The role of physical and human capital in FDI-pollution-growth nexus in countries with different income groups: A simultaneity modeling analysis

Abstract

This paper examines the causal links between foreign direct investment (FDI), CO2 emissions, and economic growth in a global panel of 101 countries and four diverse income groups (low, lower-middle, upper-middle, and high) countries using the simultaneous equations framework, with data from 1990 to 2014. Considering physical capital and human capital, this is the first time these two determinants have been linked to the FDI-pollution-growth simultaneous equation model. The dependent variables in the three simultaneous equations are inflow of foreign direct investment, CO2 emissions as a proxy for environmental pollution, and real gross domestic product. Three critical inferences can be drawn from the results. First, there is a two-way causal relationship between growth and FDI in the global panel and across all income groups (except for lower-middle-income groups). Likewise, except for high-income countries, there is a two-way causal relationship between FDI and CO2 emissions in the global panel. Second, the results support a one-way causal relationship between economic growth and CO2 emissions in the global panel and the income subgroup, but only in the low-middle and high-income groups support the environmental Kuznets curve (EKC) and pollution haven hypothesis (PHH). Third, the heterogeneous impact of human and physical capital on the environment is genuinely striking: human capital improves its quality while physical capital degrades it. The results suggest that physical and human capital contributes to economic growth and attracts foreign direct investment.