Do Countries Adjust the Carbon Intensity of Energy Towards Targets? – The Role of Financial Development on the Adjustment

A sign of emerging downward trends in the carbon intensity of energy (CO2 intensity) is an early indicator of progress in transitioning to low-emission energy. To trade off the obligation of reducing carbon emissions against the cost saving benefits of using fossil fuels, a country may choose an optimal share of using low-emission energy. We apply the partial adjustment to investigate whether countries adjust their CO2 intensities towards specific targets. Using the sample covering 62 economies from 1992 to 2013, we find that the gaps between their actual and target CO2 intensities narrow over time, suggesting adjustment towards their optimal levels in the use of low-emission energy. Important determinants of countries’ target CO2 intensities include GDP growth, the share of fossil fuel consumption, shares of electricity production generated from fossil fuels versus non-fossil fuel sources, emission transfers related to trade activities, and emissions generated in cement production. Financial development is shown to have an asymmetrical moderating effect on the adjustment process towards targets among countries. Specifically, countries with a higher degree of financial development display faster downward than upward speeds of adjustment towards their targets. Indeed, countries with a higher degree of financial development consistently adjusted their CO2 intensities faster downwards and slower upwards towards their targets, while countries with a lower degree of financial development adjusted their CO2 intensities slower downwards and faster upwards. Such findings are not related to the state of economic development of the countries. This demonstrates that financial development plays an important role in mitigating CO2 emissions, given that more developed and deeper financial markets could reallocate investment towards cleaner energy and thus increase the supply of low-emission energy