandard errors) ( ) ( ) ( ) Korea β coef iciens of he ECT * (sandard errors) (0.0018) ( ) Coefficien on he ECT(α) * * (sandard errors) ( ) ( ) ( ) Noe: * Significan a he 5% level, (sandard errors are in parenheses). ECT is error correcion erm. The coefficien on he ECT (α), adjusmen speed in he long-run for CO2 and GDP in case of Korea is and If he coefficien value is over-valued, hen i will be adjused downward and vice versa. The ECT suggess ha when once a shock emerges, convergence o equilibrium is rapid so ha he size of coefficien of he ECT (α) can be inerpreed as an adjusmen speed. The coefficien on he error correcion erm implies ha a deviaion from he equilibrium level during he curren period will be correced in he nex period. In he same way, we can analyze he coefficien of he ECT (α) for GDP in China. The size of coefficien on he ECT is inerpreed as speed of adjusmen, where means ha abou 18.6% of he imbalance siuaion is correced in he firs period. In Korea, he coefficien of OPEN is significan a he 5% level and is sign is negaive. The degree of openness (OPEN) increases by 1% and hen CO2 emissions decrease by 5.8%. This negaive relaion varies from o only in he shor-run. On he conrary, OPEN does no have a significan long-run relaionship. The coefficien of GDP is no significan a he 5% level. In he previous saemen, we have already 17

20 menioned our observaion ha CO2 has a posiive long-run relaionship bu he relaionship of CO2 and GDP is insignifican in a shor-run perspecive. The shor-run resuls based on he VECM model for China and Korea are repored in Table 7. In China, here is no significan shor-run relaionship beween OPEN and CO2 bu he relaionship of OPEN and GDP is significan. If GDP increases by 1%, i leads o a 0.67% increase in CO2 emission jus in he shor-run. However, we have already obained he resul ha CO2 and GDP have a posiive long-run relaionship. In case of China he CO2 emissions and GDP have a posiive relaionship regardless of wheher i is long-run or shor-run. Table 7: Shor-run Coefficien of he VECM CO2 GDP OPEN China co * * co GDP * * GDP * * OPEN OPEN Korea co * * co * * co * * * co * * GDP GDP GDP GDP OPEN * * OPEN * * OPEN * * OPEN * * Noe: * Significan a he 5% level Table 8: The resuls of VAR log(co2) log(gdp) log(open) log(co2-1 ) * * log(gdp ) * * log(open -1 ) * Consan * VAR in Japan Table 8 shows he resul of VAR esimaion for Japan. All variables in he VAR model are ransformed ino naural logs. As a resul of he esimaion, we find ha he increased GDP in he preceding erm increases CO2 emissions. However, he esimaed coefficien of he OPEN is no saisically significan in he equaion of he CO2. Even hough he VAR model is useful in showing he dynamic relaionship among he 18

21 variables, he esimaed coefficien is no easy o inerpre inuiively. Therefore, variance decomposiions (VDCs) and he impulse response funcions will be carried ou o check he sabiliy of he models. 5.6 Tes of sabiliy If he esimaed VAR and VECM are sable, hen all coefficiens should be less han 1 and inside he uni circle. If he VAR and VECM are no sable, analyzing cerain resuls is meaningless. If he number of endogenous variables is k and he maximum lagged period is p, hen he number of uni roos ha we have is k imes p. If we esimaed he model wih r coinegraing relaions, hen k-r roos lie inside he uni circle. In case of China and Japan, when we use CO2, GDP and OPEN as endogenous variables, his model is a poor VAR and VECM model. As a resul, furher analysis is no needed because he resuls do no mean anyhing. To saisfy he sabiliy, modified models are need. The soluion is using he endogenous variables log(co2), log(gdp) and log(open). Here he used VAR and VECM model are no misspecified models. The VAR and VECM models hrough he impulse response funcions allow for analysis of cerain variable s influence on dynamic response of endogenous variables. The resuls of he VAR/VECM sabiliy es showed ha: Korea, VEC specificaion imposes 1 uni roo, China s imposes 2 uni roos of which no roos lies ouside he uni circle, and finally in he case Japan, VAR saisfies he sabiliy condiion. 5.7 Variance decomposiions (VDCs) and Impulse response funcions We adap variance decomposiion o explain he magniude of he forecas error variance deermined by he shocks o each of he explanaory variables over ime. The resuls are presened in Table 9. Deecing Granger causaliy is sricly resriced o wihin-sample ess and does no show he relaive magniude of hese variables. In order o esimae he degree of exogeneiy of he variables, dynamic properies of he sysem, and he relaive srengh of he Granger-causal relaionship beyond he sample period, we consider he decomposiion of variance mehodology. The variance decomposiion mehod measures he percenage of a variable s forecas error variance ha occurs as he resul of a shock from each of he variables ino conribuions arising from is own and he oher variables variance. The resuls of variance decomposiion for he hree counries are summarized in Table 9 over a 20-year period. Based on he Korean daa, he variance decomposing value of GDP and OPEN is almos he same level a he end of 6 year. Afer hen, he variance of OPEN decreases rapidly. From 13 h year o 20 h year OPEN approximaely accouned for 7% o he oal variance. A he same ime, GDPs share increase rapidly. Finally, a he end of 20 years, he forecas error variance for CO2, explained by is own innovaions, is 25.75% and GDP represens 67.25% percen of he variance of CO2. In he shor-run, OPEN considerably effecs CO2 emission. This resul coincides wih he analysis of he coefficien of VECM. Furhermore, in he long-run, GDP absoluely influences CO2 emission. 19

22 Table 9: Decomposiion of Variance China Korea Japan Period S.E. CO2 GDP OPEN S.E. CO2 GDP OPEN S.E. CO2 GDP OPEN In he case of China, a he firs period, he forecas error variance for CO2 is perfecly explained by is own innovaion. Ineresingly, a he early par of he period, he forecas error variance of CO2 explained by is own innovaion is 100.0% bu he variance decomposiion of resuls indicaes ha GDP and OPEN have a grea influence as ime elapses. For insance, a he end of 3 years, he direc effec of CO2 falls rapidly by as much as 74.26%. Also noable is he fac ha OPEN s share sharply increases and i accouned for percen by sevenh year. CO2 can be mainly explained by innovaions in OPEN in he early sage. Afer ha, he siuaion is reversed. Since he sevenh year, he Table 9 shows a rapid rise in GDP from 8.68% o 77.56%. A he end of 20 years he forecas error variance for CO2 explained by is own innovaions is jus 3.35% and oher variables show higher percenage error variance in explaining CO2 variaions. This resul corresponds o Granger causaliy ess ha GDP and OPEN Granger-cause CO2. When he Japanese daa is concerned, he forecas error variance for CO2 is considerably explained by is own innovaion by 68.62% a he end of 20 years. GDP has an effec equal o wice as much as OPEN bu hese have a weaker influence on CO2 emissions afer 20 years from he shocks. The difference of Japan s daa is very marked indeed comparing Korea and China. Japan explains 69.0% of is own shocks. In order o idenify he impulse response, we impose an addiional resricion on he VAR/VECM model. This paper uses he Choleski impulse funcions. The impulse response funcions are described in Figure 5. 20