Evaluating race-to-the-top/bottom hypothesis in high-income countries: controlling emissions cap trading, inbound FDI, renewable energy demand, and trade openness

Abstract

The massive rise in the world's average temperature has created major economic and environmental issues that must be addressed by strict environmental legislation. Carbon pricing is seen as a sustainable instrument capable of assisting in the reduction of negative environmental externalities associated with global carbon emissions. The race-to-the-bottom (RTB) hypothesis describes a competitive environment in which economies sacrifice environmental quality standards to undercut competitors, thus undermining the ecological sustainability objective. The study contributed to the evaluation of the RTB hypothesis by examining the role of emissions cap trading instruments in conjunction with inbound foreign direct investment, economic growth, renewable energy demand, and trade openness in reducing carbon emissions, using aggregated data from high-income countries from 1975 to 2019. The linear and non-linear ARDL estimator is used for empirical analysis. The results show that emissions cap trading lowers carbon emissions in the long run while increasing in the short run. Inbound FDI confirmed the "pollution halo hypothesis" in the long run while verifying the "pollution haven hypothesis" in the short run. The per capita income and its associated positive shocks substantially decrease carbon emissions in the short and long runs. Renewable energy demand and trade openness increases carbon emissions in the short and long runs, respectively. On the other hand, trade openness decreases carbon emissions in the short run. The results confirmed the RTB hypothesis in the short run. At the same time, it substantiates the "race-to-the top" (RTT) in the long run, by imposing stringent environmental policies to the way forward towards green and clean development. The study concludes that emissions cap trading and investment in cleaner technologies played a decisive role in reducing environmental pollution. As a result, it is desired to make environmental regulations more environmentally friendly by adopting carbon pricing and technology transfer that will lower the average world temperature.

Keywords: Carbon emissions; Economic Growth; High-income countries; Inbound FDI; Renewable energy demand; Trade Openness.