Energy mix, financial development, and carbon emissions in China: a directed technical change perspective

Based on a two-sector (clean energy and dirty energy) model of directed technical change, we examine the relationship between carbon emissions, clean energy consumption, and financial development in China using the ARDL method. The results show that clean energy consumption reduces carbon emissions effectively but the effect of financial development is opposite, suggesting that financial development increases carbon emissions, contradicting the findings of many existing studies. Then, we decompose financial development on carbon emissions into two different effects: substitution and income effects. The substitution effect reflects more dirty energy consumption as a result of directed technological change promoted by financial development, leading to more carbon emissions. The income effect results in a decline in carbon emissions because financial development enables firms to use more clean energy. The empirical results indicate that the net effect of financial development has caused more carbon emissions and a 1% increase in financial development results in a 0.45-0.79% increase in carbon emissions. The policy implication is also discussed.