Financial Development and Industrial Pollution

Abstract

The 2015 Paris Climate Conference put finance at the heart of the debate on environmental degradation. But what exactly is the relationship between finance and environmental pollution? This paper analyses the mechanisms that connect financial development, industrial composition and environmental degradation, as measured by carbon dioxide emissions. It finds that when credit markets develop, polluting industries emit more CO2, but that when stock markets grow, these industries start to emit less. One important mechanism is that stock market development (but not credit market development) is associated with cleaner production processes in technologically “dirty” industries. These industries also produce more green patents when stock markets expand.

Keywords: Financial development, industrial pollution, innovation, reallocation.

JEL Classification: G10, O4, Q5.