Environmental Kuznets curve and Covid-19 crisis

In an atmosphere of COVID-19 terrible wrecking, the impact of the health crisis on climate change has identified as something of a bright spot. The Global Energy Report 2020 of International Energy Agency (IEA) recently presented some astonishing results, including the following:

• “Countries in full lockdown are experiencing an average 25% decline in energy demand per week and countries in partial lockdown an average 18% decline.
• Global energy demand declined by 3.8% in the first quarter of 2020, with most of the impact felt in March as confinement measures were enforced.
• Global coal demand was hit the hardest, falling by almost 8% compared with the first quarter of 2019.
• Oil demand was also hit strongly, down nearly 5% in the first quarter, mostly by curtailment in mobility and aviation, which account for nearly 60% of global oil demand. By the end of March, global road transport activity was almost 50% below the 2019 average and aviation 60% below.
• Global CO2 emissions are expected to decline by 8%, or almost 2.6 gigatonnes (Gt), to levels of 10 years ago. Such a year-on-year reduction would be the largest ever, six times larger than the previous record reduction of 0.4 Gt in 2009 – caused by the global financial crisis – and twice as large as the combined total of all previous reductions since the end of World War II.
• Renewables were the only source that posted a growth in demand, driven by larger installed capacity and priority dispatch.
• And, last but not least, as after previous crises, however, the rebound in emissions may be larger than the decline, unless the wave of investment to restart the economy is dedicated to cleaner and more resilient energy infrastructure.”

Some of these figures were absolutely unimaginable a couple of months ago, as given the intense debate around the climate change. Now, and only with data considering the beginning of the economic disruption, it is already crystal clear that the COVID-19 crisis impacted brutally on climate change, viz on global energy demand and CO2 emissions. This impact seems an opportunity to reverse the environmental degradation and to rethink our society in terms of sustainability.

A paper I wrote, few months ago, with my friends João Bento and Paolo Maranzano, explored precisely this problem¹. We go up the shoulders of the Nobel prize Simon Kuznets to study the effect of foreign direct investment (FDI) on environmental degradation.

During the 1950s and 1960s, Kuznets, beyond an immense legacy on economic structure and process of development, found that environmental degradation resulting from investment just persists until average income reaches a certain point over the course of economy’s development. Since then, considerable evidence supported the claim that environmental health indicators, e.g., water and air pollution, show an inverted U-shaped curve, the famous Environmental Kuznets Curve (EKC), and that inequality is just a side effect of growth, and, in fact, there is an inverted U-shaped relation between income inequality and economic growth, meaning that economic growth increases income disparity between rich and poor in poorest countries, but decreases it in wealthy countries, i.e., the distribution of income is more unequal at early stages of income growth but then, up to a certain turning point, income inequality starts decreasing so that income distribution moves back toward greater equality as economic growth progresses.

We take this seminal paper², which established that various indicators of environmental degradation tend to get worse as economic growth occurs, to study the impact of US outward FDI abroad. Specifically, in our empirical paper, we analyzed whether the American investment abroad contributes to mitigating environmental degradation in host countries during long periods or not – using the EKC framework and dynamic panel data models which include trade openness and environmental regulation as controlling variables.

Using recent data, we found that Kuznets was right and that capital expenditures from majority-owned foreign affiliates of US multinationals relatively decrease carbon dioxide emissions per capita and provide support for the pollution halo hypothesis, i.e., multinationals engaging in FDI will tend to spread its greener technology to their counterparts in the host countries.

Our conclusion was precisely in line with the last two points of Global Energy Report, offering scientific support for host government policies to welcome FDI offering conditions to attract environmentally friendly investments to improve environmental sustainability. The health crisis of our time and the greatest challenge humanity have faced since World War Two is the time to cross the Rubicon, benefiting from this opportunity to regain courage, rethink our society and find the right track for this “one strange rock” – the epithet given to a thrilling journey exploring the fragility and wonder of our planet in a National Geographic series.

¹_{Bento, J. P., Torres, M. M., & Maranzano, P. (2019). Outward US foreign direct investment and environmental degradation. In Carrizo Moreira, A. and Silva, P., editors, Handbook of Research on Corporate Restructuring and Globalization. Hershey, PA (USA).}

²_{Kuznets, S. (1955). Economic Growth and Income Inequality. The American Economic Review, 45(1), pp. 1-28.}