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Financial development, FDI, and CO2 emissions: does carbon pricing matter?

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  • Xiaojie Yu
  • Duminda Kuruppuarachchi
  • Sriyalatha Kumarasinghe

Abstract

This study investigates the impact of financial development and foreign direct investment (FDI) on CO2 emissions, with a special focus on carbon pricing (emissions trading and taxing) in 57 developed and developing economies between 2000 and 2017. Using an eight-fold financial development construct for the first time, we find that financial depth in institutions negatively (positively) affects the CO2 intensity of developed (developing) economies, while financial access to institutions has a negative impact in both types of economies. Financial depth (stability) in markets negatively affects developing (developed) economies’ CO2 intensity, while financial access to markets increases (decreases) CO2 intensity in developed (developing) economies. Moreover, inward FDI stock quality (a net FDI position) increases (reduces) CO2 intensity in developing (developed) economies. Finally, we document that carbon pricing in developed economies helps reverse the positive effect of inward FDI quality on CO2 intensity, implying that a such policy helps those economies attract climate-friendly FDI. Our study reveals the implications of the reduction of CO2 emissions placing the focus on both financial development and FDI fully and together for the first time.

Suggested Citation

  • Xiaojie Yu & Duminda Kuruppuarachchi & Sriyalatha Kumarasinghe, 2024. "Financial development, FDI, and CO2 emissions: does carbon pricing matter?," Applied Economics, Taylor & Francis Journals, vol. 56(25), pages 2959-2974, May.
    • Handle: RePEc:taf:applec:v:56:y:2024:i:25:p:2959-2974
    DOI: 10.1080/00036846.2023.2203460
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    3. Nacer Mebrek & Bilal Louail & Siham Riache, 2025. "The impact of foreign direct investment on CO2 emissions in middle east and north African countries in the period 1990-2020: using the panel ARDL model," Letters in Spatial and Resource Sciences, Springer, vol. 18(1), pages 1-23, December.
    4. Yu Luo & Ze Li & Lu Xu & Hendrik Gerrit, 2026. "Turning the Curve: Renewable Energy, Higher Education, and the Quest for Low‐Carbon Development in the E‐7," Sustainable Development, John Wiley & Sons, Ltd., vol. 34(2), pages 2090-2107, April.
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    6. Umut Halaç & Fatma Dermenci & Seher Gören Yargı & Melis Gultekin, 2025. "Examining the Impact of Financial Development on Carbon Emissions: Insights from Emerging Economies," Istanbul Journal of Economics-Istanbul Iktisat Dergisi, Istanbul University, Faculty of Economics, vol. 75(1), pages 156-169, July.
    7. Tiwari, Aviral Kumar & Trinh, Hai Hong & Vo, Diem Thi Hong & Sharma, Gagan Deep, 2025. "How do economies decarbonize growth under finance-energy inequality? Global evidence," Energy Economics, Elsevier, vol. 142(C).
    8. Febriyanto, Ahmad & Azzam, Abdullah & Kutia, Hanifah Ramadhani & Rizal, Achmad & Yusfiarto, Rizaldi, 2024. "The impact of foreign direct investment on carbon emissions: A comparative study in the ASEAN countries with the highest foreign direct investment," Innovation and Green Development, Elsevier, vol. 3(4).
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