Relationship between fixed capital formation and carbon emissions: Impact of trade liberalization in India

Abstract

Abstract The liberalization of economies is aimed at boosting domestic growth through foreign investment and trade. The proponents of liberalization argue that opening up markets in developing economies provides access to capital to enhance production. However, proponents of the pollution haven hypothesis (PHH) argue that liberalization and trade agreements have led to the export of carbon-intensive production from wealthier countries to developing economies. The difference between the two outcomes lies in the nature of fixed assets built by developing countries. In this study, we examine the role of fixed capital formation on carbon emissions during two distinct periods of India’s economic development. India liberalized its economy with trade reforms in 1991, thereby providing two distinct time periods of closed and open trade policies. The economic data during 1971–2021 is divided into two parts—before (1971–1990) and after (1991–2021) liberalization. Gross fixed capital formation (GFCF) is used as a measure of capital formation while carbon emissions are used to represent environmental impact. Auto-regressive distributed lag (ARDL) model is used for analysis. Results indicate that GFCF had no significant relationship with carbon emission before liberalization, whereas, there was a significant, positive impact post-liberalization. The study is of significance to policymakers in developing countries as it suggests a change in the capital formation towards low carbon-intensive products and services. It also strengthens the argument for investing capital in cleaner energy and technologies.