The Impact of Financial Development and Economic Growth on Environmental Quality of Kenya

Abstract

Of recent times many countries are suffering from environmental problems such as global warming and emission of greenhouse gases. Emissions of carbon dioxide as been recognized as the major contributor to global warming and climate change. This paper examines the long run relationship among the variables environmental quality, financial development and economic growth in Kenya using time series for the period 1970-2019. Autoregressive distributed lag bounds test is used to investigate long run relationship and Granger causality method is used to test for causality among the variables. Empirical results indicate that there is long-run relationship among the variables. Long run results suggest that increases in financial development, lagged CO2, energy consumption, population growth, and trade openness significantly worsens environmental quality in Kenya. Natural resources significantly improve environmental quality in Kenya. According to the results the relationship between CO2 and financial development in Kenya is non-linear suggesting presence of EKC between CO2 and financial development. The empirical results confirm that the Environmental Kuznets curve does not exist between CO2 and economic growth in Kenya in the long run. Short-run results also show that financial development, lagged CO2, FDI, population growth, and trade openness increase CO2 emissions while natural resources reduce it. Causality results show unidirectional causality running from financial development to environmental quality and from CO2 to GDP. According to the findings, there is evidence of neutrality hypothesis between financial development in Kenya and economic growth. Existence of long run relationship suggests that the government of Kenya needs to implement appropriate environmental policies that reduce pollution during economic growth. The government should set policies and guidelines to the financial sector so that the sector offers credit to firms that reduce air pollution.