1 Prof. George E. Halkos & Epameinondas A. Paizanos The channels of the effect of government expenditure on the environment: evidence using dynamic methods Prof. George Halkos & Epameinondas Paizanos Lab of Operations Research, Dept of Economics University of Thessaly Οικονομική των Φυσικών Πόρων και του Περιβάλλοντος 3 ο Πανελλήνιο Συνέδριο Volos, October 2015 This research has been co-financed by the European Union (European Social Fund – ESF) and Greek national funds through the Operational Program "Education and Lifelong Learning" of the National Strategic Reference Framework (NSRF) - Research Funding Program: Heracleitus II. Investing in knowledge society through the European Social Fund. 1

2 Introduction A large fraction of national GDP (≈ 45% in OECD) is spent by governments affecting a variety of economic variables and welfare. Expansionary fiscal policy has been employed in many countries to alleviate the adverse effects of the economic crisis. Despite the immense importance of government expenditure and government revenues in many economies worldwide, little effort has been so far devoted to the study of the impact of fiscal policy on environmental quality (Lopez et al., 2011, Halkos and Paizanos, 2013; Galinato and Islam, 2014; Halkos and Paizanos, 2015). 2 Prof. George E. Halkos & Epameinondas A. Paizanos

3 Fiscal Policy - Environment Mechanism and effect may differ according to whether pollution is production- or consumption-generated (McAusland, 2008). Production-generated pollution (Lopez et al., 2011) Scale effect (change in environmental pressures due to the effect of government expenditure on economic growth), Composition effect (increased human capital activities instead of physical capital intensive industries that harm environment more), Technique effect (due to higher labor efficiency) Income effect (increased income raises demand for improved environmental quality). 3 Prof. George E. Halkos & Epameinondas A. Paizanos

4 Fiscal Policy – Environment (cont’d.) Consumption-generated pollution (Galinato and Islam, 2014 ) Scale (Income) effect (spending on health and education increases the current and future income of households and leads to an increase of consumption pollution) Regulation effect (government expenditure encourages the development of institutions and therefore the establishment and enforcement of environmental regulations which enhance environmental quality) - Fullerton and Kim, Prof. George E. Halkos & Epameinondas A. Paizanos

5 Fiscal Policy – Environment (cont’d.) Other related channels Governance quality (enhanced institutional quality reinforces the alleviating effect of government expenditure on both production- and consumption-related pollution) – Galinato and Islam 2014; Bernauer and Koubi, Special interest groups (influence the strictness of environmental regulation the government imposes) - Mueller and Murrell 1986; Bernauer and Koubi, 2013; Galinato and Islam, 2014; Sobel, Empirical evidence (ambiguous effect on environmental degradation) Positive effect (Koubi Bernauer, 2013) Mixed evidence (Frederik and Lundstrom, 2001) Negative effect (Lopez et al., 2011; Lopez and Palacios, 2014; Galinato and Islam, 2014; Halkos and Paizanos, 2015). 5 Prof. George E. Halkos & Epameinondas A. Paizanos

6 Contribution Our paper is the first to examine how the magnitude of the direct effect of government spending on pollution varies conditional on the level of economic development and the level of institutional quality. 6

7 Prof. George E. Halkos & Epameinondas A. Paizanos Data Sample of 94 countries covering the period ,525 observations per variable Production-generated and consumption–generated pollution. Local and global pollution externalities. 7

8 Prof. George E. Halkos & Epameinondas A. Paizanos Methodology Control variables in Eq. (1) include GDP/c (scale effect and income effect), and democracy level (proxy for environmental regulation). Therefore the coefficient of GOVSHARE mainly captures the composition effect and part of the technique effect. 8

9 Prof. George E. Halkos & Epameinondas A. Paizanos Methodology Use of dynamic estimation methods (slow adjustment) – Perman and Stern, 1999 Partial Adjustment Model. Dynamic Fixed Effects (appropriate for large N and T panels). Assumes that the intercepts differ across countries but the long-run coefficients and the adjustment process are assumed to be equal. 9

10 In all cases variables are I(1) 10 Results Prof. George E. Halkos & Epameinondas A. Paizanos

11 Application of DFE requires variables cointegrated (LR relationship). We reject Ho: no-cointegration in 6/9 cases for all pollutants equations. Evidence of cointegration. DFE is applicable. 11 Prof. George E. Halkos & Epameinondas A. Paizanos

12 Results (cont’d.)

13 Results (cont’d.) Prof. George E. Halkos & Epameinondas A. Paizanos

14 Magnitude of the indirect effect

15 Results (cont’d.)

16 Results (cont’d.)

17 Results (cont’d.)

18 Results (cont’d.) Prof. George E. Halkos & Epameinondas A. Paizanos

19 Prof. George E. Halkos & Epameinondas A. Paizanos Conclusions There is a significantly negative direct effect of government expenditure on SO 2 and NO x emissions, while this effect is insignificant on N 2 O and CO 2 related pollution. The estimated effects are greater in significance and in magnitude on pollutants that are characterized by shorter atmospheric life time, local geographical range and therefore more immediate impact on human health (SO 2 and NO x compared to N 2 O and CO 2 ). There is evidence that production-generated pollution is easier to be controlled by the implementation of fiscal policy, compared to consumption-generated pollution. 19

20 Prof. George E. Halkos & Epameinondas A. Paizanos Conclusions (cont’d.) Results provide reassurance to macroeconomic policy makers that the direct effect of a fiscal spending expansion is not detrimental to environmental quality. In fact, fiscal spending may be used to complement the efforts to improve environmental quality rendering them easier and more cost efficient. 20

21 Prof. George E. Halkos & Epameinondas A. Paizanos Conclusions (cont’d.) The weak direct effect of government spending on environmental quality in developing countries and autocratic regimes can be enhanced by enforcing property rights on natural resources which may promote the internalization of environmental externalities. There is a need for technological and knowledge diffusion to developing countries in order to advance the abatement methods used and encourage the use of environmental cleaner production methods. The mitigation of pollutants with more global impact, requires the adoption of international environmental treaties which will internalize such externalities. 21

22 Thank you for your attention! 22 Prof. George E. Halkos & Epameinondas A. Paizanos