INTERNATIONAL FINANCE ASSIGNMENT

GROUP
Artha Sampura Sitorus (19KN713S)
Aryo Galih Saloko (19KN714W)
Tito Sulistyo (19KN716N)

THE IMPACT OF GROWTH AND ENERGY CONSUMPTION

TOWARDS ENVIRONMENTAL DEGRADATION IN INDONESIA

1. INTRODUCTION
According to the Global Carbon Atlas (2017), Indonesia is the 12th largest carbon
producer in the world (487 Metric Tons of CO2), ranked 5th in Asian-level carbon-producing
countries and ranked 1st in South East Asia. The high level of carbon emissions from CO2 is a
negative externality of an increase in per capita GDP in Indonesia to $3927 or around Rp.
56,000,000 per capita per annum (BPS, 2018). CO2 carbon emissions, according to Lipsey
(1994), are pollution that occurs as a consequence of increasing the economic size of a country.
Indonesia's high rating of CO2 carbon emissions has prompted the government to sign the Paris
agreement, which was joined by 196 countries (UNFCCC, 2015). The agreement contains the
nationally determined contribution (NDC) target or contribution to the reduction of emission
levels set by the government. According to Indonesia Climate Watch (2019), Indonesia has
voluntarily committed to reduce 29% of unconditional greenhouse gas emissions by 2030. From
this explanation, it is necessary to look at the factors that drive the increase in carbon dioxide
emissions, which ultimately leads to environmental degradation in Indonesia.
The relationship between economic activity and environmental degradation is explained
by Panayotou (1997). He said when a country's income is relatively low, the government will
focus on how to increase national income through economic growth; therefore, it affects the level
of pollutants produced. In developing countries, economic growth that leads to increased income
often ignores environmental quality issues. Meanwhile, in developed countries with high
incomes, increased public awareness of environmental quality (Coondo & Dinda, 2008). The
interaction between per capita income and environmental quality, in the long run, will resemble
an inverse U curve, and this phenomenon is called the EKC (Environmental Kuznets Curve)
(Grossman & Krueger, 1991).
 Many diverse studies related to the EKC curve in Indonesia. Kuswantoro (2009) shows
that EKC consistency is the results of deforestation in Indonesia. Moreover, Sugiawan & Managi
(2016) showed the existence of EKC curves in Indonesia due to the use of renewable energy
outside of fossil energy sources. Apergis & Ozturk (2015), by using the variable GDP per capita,
population density, area, and GDP of the industrial sector, proves the existence of EKC in
Indonesia. Meanwhile, the results of other studies using economic growth variables, and
economic openness indicate no occurrence of EKC in Indonesia (Octavilia, 2017). Ali Nasir
(2019), in Indonesia, using the variable FDI, GDP, quadratic GDP, and the financial sector,
showed insignificant results. Since conflicting findings still exist about the presence of EKC
curves in Indonesia, further research is needed.

2. LITERATURE REVIEW
The explanation for the shape of the EKC curve is when a country reaches a relatively
high-income standard; people increasingly care about the environment (Pezzey, 1989; Selden &
Song, 1994; Baldwin, 1995). According to Aye & Edoja (2017), there are four perspectives on
the impact of financial development on carbon emissions, namely environmentally friendly
technology, foreign direct investment (FDI), an increase in the manufacturing sector and an
increase in consumer credit. Subsequently, increasing the financial sector reduces carbon
emissions exist when the financial markets provide financial / credit assistance to local
companies to obtain environmentally friendly and clean technology for manufacturing or
industrial purposes. This view is supported by Yu Xiang & Chen (2010) that lending from the
financial sector provides funds and technical assistance that enables companies to adopt new and
sophisticated technologies which are environmentally friendly. Moreover, Frankel & Rose
(2002) argue that financial markets can effectively provide credit assistance to companies
domestic to enable them to buy environmentally friendly technology. On the other hand, more
lending to consumers can increase the scale of purchases of goods such as household appliances
and cars that consume much energy (Xing, Jiang, & Ma, 2017).
Energy consumption carried out in economic activity both household or country, will
produce energy changes from one form to another. The results of these energy changes produce a
residue called pollution. In Indonesia, the energy consumption is still dominated by fuel (BPPT,
2018), from the burning of fossil fuels according to (Astra, 2010) quoted from (Edward &
Anderson, 1993) and (Yunus & Michael, 1985) causing smoke, rain acids, and the greenhouse
effect which ultimately causes global warming. Population affects the quality of the
environment, as the increasing population would reduce the environmental carrying capacity
(Cropper & Griffiths, 1994).
The theory of the EKC describes that initially, economic development would increase
environmental degradation. This is because the country would concentrate on increasing
development without taking into account environmental concerns (Grossman & Krueger, 1991).
The continuous production process will then cause environmental damage, such as soil, water ,
and air pollution. At a certain point, economic development followed by an rise in income makes
people aware that the need for good environmental quality is very significant. This point is called
the turning point where economic development can minimize deterioration of the environment
(Shaharir & Alinor, 2013).

3. EMPIRICAL ANALYSIS
3.1. Data
This study uses secondary data; we employ time series from Indonesia covers the period 1969-
2016 taken from WDI data (world development index) of the world bank, WRI (world resource
index), and Global Atlas Carbon. There are six variables in this study: CO2 is the level of carbon
emissions (metric tons) proxy to see environmental degradation, GDP is the income per capita in
a year (US $), FS is a credit to the private sector (% of total GDP), TRADE is trade openness /
the sum of exports and imports (% of total GDP), E is energy consumption (terra-watt / hours),
and Pop is the population (Million). The letter Ln is the transformation of the variable into a
natural logarithmic form.
Table 1 represents the descriptive statistics of the variables. Table 2 shows the correlation matrix
of the variables.
Table 1 descriptive statistics
Variable Obs Mean Std. Dev. Min Max
LnCO2 48 474964 1514776 46559 64506
LnGDP 48 583822 2257772 73691 82128
LnE 48 531989 2313120 73312 75847
LnTRADE 48 367471 918262.2 38496 45662
LnFS 48 326342 848205.5 31928 41283
LnPOP 48 164629 630031.6 19067 19382
Table 2 Correlation matrix
LnCO2 LnGDP LnE LnTRADE LnFS LnPOP
LnCO2 10.000
LnGDP 0.1550 10.000
LnE 0.3300 0.0405 10.000
LnTRADE 0.0508 0.0483 0.1507 10.000
LnFS 0.2950 0.1726 0.0897 0.3241 10.000
LnPOP 0.0158 0.1341 0.1283 0.1066 0.0463 10.000

3.2. Model specification

The econometric model used to analyze how GDP and energy consumption relate to CO2
emission at the country level by evaluating the long- and short-run relationships among CO2
emissions, GDP, and energy consumption, with the consideration of trade openness, credit to the
private sector and population. We estimate the following empirical equation:
LnCO2 = α0 + α1LnGDP + α2LnE + α3LnTRADE + α4LnFS +α5LnPop+ ɛ……….(1)
To find out the existence of EKC then added income per capita squared variable (GDP 2) so that
the curve formed is shown in equation model (2) as follows
LnCO2 = α0 + α1LnGDP + α2LnGDP2 + α3LnE + α4LnTRADE + α5LnFS
+ α6LnPop+ ɛ……………………………………………………………(2)
The estimation method still depends on the stationarity of the data. If there is non-
stationary data at the level, use ARDL (autoregressive distribution lag). ARDL is used to
overcome models with different levels of stationarity (Widarjono, 2018). The equation (3) of
ARDL can be written as follows:
n n n n n
∆ LnCO 2=α +∑ α 1 LnCO 2 t−i+ ¿ ∑ α 2 LnGDPt−i+¿ ∑ α 3 LnEt −i+ ¿ ∑ α 4 LnTRADEt−i+¿ ∑ α 5 L nFSt
i=1 i=1 i=1 i=1 i=1

4. RESULTS AND DISCUSSION

4.1. Panel unit root and cointegration tests
Following past studies on time series analysis, our study first conducts the stationarity tests to
confirm the stationarity of the variables at the level and the first-difference. Testing using ADF
(augmented dicky fuller). Based on the ADF stationary test results shows some variables have
been stationary at the LnTRADE, LnE, and LnPop levels. In contrast, at the first difference level,
all variables have been stationary.
Table 3 Panel unit root tests (1969–2016).
ADF
Variable Level First
t-Stat Prob t-Stat Prob
LnCO2 -2,0506 0,2650 -6,0660 0,0000***
LnGDP -1,5287 0,5105 -6,0663 0,0000***
LnE -3,5016 0,0122** -5,3640 0,0000***
LnTRADE -3,5591 0,0105** -8,6290 0,0000***
LnFS -1,5003 0,5242 -3,0963 0,0341**
LnPop -3,1649 0,0301** -1,6902 0,0858*
Notes: ***, ** & * represent the significance at 1%, 5%, and 10% levels, respectively.

A cointegration test is a form of one test to determine the existence of a long-term

relationship between the variables used. Whether there is a long-term relationship between
variables in ARDL is tested using the cointegration bound testing approach. Bound testing
approach is based on the results of the statistical test F. If the calculated F value is higher than
the upper bound value of I (1), then there is cointegration. Meanwhile, if the value of F is
calculated between lower bound I (0) and upper bound I (1), then there is no cointegration. The
c-integration test result of the F-Bound Test model 1 shows that the calculated F value is higher
than the upper bound of 10,887. Show that there is a long-term cointegration relationship
between variables. The c-integration test result of the F-Bound Test model 2 shows that the
calculated F value is higher than the upper bound of 10,031. Show that there is a long-term
cointegration relationship between variables

Table 4 F-Bound Test Model 1 Cointegration Test Results (1969–2016).

Value α I(0) I(1)

F-stat (10,887) 1% 3,06 4,15

K (5) 5% 2,39 3,38
10% 2,08 3
Table 5 F-Bound Test Model 2 Cointegration Test Results (1969–2016).
Value α I(0) I(1)

F-stat (10,031) 1% 2,88 3,99

K (6) 5% 2,27 3,28
10% 1,99 2,94

4.2. Long-run estimates and short-run dynamics

Equation 1 is used to measure the effect of per capita income, credit to the private sector,
economic openness, energy consumption and population on environmental degradation.
Estimation results of equation (1) using ARDL (2,0,0,2,0,2) are shown in table 6.

Table 6. ARDL Regression Estimation Results (2,0,0,2,0,2) Equation (1)

Long-Run Short-Run
Coefficien t-stat Prob Coefficient t-stat Prob
t

LnGDP 0,2061 3,9520 0,0004*** D(LnCO2(-1)) 0,3738 3,9468 0,0004***

LnE 0,6492 0,1590 0,0003*** D(LnTRADE) -0,0813 -1,3081 0,1996
LnTRADE -0,2045 -2,1761 0,0366** D(LnTRADE(-1)) 0,1824 2,8756 0,0069***
LnFS 0,00003 0,0006 0,9996 D(LnPop) 132,9832 3,3291 0,0021***
LnPop -0,6287 -0,9233 0,3623 D(LnPop(-1)) -165,3030 -4,1076 0,0000***
C 13,0408 1,0217 0,3141
ECT(-1) -0,9858 -9,4690 0,0000
2 0,995 2 0,735
R R
2
Adjust R 0,993 Adjust R2 0,701
F-stat 664,5536 (0,0000) Sum Square Residu 0,121
Notes: ***, ** & * represent the significance at 1%, 5%, and 10% levels, respectively.

Equation (2) is used to see the EKC curve shape by adding the GDP2 variable. ARDL
estimation results (2,2,2,0,1,0,1) are shown in table 7 as follows:

Table 7 ARDL Regression Estimation Results (2,0,0,2,0,2) Equation (2)

Long-Run Short-Run
Coefficien Coefficien Coefficient Coefficient
 t t
LnGDP -0,5264 -3,8407 0,0006*** D(LnCO2(-1)) 0,3914 4,6951 0,0001***
LnGDP2 0,0602 5,8515 0,0000*** D(LnGDP) 0,5897 1,7084 0,0976*
LnE 0,6682 4,2696 0,0002*** D(LnGDP(-1)) -1,7964 -5,3246 0,0000***
LnTRADE 0,2360 2,8171 0,0084*** D(LnGDP2) -0,0253 -0,9342 0,3574
LnFS 0,0001 0,0028 0,9978 D(LnGDP2(-1)) 0,1411 5,3394 0,0000***
LnPop -1,3276 -2,6408 0,0467*** D(LnTRADE) 0,0413 0,6767 0,5036
C 26,7965 2,2254 0,0335 D(LnPop) -47,4186 -10,4052 0,0000
ECT(-1) -1,0642 -10,8874 0,0000
2 0,997 2 0,846
R R
Adjust R2 0,996 Adjust R2 0,818
F-stat 822,5159 (0,0000) Sum Square Residu 0,070
Notes: ***, ** & * represent the significance at 1%, 5%, and 10% levels, respectively.
Based on the results in table 6 using equation (1) per capita income in Indonesia affects
the increase in emission levels by 0.2061%, the results are in accordance with the research of
Sugiawan & Managi (2016) in Indonesia, which shows that income per capita (LnGDP)
increases the level CO2 carbon emissions. In ASEAN countries there is a long-term co-
integration relationship between CO2 emissions and economic growth (Ali Nasir, Duc Huynh, &
Xuan Tram, 2019). While, equation (2) table 1.5 shows that income per capita in Indonesia has
an effect on decreasing the level of emissions by 0.5264%. These findings deny the existence of
an inverse U relationship, but rather indicate a U-shape relationship between income per capita
and environmental degradation in Indonesia. These results are consistent with the results of Mor
& Singh's research (2019) in high-income and upper middle-income countries, when the level of
income is high, CO2 carbon emissions begin to increase. This is supported by the BPS report
(2018) that Indonesia is in the category of upper middle income with a range of $ 3896- $ 12055.
Furthermore, results in table 6 and table 7 shows that the coefficient of the variable credit
to the private sector (LnFS) has a positive and not significant effect. According to Awaworyi et
al. (2018) The coefficient on credit to the private sector can be positive or negative. The negative
side of giving credit to the private sector is being able to fund consumer activities to obtain
goods, such as cars and other machines, which produce CO2 (Sadorsky, 2010). On the positive
side, credit to the private sector provides technological innovation and facilitates access to new
technologies that can increase efficiency in production and reduce carbon emissions (Tamazian
& Rao, 2010). Indonesia's credit to the private sector shows insignificant results. This happens
because the provision of credit to the private sector is used for physical infrastructure
development activities to support the acceleration of the current government infrastructure,
which has no direct effect on the level of emissions produced.
 The results in table 6 shows the coefficient of the variable trade openness (LnTRADE)
has a negative and significant effect. Increasing trade openness by 1% will reduce CO2 carbon
emissions by 0.2045%. Table 7 shows that trade openness variables have positive and significant
effects. Increasing trade openness by 1% will increase the level of CO2 carbon emissions by
0.2360%. Trade openness, according to Dinda (2004), allows an increase in pollution and a
decrease in environmental quality due to the production of waste generated from production
activities as market access expands. In line with research conducted by Oktavilia, Sugiyanto, &
Firmansyah (2017) in ASEAN countries, trade openness increases the level of CO2 carbon
emissions. In contrary, the results of this study are different, by showing positive and negative
coefficients in Indonesia. Another opinion explains that trade openness can reduce pollution and
improve environmental quality. According to Reppelin-Hill (1999) trade openness allows easy
access to technologies that use cleaner production techniques and improve environmental
quality. This is supported by the presence of gross industrial migration from developed countries
to developing countries due to the openness of trade and the flow of foreign investment (Gill,
2018).
Moreover, the results in table 6 and table 7. shows that the coefficient of the variable
energy consumption (LnE) has a positive and significant effect. Increasing energy consumption
by 1% will increase the level of carbon dioxide emissions by 0, 6492% in model 1 and model 2
by 0.6682%. According to BPPT (2018) Indonesia's energy consumption is still dominated by
fuel (fuel oil). Research conducted by Sugiawan & Managi (2016) in Indonesia, shows that to
reduce the level of carbon dioxide emissions, it is necessary to use environmentally friendly
renewable energy outside of fossil energy sources.
Finally, the results of in table 6 using equation (1) shows that the coefficient of the
variable population (LnPop) has a negative and not significant effect, but equation (2) in table
1.5 has a negative and significant effect. Increasing the population by 1% will reduce CO2
carbon emission level by 1.3276%. Increased growth in carbon dioxide emissions is associated
with high energy consumption, as it occurs due to increased in population growth (Cropper &
Griffiths, 1994; Myers, 1997). The coefficient of the population has a negative effect on the level
of carbon dioxide emissions, explaining that the population has become aware of environmental
problems. Residents or communities already have attitudes and rational behavior and are
responsible for protecting the environment.
5. CONCLUSION AND RECOMMENDATION
Based on the results of this study, the factors that influence environmental degradation in
Indonesia are per capita income, trade openness, energy consumption, and population. These
results indicate the existence of a curve that forms the letter U, and does not indicate the
existence of an environmental kuznet curve (EKC) in Indonesia.
Referring to the conclusions above, so that the condition of environmental quality is
consistently maintained the need for enforcement of the emission tax applies, which at the initial
stage only applies to large industries that have not used environmentally friendly technology,
then gradually towards medium industries to the imposition at the household level that has motor
vehicle.

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