A Bayesian Approach to Analyse the Nexus Between the Environmental and Financial Factors to Affect Energy Efficiency in the GCC Region

Abstract

Energy, being a significant input in the production process is considered an important element in the socio- economic development of a country. In this context, global economy is concentrating on attaining financial stability through increased energy efficiency and plummeting the energy intensity. Efficient use of energy enables the countries to improve their trade balance whereas it helps to reduce operating costs at micro level. Using energy-efficient techniques can reduce the environmental risks posed by the higher level of economic activity. Similarly, development of financial sector stimulates economic efficiency through the expansion in the financial activities (Sadorsky, 2010). Financial development helps to reduce cost of borrowing and financial risk, thereby creating transparency between lenders and borrowers. In addition, financial sector development facilitates the acquisition of sophisticated energy efficiency products and technology. However, with the rapid economic development, the environmental degradation has become a focus point for the nations across the globe. The feedback effects from environment to economic growth have stimulated the researchers to investigate the reasons for environmental dilapidation and determine the solutions for environmental conservation. Many of these research studies are encircled around the environmental Kuznets curve (EKC) hypothesis (Grossman &Krueger, 1991) which elaborates the linkages between the environmental degradation and economic growth. Middle Eastern economies are heavily reliant on the energy-based revenues and any curb on the energy production directly affects their economic growth in the region. Furthermore, financial system in the Middle Eastern region is technologically advanced with strong regulatory frameworks related to data protection, consumer protection, cybersecurity, and anti-money laundering. These regional characteristics provide a strong base to assess the existence of environmental Kuznets curve in the region and to examine the nexus between the financial sector development, economic growth, energy efficiency and Co2 emission in the region. The relationship between the environmental quality and economic growth is explored by various studies such as Jaeger et al. (1995), Tucker (1995), Barbier (1997), Horvath (1997), Ansuategi et al. (1998), List and Gallet (1999), Stern and Common (2001), Roca (2003), Dinda and Coondoo (2006), Coondoo and Dinda (2008) and Akbostanci et al. (2009). However, this research is unique as it is first to examine the environmental Kuznets curve hypothesis for the oil based Middle Eastern economies while using a conditionally homogenous autoregressive model for the panel of Middle Eastern economies. This model considers homogeneity across the cross-sectional units with identical structural characteristics. The panel conditionally homogenous vector autoregressive specification permits the heterogeneity in the dynamic panel data set and evaluates the relationship between the observed heterogeneity across the units and their structural characteristics