Energy Economics 40 (2013) 8–21

Contents lists available at ScienceDirect

Energy Economics
journal homepage: www.elsevier.com/locate/eneco

The dynamic links between energy consumption, economic growth,

financial development and trade in China: Fresh evidence from
multivariate framework analysis
Muhammad Shahbaz a,⁎, Saleheen Khan b, Mohammad Iqbal Tahir c,d
a
Department of Management Sciences, COMSATS Institute of Information Technology, Lahore, Pakistan
b
Department of Economics, Minnesota State University, Mankato, 121 Morris Hall, Mankato, MN 56002, United States
c
The University of Faisalabad, Faisalabad, Pakistan
d
Griffith University, Brisbane, Australia

a r t i c l e i n f o a b s t r a c t

Article history: This study investigates the relationship between energy use and economic growth by incorporating financial
Received 30 November 2012 development, international trade and capital as important factors of production function in case of China over
Received in revised form 6 June 2013 the period of 1971–2011. The ARDL bounds testing approach to cointegration was applied to examine long
Accepted 9 June 2013
run relationship among the series while stationarity properties of the variables was tested by applying struc-
Available online 18 June 2013
tural break test.
Keywords:
Our empirical evidence confirmed long run relationship among the variables. The results showed that energy
Growth use, financial development, capital, exports, imports and international trade have positive impact on eco-
Energy nomic growth. The Granger causality analysis revealed that unidirectional causal relationship running from
Financial development energy use to economic growth. Financial development and energy use Granger cause each other. There is
Trade bidirectional causality between international trade and energy use. The feedback relation exists between fi-
nancial development and international trade. There is also bidirectional causality exists between capital and
energy demand, financial development and economic growth and, international trade and economic growth.
This paper makes significant contribution in energy economics and opens up new direction for policy makers
to explore new and alternative sources of energy which would be helpful in meeting the rising demand of
energy due to sustained rate of economic growth.
© 2013 Elsevier B.V. All rights reserved.

1. Introduction This has raised interest in the underlying dynamics between energy
demand and GDP (see Ozturk, 2010); and between international
The relationship between output and energy use has drawn much trade and economic growth (see Cuadros et al., 2004; Dritsaki et al.,
research interest in recent years perhaps due to increased awareness 2004; Giles and Williams, 2000). Knowledge of the relation is impor-
of greenhouse gas emission (GHG) and its impact on sustainable en- tant to policy makers for several reasons. If energy use Granger causes
vironment. Despite the emergence of a bourgeoning literature on output, energy conservation, unrelated to technological change, can
the topic, consensus remains elusive because results are often based have adverse impact on the former (Karanfil, 2009). If energy use
on ad hoc approach compounded by omitted variables bias (see Granger causes exports/imports, any reduction in energy use due to
Akarca and Long, 1980; Yu and Hwang, 1984; Yu and Jin, 1992). It is say, energy conservation polices may lower potential benefits from
against this backdrop that more recent studies have adopted multi- trade. Again, if conservation policies lower energy use then trade
variate approach by including capital and labor, inter alia (Shahbaz led-growth might not seem to work. If unidirectional Granger causal-
et al., 2012; Stern, 1993, 2000). ity runs from exports or imports to energy use then conservation pol-
The emerging and developing economies have been experiencing icies will have unfavorable effect on trade liberalization policies
remarkable rates of growth in international trade with a concomitant which may ultimately retard economic growth.
increase in energy use, raising the specter of gloomy future of GHG. Narayan and Smyth (2009) and Lean and Smyth (2010a,b) appear
to be the only published papers which aims at the relationship be-
tween energy demand and exports. It is now clear that exclusion of
⁎ Corresponding author. Tel.: +92 42 111 001 007, + 92 334 3664 657(mobile); a relevant variable(s) not only makes the estimates inconsistent and
fax: + 92 42 99203100.
E-mail addresses: shahbazmohd@live.com (M. Shahbaz), saleheen.khan@mnsu.edu
biased, but also produces ‘no-causality’ (Lütkepohl, 1982). Even the
(S. Khan), advisor@tuf.edu.pk (M.I. Tahir).URL: http://www.ciitlahore.edu.pk direction of causality changed for some African nations, once capital
(M. Shahbaz). and labor were included (Wolde-Rufael, 2009). Empirical models

0140-9883/$ – see front matter © 2013 Elsevier B.V. All rights reserved.
http://dx.doi.org/10.1016/j.eneco.2013.06.006
 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21 9

that are grounded in sound theory produce better outcomes. Contem- literature; Section 4 describes the methodological framework and data
porary research also shows that the financial development directly sources; Section 5 reports and analyses the results and, Section 6 offers
impacts energy use and productivity (Shahbaz, 2012; Shahbaz and concluding remarks with policy implications.
Lean, 2012b). Thus, inclusion of both financial development and
trade along with labor and capital appears well justified on theoreti- 2. An overview of Chinese economy
cal grounds. The framework used here is based on a conventional en-
ergy demand model. China has maintained rapid economic growth for the last three de-
The long-run relationship and the direction of causality results are cades and the average annual income growth in the recent years has
different in different countries. Studies conducted in same country been 9%. As a growing economy, China has experienced in rapid devel-
may produce different result (see Karanfil, 2009; Payne, 2010) due opment of its industries, especially the energy intensive industries. The
to country-specific conditions and methodological differences. Results energy demand has increased tremendously in the last decades. Ac-
may also vary due to omitted variable bias or due to absence of inputs cording to U.S. Energy Information Administration (2011), currently
substitution possibilities (Akinlo, 2008; Ghali and El-Sakka, 2004; China is the second largest energy consumer behind the United States,
Stern and Cleveland, 2004). Using Australia data from 1960 to 1999, with a total energy use of 85 quadrillion British thermal units. A 71%
Fatai et al. (2004) found cointegration between energy use and elec- of the total energy use is supplied by coal, which is followed by oil
tricity consumption; and unidirectional causality from output to elec- (19%), hydroelectric sources (6%), natural gas (3%), nuclear power
tricity consumption. Narayan and Smyth (2005) found cointegration (1%), and other renewable (0.2%) respectively. Furthermore, China is
between electricity consumption, employment, and real income; and also one of the biggest energy producers in the world. The country has
long-run causality from employment and real income to electricity recoverable reserves of 176.8 billion tons of coal, 21.2 billion tons of
consumption. Narayan and Prasad (2008) used a bivariate model crude oil, 14.3 billion tons of non-conventional oil, 22.03 trillion cubic
and showed that long-run causality runs from electricity consumption meters of natural gas, and 400 GW of hydropower (Wang et al., 2011).
to output. These findings however, differ from the results of China has significant influence in the world's energy sector as its en-
Chontanawat et al. (2008), who did not find cointegration between ergy use as well as production is very high in the world energy market.
per-capita energy use and per-capita GDP in Australia for a sample China is the second largest oil consumer after the United States. China is
of 1960–2000. To avoid potential omitted-variable bias in the above both the largest consumer and the largest producer of coal in the world.
mentioned papers, Yuan et al. (2008) applied neo-classical production The tremendous amount of fossil fuels used in energy use also makes
function to investigate causality between energy use and economic China the number one source of GHG emissions in the world, causing
growth by incorporating capital and labor in case of China. Their em- serious environmental concerns both domestically and internationally.
pirical exercise found unidirectional causality running from energy Environmental issues should be major factor influencing future energy
use to economic growth. Wang et al. (2011) reported that energy de- development and use in China. China already is experiencing serious
mand, capital and employment Granger cause economic growth. You environmental problems that are caused by energy activities, especially
(2012) opined that clean and renewable energy use stimulates eco- air pollution from industrial, transportation, and residential fuels com-
nomic growth. On contrary, Zhang and Xu (2012) found causality is bustion. As economic development in China continues, environmental
running from energy use to economic growth. Furthermore, Shuyun problems in general will worsen with the projected rapid increases in
and Donghua (2011) supported the feedback hypothesis between en- energy demand. The Chinese government recognized the fact that
ergy use and economic growth and the same inference is reported by energy consumption has to be brought under control to achieve sus-
Soile (2012) in case of Indonesia. tainable growth with an ever increasing energy demand. The 11th
Clearly, there is a lack of consensus on the causality between energy Five-Year Plan has called on the nation to reduce energy intensity by
use and income that points to the need for further research. The current 20% in the next 5 years.
study can be considered as a modest attempt to provide further evi- Since the introduction of opening-up policy and reforms in 1978,
dence by using a theoretically more justified model to complement Chinese financial sector has experienced significant development.
some of the existing research to better understand the underlying dy- The commercial banking, stock markets system and new regulatory
namics. This is main motivation for authors to fill gap research in case bodies were established. Stock markets were introduced in China in
of China. The findings are expected to help craft appropriate economic, 1990, even though the role of stock and bond markets is still rather
energy/environment, financial and trade policies to sustain economic limited, one being in Shanghai and another one being in Shenzhen.
growth in China. However, the banking sectors contribute to the major share of finan-
The objective of the paper is to use production function approach to cial transactions in China. Thus it seems reasonable when analyze
explain the relationship between energy use and economic growth finance-growth nexus to focus our attention on banks, which have
(Stern, 1993, 2000) where GDP depends on energy use, capital and the biggest share in financial sector. Debt market in China, though de-
others inputs such as financial development and international trade. veloping, is still relatively narrow, segmented and lacking liquidity.
The extended Cobb–Douglas production framework helps us to explore The first unofficial bond markets began to develop in the 1980s. The
a long run relation among the variables: energy use, economic growth, government began to regularize the bond market in the early 1990s.
capital, financial development and international trade. The variables are Trading of government bonds was launched on the interbank market
chosen to capture the particular characteristics of Chinese economy. For in 1997. The corporate bond market was reserved for several selected
a long run relation we implement the Autoregressive Distributed Lag state owned enterprises and remained very small. In sum, the bank-
(ARDL) and the Johansen Juselius approaches to cointegration, and ing sector plays the biggest role in the Chinese financial sector
the vector error correction model (VECM) for short run dynamics. The which possibly has the strongest connection with economic growth.
study period 1971–2011 is relatively long and hallmarked by major International trade expansion has been one of the most phenomenal
changes in the global landscape. These events may potentially cause developments of China's economy in the era of systemic reform and
structural break in the time series. In testing for the stationarity proper- opening up to the world market which began in 1978. Trade-to-GDP
ties, this factor has been taken into account. The paper contributes by ratio rose remarkably over the last two decades. China's has trade surplus
taking a comprehensive approach to examine the energy-economic with its trading partners over the last decade. Net export has an effect on
growth nexus for China within a theoretically justified model that has money supply in the domestic credit market and, as a result, could indi-
not been done so far. rectly affect output in the private sectors. From our discussion of the
The rest of the paper is organized as follows. Section 2 provides Chinese economy, we can see that trade openness, economic growth,
brief overview of Chinese economy. Section 3 reviews the relevant energy use and financial development are dynamically interrelated.
10 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21

The paper examines this dynamic relationship by applying a growth and affect the demand for energy (Sadorsky, 2010, 2011a,b;
Autoregressive Distributed Lag (ARDL) bound testing and the Johansen Shahbaz and Lean, 2012b). Financial development lowers CO2 emissions
Juselius approaches to cointegration, and the vector error correction (Tamazian et al., 2009). Sadorsky (2011a) pointed out that financial de-
model (VECM) to account for the short run and long run behavior of velopment improves access to financial resources that boosts demand
their dynamic interactions. for big ticket items and adds to energy demand which also have indirect
positive impact to boost business activity. The overall effect is to raise en-
3. Literature review ergy use.
Following Karanfil (2009), Dan and Lijun (2009) examined the ef-
Much of the studies on the link between economic growth and en- fect of financial development on primary energy use in Guangdong,
ergy use, financial development and trade are carried on a piecemeal China. They found unidirectional causality from energy use to finan-
basis without a comprehensive model in mind and thus ignore the cial development. Sadorsky (2010) also examined 22 emerging econ-
potential interaction among the series. Many macroeconomic series omies between 1990 and 2006 using different indicators of financial
are often affected by permanent exogenous shocks which can create development. He found a small but positive effect of energy on eco-
structural breaks and disrupt important relationship which can pro- nomic growth. Shahbaz and Lean (2012b) found that financial devel-
duce misleading results. Thus this paper reviews the literature opment boosts energy demand via stock market development and
under three subsections, e.g. (a) economic growth and energy use; that the two Granger cause each other, but the former dominates
(b) financial development and energy demand (c) international the later in Pakistan. Islam et al. (2013) found causality from financial
trade and energy use. We discuss them in turn below. development to energy demand in Malaysia.
Financial development promotes economic growth by increasing ef-
3.1. Economic growth and energy use ficiency (Bell and Rousseau, 2001; Xu, 2000). Improved financial devel-
opment facilitates savings, borrowing and investment. With low
Four hypotheses can be identified to describe energy-growth nexus: borrowing cost, consumers tend to buy consumer durables which add
growth hypothesis; conservation hypothesis; feedback hypothesis; and to energy demand (Sadorsky, 2011b). Islam et al. (2013) argue that fi-
neutrality hypothesis. The growth hypothesis regards energy use vital nancial development facilitates the purchase of energy efficient appli-
for economic growth. A reduction in energy use lowers GDP — the econ- ances which lowers energy use. Mielnik and Goldemberg (2002)
omy is energy dependent. Under the conservation hypothesis, unidirec- found inverse relationship between FDI and energy intensity. Further
tional causality runs from economic growth to energy use. So, policy to evidence may help resolve the ongoing debate. Recently, Tang and
reduce energy demand may not have much impact on economic Tan (in press) investigated the impact of financial development, energy
growth. The feedback hypothesis assumes bi-directional causality — prices and foreign direct investment on energy use by utilizing energy
energy and growth affect each other. In neutrality hypothesis lower demand function. Their empirical evidence showed that financial devel-
energy use does not affect economic growth, and vice versa (Belke opment and energy use are complementary i.e. feedback effect exits.
et al., 2011).
Kraft and Kraft's (1978) was the first study on the growth-energy
nexus. Using US data from 1947 to 1974 they found unidirectional 3.3. International trade and energy use
causality from GNP growth to energy use. However, using the same
data set but from 1947 to 1972, Akarca and Long (1980) did not find The relationship between international trade and energy use has
any link. They argue that inclusion 1973–1974 data can contaminate been investigated by various researchers. For example, Narayan and
the series due to the effect of oil embargo. Erol and Yu (1988) used Smyth (2009) used multivariate Granger causality approach to inves-
data from six industrialized countries and with a sample of 1952– tigate causal relationship between energy, exports and economic
1982. They found bidirectional causality for Japan, unidirectional cau- growth in case of Middle Eastern countries1. Their empirical exercise
sality from energy to economic growth for Canada, from economic did not show any relationship between exports and energy use. Erkan
growth to energy for Germany and Italy, and none for France and et al. (2010) examined the relationship between energy and exports
England. Masih and Masih (1996) found causality from energy use to in case of Turkey. They applied Johansen–Juselius cointegration ap-
economic growth in India, and from economic growth to energy in proach and the VECM Granger causality approaches for long run
Pakistan and Indonesia, but none for Malaysia, Singapore and the and causal relationship between the variables respectively. Their re-
Philippines. Soytas and Sari (2003) found that economic growth sults showed cointegration between exports and energy use while
Granger causes energy use in Italy and Korea, and unidirectional cau- energy use Granger causes exports. Similarly, in case of Malaysia,
sality runs from energy use to economic growth in France, Germany, Lean and Smyth (2010a,b) reported that exports and energy genera-
Japan and Turkey. Huang et al. (2008) found no causality between en- tion do not seem to Granger cause each other.
ergy use and economic growth for low-income countries, but found Sami (2011) used data of Japan to investigate the impact of exports
unidirectional causality from economic growth to energy for middle on energy use by incorporating income per capita in energy demand
and high-income countries as did Aqeel and Butt (2001), Shahbaz function. The empirical analysis indicated cointegration between the
and Lean (2012a), Shahbaz and Feridun (2012) for Pakistan; Lee variables and the VECM Granger causality confirmed unidirectional
(2006) for France, Italy and Japan, and Lee and Chien (2010) for France causality running from exports and economic growth to energy use.
and Japan. The reverse causality is reported by Lee (2006) for Canada, Sultan (2011) also investigated the relationship between aggregate out-
UK, Germany Sweden, and Switzerland; Narayan and Smyth (2008) put, exports and energy in case of Mauritius. The results reported that
for G-7 countries, Bowden and Payne (2009) for the US. The lack of variables are cointegrated and energy use and exports Granger cause
consensus in these papers can be due to methodological differences, economic growth. Sadorsky (2011b) used panel cointegration data esti-
use of different time periods, country heterogeneity in climate, differ- mation techniques for the period of 1980–2007 in case of Middle East2.
ent stages of economic growth and energy use patterns. He found short-run dynamics of Granger causality from exports to ener-
gy use, and a bi-directional feedback relationship between imports and
3.2. Financial development and energy demand energy use. The long run positive effects of both exports and imports on
energy use were also observed. Using Turkish data, Halicioglu (2011)
Financial development includes increase in the flow of FDI, improved
stock market and banking activities and favorable reforms; and domestic 1
Iran, Israel, Kuwait, Oman, Saudi Arabia and Syria.
credit to private sector. Financial infrastructure can enhance economic 2
Bahrain, Iran, Jordan, Oman, Qatar, Saudi Arabia, Syria, United Arab Emirates.
 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21 11

investigated the causal relationship between economic growth, exports where, lnGt, lnEt, lnFt, lnTRt and lnKt represent real GDP, energy use,
and energy using multivariate Granger causality approach. The results real domestic credit to private sector as a proxy for financial develop-
showed long run relationship between the variables and unidirectional ment, real trade openness and real capital use, respectively, each
causality from exports to energy demand in short run. transformed into logarithm and expressed in per capita terms. In
Hossain (2012) applied multivariate Granger causality approach to this paper we use three different indicators of trade openness in per
examine causal relationship between economic growth, exports, remit- capita terms, real exports, real imports, and real trade7, which are
tances and energy consumption using the data of SAARC countries3. The then, estimated as separate equations. The term μt is a random error
results of Johansen–Fisher panel cointegration approach confirmed term. The specification also captures the relationship between energy
cointegration between the series and neutrality effect found between use and economic growth where technology takes effect through fi-
exports and energy consumption. Sadorsky (2012) also confirmed the nancial development and international trade.
long run relationships between energy and exports; energy and im- Energy is an important determinant of economic growth like other
ports; and energy and trade (exports and imports) using data of 7 factors of production such as labor and capital. We find four compet-
South American countries4. For the short run dynamics, feedback rela- ing hypotheses of energy use and economic growth relationship. For
tionship between energy use and exports, and energy use Granger example, reductions in energy would not have adverse impact on
causes imports is also revealed. In case of Pakistan, Shahbaz et al. economic growth if economic growth Granger causes energy use or
(2013) reinvestigated relationship between energy use and economic neutral hypothesis exists between both the variables. If bidirectional
growth by incorporating exports in energy demand function. They ap- causality is found between both the variables or energy use Granger
plied the ARDL bounds testing for long run and innovative accounting causes economic growth then new sources of energy should be en-
approach for causal relationship between the variables. Their results in- couraged. Energy is an important stimulus of production process
dicated that variables are cointegrated and energy demand Granger and energy must Granger cause economic growth. An expansion in
causes exports. production is linked with energy demand and economic growth
might Granger cause energy use.
4. Data and methodological framework Financial development illustrates the actual level of financial re-
sources available for productive purpose and channels funds to projects
To investigate a long run relation between energy use and eco- through banks and stock markets (Minier, 2009; Sadorsky, 2010). Fi-
nomic growth in case of China, the following augmented Cobb–Doug- nancial development contributes to economic growth by boosting in-
las production function is employed: vestment through transparent transactions. Developed financial
markets enhance confidence of local as well as of the foreign investors,
α α α u
G ¼ AE 1 K 2 L 3 e ð1Þ and attract foreign direct investment (Sadorsky, 2010). Increased li-
quidity helps asset diversification as per returns. The effect of financial
where, G is real domestic output; E, K and L denote respectively, ener- development on economic growth and thus on energy demand is posi-
gy, capital and labor. The term A refers to technology and e the error tive due to higher standard of living. Financial development benefits
term assumed N(iid). The output elasticity with respect to energy producers by offering cheaper loans that then purchase advanced ma-
consumption, capital and labor is α1, α2 and α3respectively. When chinery and equipment and raises energy demand.
Cobb–Douglas technology is restricted to (α1 + α2 + α3 = 1) we The relationship between exports and energy use is an important
get constant returns to scale. In the model we allow technology to topic to study for several reasons. If Granger causality runs from ener-
be endogenously determined by level of financial development and gy use to exports or there is a feedback relationship between energy
international trade within an extended Cobb–Douglas production and exports, then energy conservation policies will reduce exports
function5. Financial development promotes economic growth via cap- which may decline economic growth. If causality running from ex-
ital formation in making its efficient use; encourages FDI inflow and ports to energy or evidence of no Granger causality in either direction
transfer of superior technology and managerial skill. Entrepreneurs then energy conservation policies can be implemented without af-
are the main actors in a free market who are the force behind innova- fecting exports. Theoretically, there are a number of reasons for why
tion and technological progress. International trade helps technolog- exports can affect energy. For an increase in exports to take place, ma-
ical advancements and its diffusion. The model thus can be written as: chinery and equipment must be used to load and transport the ex-
ports to seaports, airports or other docking stations where the
α δ exports are then offloaded and re-loaded for voyages abroad. The ma-
Aðt Þ ¼ ϕ:TRðt Þ F ðt Þ ð2Þ
chinery and equipment used in the process of producing and
transporting goods for exports requires energy to operate. An in-
where ϕ is time-invariant constant, TR is indicator of trade openness
crease in exports represents an increase in economic activity and
and F is financial development6. Substituting Eq. (2) into Eq. (1):
this should increase the demand for energy. It is also possible for
δ δ δ β 1−β changes in energy to affect exports because energy is an important
Gðt Þ ¼ ϕ:Eðt Þ 1 F ðt Þ 2 TRðt Þ 3 K ðt Þ Lðt Þ : ð3Þ
input into the production and transportation of goods destined for ex-
ports. The exporting manufactured goods or raw materials also re-
Following Lean and Smyth (2010a), Shahbaz and Lean (2012b) we quire energy to fuel transportation. Without adequate energy to fuel
divide both sides by population and get each series in per capita transportation, export expansion will falter. Consequently, energy is
terms; but leave the impact of labor constant. By taking log, the line- an important input into export expansion and adequate usage of en-
arized Cobb–Douglas production function is: ergy is essential to expanding exports. A dramatic decrease in energy
use, resulting from say an energy conservation program, could affect
lnGt ¼ β1 þ βE lnEt þ βF lnF t þ βTR lnTRt þ βK lnK t þ μ t ð4Þ the ability to produce and transport exports. The export-led energy
hypothesis posits that change in exports impact changes in energy.
The energy-led export hypothesis notes that change in energy impacts
changes in exports. It is also possible that a feedback relationship ex-
3
Bangladesh, India and Pakistan. ists between energy and exports whereby energy is important for
4
Argentina, Brazil, Chile, Ecuador, Paraguay, Peru, Uruguay.
5
See Shahbaz (2012) for more details.
6
We have used three indicators of trade openness such real exports per capita, real
7
imports per capita and real trade per capita (exports + imports/population). Trade intensity equals exports plus imports as share of GDP.
12 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21

explaining movements in exports and exports are important for Δ ln Et ¼ α 1 þ α T T þ α D D þ α G ln Gt−1 þ α E ln Et−1 þ α F ln F t−1
explaining movements in energy demand. It is also possible for the re- X
p
lationship between energy and exports to be neutral. In this case, the þ α TR ln TRt−1 þ α K ln K t−1 þ βi Δ ln Et−i
correlation between energy and exports is so small that it does not i¼1
X
q X
r X
s
ð6Þ
show up as a statistically significant relationship at conventional þ βj Δ ln Gt−j þ βk Δ ln F t−k þ βl Δ ln TRt−l
tests levels. The energy use and imports are dynamically inter- j¼0 k¼0 l¼0
related as well. If energy consumption Granger causes imports or if X
t

there is feedback effect between energy and imports, then energy con- þ βm Δ ln K t−l þ μ t
m¼0
servation policies will reduce imports. Curtailing of energy intensive
imports such as machinery, equipment and new technology products,
desirable for their ability to boost productivity and create economic Δ ln F t ¼ α 1 þ α T T þ α D D þ α G ln Gt−1 þ α E ln Et−1 þ α F ln F t−1
wealth, could have very undesirable impacts on Chinese economy. X
p
The causality running from imports to energy use or evidence of no þ α TR ln TRt−1 þ α K ln K t−1 þ βi Δ ln F t−i
Granger causality in either direction means that energy conservation i¼1

policies can be implemented without affecting imports. Theoretically, X

q X
r X
s
ð7Þ
þ βj Δ ln Gt−j þ βk Δ ln Et−k þ βl Δ ln TRt−l
changes in imports can affect energy demand in two ways. First, the j¼0 k¼0 l¼0
distribution of imported goods into a country requires a transporta- Xt
tion network and this transportation network is fueled by energy. Sec- þ βm Δ ln K t−m þ μ t
ond, imported goods can also affect energy consumption if imports are m¼0

energy intensive. Durable imported goods like automobiles, air condi-

tioners, refrigerators, etc. are big users of energy and an increase in Δ ln TR ¼ α 1 þ α T T þ α D D þ α G ln Gt−1 þ α E ln Et−1 þ α F ln F t−1
these types of imported goods will increase the demand for energy. X
p
þ α TR ln TRt−1 þ α K ln K t−1 þ ϑi Δ ln TRt−i
Since energy is an essential input into the transportation process
i¼1
that facilitates imports, changes in energy use can impact imports. It X
q X
r X
s
ð8Þ
is also possible that there is a feedback relationship between energy þ ϑj Δ ln Gt−j þ ϑk Δ ln Et−k þ ϑl Δ ln F t−l
and imports or that there is no statistically significant relationship be- j¼0 k¼0 l¼0
tween energy use and imports. X
t

Prior to testing for cointegration, we check for stationarity of each þ ϑm Δ ln K t−m þ μ t

m¼0
series8. The study period is characterized by major changes in the global
landscape which can potentially cause structural breaks. There are var-
Δ ln K t ¼ α 1 þ α T T þ α D D þ α G ln Gt−1 þ α E ln Et−1 þ α F ln F t−1
ious unit root tests such as ADF, PP, DF-GLS, KPSS, and Ng-Perron tests
that are available in determining the integrating properties of the vari- X
p
þ α TR ln TRt−1 þ α K lnK t−1 þ ρi Δ lnK t−i
ables. But these unit root tests provide misleading results due to their i¼1
low size and power. Furthermore, these tests failed to provide any infor- X
q X
r X
s
ð9Þ
mation about structural breaks stemming in the series. We check the þ ρj Δ ln Gt−j þ ρk Δ ln Et−k þ ρl Δ ln F t−l
j¼0 k¼0 l¼0
stationarity properties using ADF with intercept and trend keeping in
X
t
mind that such test is not appropriate in the presence of structural þ ρm Δ ln TRt−m þ μ t
break in the series. Therefore, we apply the Zivot and Andrews (1992) m¼0
and Clemente et al. (1998) unit root tests to identify structural break.
The former is used in one structural break; and latter in two breaks in where, Δ is difference operator, T is time trend and D indicates the struc-
the series. The Clemente et al. (1998) test has more power compared tural break point based on findings of Zivot and Andrews (1992) test.
to the Zivot and Andrews (1992) test. Testing cointegration involves comparing the computed F-statistic
We choose the ARDL bounds testing approach in presence of struc- with the critical bounds generated by Pesaran et al. (2001) — the
tural break. It has several advantages. First, it is flexible and applies re- upper critical bound (UCB) and lower critical bound (LCB). The null hy-
gardless the order of integration. Simulation results show that the pothesis H0 : αG = αE = αF = αTR = αK = 0 of no cointegration is
approach is superior and provides consistent results for small sample tested against the alternate Ha : αG ≠ αE ≠ αF ≠ αTR ≠ αK ≠ 0 of
(Pesaran and Shin, 1999). Moreover, a dynamic unrestricted error cor- cointegration9. The series are cointegrated if the computed F-statistic
rection model (UECM) can be derived from the ARDL bounds testing exceeds the UCB; and not cointegrated if the computed F-statistic lies
through a simple linear transformation. The UECM integrates the below the LCB. If computed F-statistic falls between the UCB and LCB,
short run dynamics with the long run equilibrium without losing any the test is uncertain10. We use the critical bounds from Narayan
long run information. For estimation purposes, the following the ARDL (2005), which are more appropriate for small sample, 45 in this case,
model is used: compared to Pesaran et al. (2001)11. The parameter stability is checked
by applying the CUSUM and CUSUMSQ tests proposed by Brown et al.
Δ ln Gt ¼ α 1 þ α T T þ α D D þ α G ln Gt−1 þ α E ln Et−1 þ α F ln F t−1 (1975).
For the long run relation among the series we use the following
X
p
þ α TR ln TRt−1 þ α K ln K t−1 þ α i Δ ln Gt−i equation:
i¼1
X
q X
r X
s
ð5Þ ln Gt ¼ θ0 þ θ1 ln Et þ θ2 ln F t þ θ3 ln TRt þ θ4 ln K t þ μ i ð10Þ
þ α j Δ ln Et−j þ α k Δ ln F t−k þ α l Δ ln TRt−l
j¼0 k¼0 l¼0
9
Pesaran et al. (2001) provide two critical values — when the regressors are I(0) and
X
t
þ α m Δ ln K t−m þ μ t I(1).
10
In such case, error correction method is appropriate method to investigate the
m¼0
cointegration (Bannerjee et al., 1998). This indicates that error correction term will
be a useful way of establishing cointegration between the variables.
8 11
The ARDL bounds test works regardless of whether or not the regressors are I(1) or The critical bounds by Narayan (2005) are appropriate for small sample (30–80).
I(0)/I(1), but the presence of I(2) or higher order makes the F-test unreliable (see The critical bounds by Pesaran et al. (2001) are significantly smaller (Narayan and
Ouattara, 2004). Narayan, 2005).
 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21 13

11

10

3
1975 1980 1985 1990 1995 2000 2005 2010
Year
lnY lnE lnF
lnEXP lnIMP lnTR
lnK

Fig. 1. Trends of variables in China.

where, θ0 = − β1/αG, θ1 = − αE/β1, θ2 = − αF/β1, θ3 = − αTR/β1, about stationarity properties of the variables is prerequisite to apply
θ4 = − αK/β1 and μt is error term assumed to be normally distrib- the ARDL bounds testing approach to investigate long run relation-
uted. Once the long run relationship is established among the series, ship between the variables as well as to avoid the spurious of the re-
we test the direction of causality using the following error correction sults. The main assumption of the ARDL bounds testing is that
representation12: variables should be stationary at level or 1st difference or variables
have mixed order of integration such as I(0) / I(1). In doing so, we ap-
2 3 2 3 2 3
ln Gt a1 b11i b12i b13i b14i b15i plied ADF and P–P unit root tests with intercept and trend. The results
6 ln Et 7 6 a2 7 X 6 b21i b22i b23i b24i b25i 7 are reported in Table 1 reveal that all the variables show unit root
6 7 6 7 p
6 7
ð1−LÞ6 7 6 7
6 ln F t 7 ¼ 6 a3 7 þ ð1−LÞ6 7
6 b31i b32i b33i b34i b35i 7 ð11Þ problem at level. All the series are stationary at 1st difference. This
4 ln TR 5 4 a 5 i¼1 4b b b b b 5
t 4 41i 42i 43i 44i 45i implies that variables are integrated at I(1). The ADF and P–P unit
ln LK a5 b51i b52i b53i b54i b55i root tests have been criticized due to ignoring the information
2 3 2 3 2 3 about structural break stemming in the series. This shows that ADF
ln Gt−1 α ε1t
6 ln Et−1 7 6 β 7 6 ε2t 7 and P–P tests provide biased results. For this purpose, we applied
6 7 6 7 6 7
6 7 6 7 6 7 two unit root tests such as Zivot and Andrews (1992) and Clemente
6 ln F t−1 7 þ 6 δ 7ECT t−1 þ 6 ε3t 7
4 ln TR 5 4ϕ5 4ε 5 et al. (1998). Former informs about single structural break and latter
t−1 4t
ln K t−1 ϕ ε5t captures information about two structural breaks stemming in the se-
ries. The results of Zivot–Andrews are detailed in Table 2 which
where, (1 − L) is the lag operator and ECTt − 1 is the lagged residual
obtained from the long run ARDL relationship; ε1t, ε2t, ε3t, ε4t, and ε5t
are error terms assumed to be N (0,σ). A long run causality requires a
significant t-statistic on the coefficient of ECTt − 1. A significant
Table 1
F-statistic on the first differences of the variables suggests short run cau-
Unit root analysis.
sality. Additionally, joint long-and-short runs causal relationship can be
estimated by joint significance of both ECTt − 1 and the estimate of Variable ADF unit root test P–P unit root test
lagged independent variables. For instance, b12,i ≠ 0 ∀ i shows that en- T-statistic Prob. value T-statistic Prob. value
ergy use Granger-causes economic growth while causality runs from lnYt −2.8109 (1) 0.2021 −3.1637 (3) 0.1062
economic growth to energy use is indicated by b21,i ≠ 0 ∀ i. lnEt −1.1923 (1) 0.8982 −0.6491 (3) 0.9701
Data used in the paper are annual from 1971 to 2011, taken from lnFt −3.1558 (5) 0.1098 −2.6203 (6) 0.3010
the World Development Indicators (WDI-CD-ROM, 2012). The vari- lnKt −2.3381 (2) 0.4041 −2.4508 (3) 0.3495
lnEXt −2.5771 (0) 0.2922 −2.7807 (3) 0.2124
ables are real GDP, energy use (kg of oil equivalent), real domestic
lnIMt −2.8674 (2) 0.1839 −2.6115 (6) 0.2571
credit to private sector, real exports, real imports and real capital lnTRt −2.7461 (2) 0.2251 2.6020 (3) 0.2815
stock; each in per capita terms (Fig. 1). Δ ln Yt −3.7415 (2)⁎⁎ 0.0315 −4.5881 (3)⁎ 0.0058
Δ ln Et −3.4819 (0)⁎⁎ 0.0555 −3.4989 (3)⁎⁎ 0.0479
5. Results and their discussions Δ ln Ft −4.0230 (1)⁎⁎ 0.0162 −4.9221 (3)⁎ 0.0015
Δ ln Kt −4.4258 (1)⁎ 0.0059 −4.7242 (3)⁎ 0.0026
Δ ln EXt −5.0742 (1)⁎ 0.0011 −4.7703 (3)⁎ 0.0023
Primarily we applied ADF and P–P unit root tests to test the inte- Δ ln IMt −5.5128 (1)⁎ 0.0003 −4.6768 (3)⁎ 0.0030
grating properties of the variables in our study. The information Δ ln TRt −5.2075 (1)⁎ 0.0007 −4.4112 (3)⁎ 0.0060

Note. Lag length of variables is shown in small parentheses.

12
If cointegration is not detected, the causality test is performed without an error ⁎ Indicates significance at 1% level.
correction term (ECT). ⁎⁎ Indicates significance at 5% level.
14 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21

Table 2 integrated at I(1). The structural break point in series real income
Zivot–Andrews structural break trended unit root test. per capita is linked to the economic package implemented by federal
Variable At level At 1st difference and local governments in 2001. It was implemented to increase do-
mestic demand by investing in human and physical capital which in-
T-statistic Time break T-statistic Time break
creased domestic production and enhanced economic growth in
lnYt −3.174 (1) 2002 −4.938 (0)⁎ 1985
2002. China adopted technological and structural changes in energy
lnEt −4.226 (1) 2001 −4.668 (2)⁎⁎ 1997
lnFt −3.453 (1) 1978 −5.714 (1)⁎ 1984 sector in 1999–2000 to improve its efficiency by applying new and
lnKt −3.557 (1) 1990 −4.800 (0)⁎⁎ 1994 developed raw material which decreased energy intensity in 2001
lnEXt −3.554 (1) 1982 −5.118 (2)⁎ 2005 (Sinton and Fridley, 2000). The break in financial development vari-
lnIMt −3.373 (1) 1986 −5.763 (2)⁎ 1980 able is related to adoption of financial reforms in financial sector in
lnTRt −4.404 (1) 1988 −5.273 (1)⁎ 1980
1978 by Chinese government which latter on improved the efficiency
Note. Lag order is shown in parenthesis. of financial sector that contributed to the economic growth signifi-
⁎ Represents significance at 1% level.
⁎⁎ Represents significance at 10% level.
cantly. Surge of inflation, social unrest and international ostracism ad-
versely impacted capitalization as well as economic growth in 1990's,
which created the demand for third generation economic reforms in
China (Ding and Knight, 2008). The structural breaks in exports, im-
shows that non-stationary process is found in all series at level with ports and trade are linked with China's foreign and domestic trade re-
intercept and trend but variables are found to be stationary at 1st forms implemented in 1980s and 1990s to reap optimal static and
difference. This confirms that energy, economic growth, financial dynamic benefits of trade to sustain economic growth for long span
development, capital, exports, imports and international trade are of time (Lardy, 1993) (Table 3).

Table 3
Clemente–Montanes–Reyes detrended structural break unit root test.

Variable Innovative outliers Additive outlier

T-statistic TB1 TB2 Decision T-statistic TB1 TB2 Decision

lnYt −1.105 (2) 1975 1990 Unit root exists −5.990 (2)⁎ 1975 1989 Stationary
lnEt −4.438 (3) 1984 2000 Unit root exists −6.719 (3)⁎ 1976 1999 Stationary
lnFt −1.223 (3) 1981 1993 Unit root exists −6.227 (3)⁎ 1978 1984 Stationary
lnKt −1.798 (1) 1989 2001 Unit root exists −6.148 (3)⁎ 1980 1988 Stationary
lnEXt −2.794 (1) 1976 2001 Unit root exists −6.140 (2)⁎ 1976 1980 Stationary
lnIMt −3.162 (3) 1976 1998 Unit root exists −6.413 (5)⁎ 1977 1984 Stationary
lnTRt −3.106 (2) 1976 1998 Unit root exists −6.407 (2)⁎ 1976 1981 Stationary

Note. Lag length of variables is shown in small parentheses.

⁎ Indicates significance at 1% level.

Table 4
The results of ARDL cointegration test.

Bounds testing to cointegration Diagnostic tests

Estimated models Optimal lag length Structural Break F-statistics χ2NORMAL χ2ARCH χ2RESET χ2SERIAL

FY(Y/E, F, K, EX) 2, 1, 2, 2, 2 2002 7.2941⁎⁎ 2.2434 [1]: 0.0093 [1]: 3.2478 [1]: 1.6007
FE(E/Y, F, K, EX) 2, 2, 3, 2, 2 2001 1.8220 0.1561 [1]: 0.3292 [1]: 0.4765 [1]: 0.8028
FF(F/Y, E, K, EX) 2, 2, 2, 1, 2 1978 8.0444⁎ 0.4161 [1]: 0.0562 [5]: 2.4728 [1]: 0.0696
FK(K/Y, E, F, EX) 2, 2, 2, 2, 3 1990 6.1165⁎⁎ 0.1498 [1]: 0.0001 [2]: 2.753 [1]: 1.8578
FEX(EX/Y, E, F, K) 2, 1, 2, 2, 2 1982 12.3520⁎ 0.1804 [1]: 0.0315 [1]: 0.3486 [1]: 0.0010
FY(Y/E, F, K, IM) 2, 1, 2, 2, 2, 2002 8.7578⁎ 0.6208 [1]: 1.8725 [1]: 2.3047 [1]: 2.0173
FE(E/Y, F, K, IM) 2, 2, 1, 2, 2 2001 3.3118 1.0613 [1]: 0.2524 [1]: 0.4263 [1]: 0.2713
FF(F/Y, E, K, IM) 2, 1, 2, 2, 2 1978 5.2460⁎⁎⁎ 0.8672 [1]: 0.0203 [1]: 0.0606 [4]: 2.6533
FK(K/Y, E, F, IM) 2, 2, 2, 3, 2 1990 8.9007⁎ 5.4387 [4]: 2.0525 [3]: 2.8302 [1]: 1.6490
FIM(IM/Y, E, F, K) 2, 1, 2, 2, 2, 1986 11.9215⁎ 1.1679 [1]: 0.3464 [1]: 0.0253 [1]: 1.2456
FY(Y/E, F, K, TR) 2, 1, 2, 2, 2 2002 7.8188⁎ 0.6608 [1]: 0.1158 [1]: 4.7387 [1]: 2.7790
FE(E/Y, F, K, TR) 2, 2, 2, 2, 2 2001 1.9407 0.2163 [1]: 0.8207 [1]: 0.6020 [1]: 0.4976
FF(F/Y, E, K, TR) 2, 1, 2, 2, 2 1978 5.0635⁎⁎⁎ 0.4053 [1]: 0.0165 [4]: 2.8407 [1]: 0.6402
FK(K/Y, E, F, TR) 2, 2, 2, 2, 2 1990 1.120 0.2671 [1]: 1.5535 [4]: 2.01163 [1]: 0.6148
FTR(TR/Y, E, F, K) 2, 1, 2, 3, 2 1988 9.4893⁎ 3.2016 [2]: 2.1182 [4]: 2.5852 [1]: 0.4545

Significant level Critical values (T = 41)

Lower bounds I(0) Upper bounds I(1)

1% level 6.053 7.458

5% level 4.450 5.560
10% level 3.740 4.780

Note. The optimal lag length is determined by AIC. [·] is the order of diagnostic tests. Critical values are collected from Narayan (2005).
⁎ Denotes significance at 1% level.
⁎⁎ Denotes significance at 5% level.
⁎⁎⁎ Denotes significance at 10% level.
 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21 15

Table 5 test is sensitive to lag length. To find the lag order we use the AIC
Results of Johansen cointegration test. criteria as reported in column-2, Table 4. The dynamic link between
Hypothesis Trace statistic Maximum eigen value the series can be captured if appropriate lag length is used
(Lütkepohl, 2006). The results of the ARDL bounds tests are reported
Yt = f(Et, Ft, Kt, EXt)
R=0 87.2865⁎ 49.8532⁎ in Table 4. As noted, we use critical bounds from Narayan (2005).
R≤1 37.4333 22.3306 The results from exports model point four cointegrating vectors
R≤2 15.1026 9.3783 once we treated economic growth, financial development, capital
R≤3 5.7242 5.6886
and exports as predicted variables. The computed F-statistics exceeds
R≤4 0.0355 0.0355
the UCB at 1, 5 and 10% levels respectively. The same inference can be
Yt = f(Et, Ft, Kt, IMt) drawn for models when we use imports and trade as indicators of
R=0 94.7030⁎ 49.5783⁎
trade openness as well as capital at 1 and 5% levels. This confirms
R≤1 45.1247 27.5562
R≤2 17.5685 12.0183 cointegration among economic growth, energy use, financial develop-
R≤3 5.5501 5.4167 ment, international trade (exports and imports) and capital in case of
R≤4 0.1333 0.1333 China over the period of 1971–2011.
Yt = f(Et,Ft,Kt,Tt)
We now report the results of Johansen and Juselies (1990)
R=0 91.6230⁎ 50.1158⁎ cointegration test to check the robustness of a long-run relationship.
R≤1 41.5072 25.0084 The results in Table 5 confirm one cointegrating vector when we use
R≤2 16.4987 11.2792 exports, imports and trade as indicators of international trade. The
R≤3 5.2194 5.1718
results are robust. After establishing cointegration among the series
R≤4 0.0476 0.0476
we explore the long and short run relationship among energy use,
Note.
financial development, capital and international trade on economic
⁎ Shows significant at 1% level of significance.
growth in case of China. The results reported in Table 6 show that
energy use is positively related to economic growth and it is statis-
tically significant at 1% level. This implies that energy demand
plays vital role to enhance economic growth in China. These findings
The robustness of Zivot–Andrews unit root is confirmed by apply- are consistent with the findings of Yuan et al. (2008) and Wang et al.
ing Clemente et al. (1998) and findings are same as indicated by ADF, (2011) that energy use is main input of production function in
P–P and Zivot–Andrews unit root tests. Armed with information China, but contradictory to Zhang and Xu (2012) who found nega-
about stationarity, we apply the ARDL bounds testing approach to tive impact of energy use on economic growth due to the use of
cointegration in the presence of structural break. The ARDL bounds energy in unproductive sectors. Our results reveal that all else

Table 6
Long and short runs results.

Dependent variable = lnYt

Variables Coefficient T-statistic Coefficient T-statistic Coefficient T-statistic

Long run analysis

Constant 1.4776⁎ 7.8180 1.3778⁎ 6.8292 1.4052⁎ 7.2233
lnEt 0.1849⁎ 4.2263 0.1872⁎ 3.9232 0.1869⁎ 4.0672
lnFt 0.3594⁎ 11.644 0.3755⁎ 11.3209 0.3670⁎ 11.3766
lnKt 0.3363⁎ 7.4553 0.3473⁎ 7.0385 0.3407⁎ 7.1722
lnEXt 0.0394⁎ 2.9963 – – – –
lnIMt – – 0.0197⁎⁎⁎ 1.7644 – –
lnTRt – – – – 0.0306⁎⁎ 2.1923

Short run analysis

Constant 0.0185⁎⁎ 2.0388 0.0239⁎⁎ 2.6212 0.0217⁎⁎ 2.3963
lnEt 0.1279⁎⁎⁎ 1.7826 0.1300⁎⁎⁎ 1.7483 0.1320⁎⁎⁎ 1.8117
lnFt 0.2549⁎ 4.5729 0.2385⁎ 3.6861 0.2429⁎ 4.0072
lnKt 0.2598⁎ 7.2848 0.2669⁎ 6.1514 0.2577⁎ 7.0613
lnEXt 0.0395⁎⁎ 2.3146 – – – –
lnIMt – – 0.0092 0.4411 – –
lnTRt – – – – 0.0264 1.3396
ECMt-1 −0.3828⁎⁎ −2.1770 −0.3335⁎⁎⁎ −1.7158 −0.3506⁎⁎⁎ −1.8715
R2 0.7564 0.7209 0.5867
F-statistic 20.4964⁎ 17.0551⁎ 10.7904⁎
D. W 1.6208 1.5541 1.7237

Short run diagnostic tests

Test F-statistic Prob. value F-statistic Prob. value F-statistic Prob. value

χ2NORMAL 5.9608 0.0507 2.6356 0.2677 4.2401 0.1200

χ2SERIAL 1.9849 0.1544 2.3153 0.1157 2.1457 0.1340
χ2ARCH 0.2912 0.5927 0.6510 0.4210 0.3583 0.5531
χ2WHITE 0.9394 0.5129 1.2267 1.3306 1.1933 0.3366
χ2REMSAY 1.8985 0.1375 2.1242 0.1032 2.1316 0.1022

Note.
⁎ Shows significance at 1% level.
⁎⁎ Shows significance at 5% level.
⁎⁎⁎ Shows significance at 10% level.
16 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21

constant, a 1% growth in energy use is expected to increase econom- positive, it is statically insignificant while exports has positive
ic growth by 0.1849–0.1872%, suggesting that the former plays a and statistically significant effect on economic growth. The negative
role in promoting domestic production of China. The effect of finan- and statistically significant estimates for each of the ECMt − 1,
cial development on economic growth is positive and statistically − 0.3828, − 0.3335 and − 0.3506 (for exports, imports and interna-
significant at 1% level. A 1% in increase in financial development tional trade models, respectively) lend support to long run relation-
raises economic growth on an average by 0.3594–0.3755%, ceteris ship among the series in case of China. The coefficients are all
paribus. Financial development plays dominant role to stimulate statistically significant at 5 and 10% levels respectively. The short
economic growth by allocating financial resources in productive run deviations from the long run equilibrium are corrected by
ventures that enhances domestic production and economic growth. 38.28%, 33.35% and 35.06% towards long run equilibrium path each
These findings support the arguments of Liu and Shu (2002), Shan year. The diagnostic tests show that error terms of short run
and Qi (2006), Ma and Jalil (2008), Burzynska (2009), Wang and models are normally distributed; and free of serial correlation,
Zhou (2010), Maswana (2011), Zhang et al. (2012) who noted that heteroskedasticity, and ARCH problems in all three models. The
financial development leads economic growth by stimulating capi- Ramsey reset test shows that functional form for the short run
talization in the country. Capital promotes economic growth as the- models are well specified.
ory predicts that capitalization enhances the capacity of an economy The test conducted by the cumulative sum (CUSUM) and the cu-
to increase domestic production. It is statistically significant at 1% mulative sum of squares (CUSUMsq) suggests stability of the long
level. The results suggest that a 0.3363–0.3473% economic growth and short run parameters (Figs. 2–7). The graphs of CUSUM which
is associated with a 1% increase in capital accumulation in the coun- confirm stability of parameters (Brown et al., 1975) but and CUSUMsq
try, on an average all else the same. This finding supports the view of test does not lie within the 5% critical bounds. The plots of the
Sahoo et al. (2010), who reported that investment in physical capi- CUSUMsq of squares statistics are not well within the critical bounds.
tal i.e. domestic gross fixed capital formation enhances economic CUMSUMsq test will have higher power if the there is a break in the
growth in China. Similarly, Shi (2012) also pointed out that infra- slope coefficients or variance of the error term (Paul Turner, Applied
structural capital promotes economic growth once Cobb–Douglas Economics Letters, 2010). Since Chinese economy went through
production function was applied. major structural changes over the last two decades, breaks in the
The results indicate that exports, imports and international trade slopes are fully justified and thus CUMSUMsq tests results are outside
have positive impact on economic growth and are statistically signifi- the bound.
cant at 5 and 10% levels, respectively. A 1 (10) and 5% increase in ex- Furthermore, we apply Chow forecast test to examine the signif-
ports, imports and international trade is expected to cause economic icance structural breaks in an economy for the period 1971–2011.
growth to go up by 0.039, (0.197) and 0.153% respectively, keeping all Structural breaks are a common problem in macroeconomic series
else constant. These findings show the dependence of Chinese economic as they are usually affected by exogenous shocks or regime changes.
growth on exports, imports and trade. For instance, Lin and Li (2003) Structural changes in energy policy or economic development, re-
reported that a 1% increase in economic growth is linked to 10% increase forms in energy regulation, or institutional developments in 1980s
in exports by applying demand oriented model. Zhu and Kota (2010) and 1990s in China have certainly affected the macroeconomic se-
reported positive impact of exports on Chinese economic growth. Hye ries of our study. China adopted an open door policy since 1978.
(2012) noted the export-led growth and import-led growth in China. Structural reforms, market incentives, and decentralization policies
Sun and Heshmati (2010) also unveiled that trade openness boosts eco- were introduced to attract foreign investment in the power sector
nomic growth by increasing total factor productivity. The elasticity of and the sector experienced rapid growth since the late 1980s. The
economic growth with respect to export on the highest, almost twice direction, strength, and stability of the relationship among energy
compared to imports and almost 29% higher compared to international use, GDP, financial development and trade have occupied central
trade in China. importance in the conduct of energy policy in China. In this study,
Table 6 also reports short run results. The impact of energy use, F-statistic computed in Table 7 suggests that there is no significant
financial development, capital, exports and international trade on structural break in the economy during the sample period. The
economic growth is positive. It is significant at 10% and 1% levels chow forecast test is more reliable and preferable than graphs
respectively. A rise in capital is positively linked with economic (Leow, 2004). This confirms that the ARDL estimates are reliable
growth. The effect of imports and international trade though and efficient.

I. Exports model

20
15
10
5
0
-5
-10
-15
-20
1985 1990 1995 2000 2005 2010

CUSUM 5% Significance

Fig. 2. Plot of cumulative sum of recursive residuals. The straight lines represent critical bounds at 5% significance level.
 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21 17

1.6

1.2

0.8

0.4

0.0

-0.4
1985 1990 1995 2000 2005 2010

CUSUM of Squares 5% Significance

Fig. 3. Plot of cumulative sum of squares of recursive residuals. The straight lines represent critical bounds at 5% significance level.

II. Imports model

20

15

10

-5

-10

-15

-20
1980 1985 1990 1995 2000 2005 2010

CUSUM 5% Significance

Fig. 4. Plot of cumulative sum of recursive residuals. The straight lines represent critical bounds at 5% significance level.

1.6

1.2

0.8

0.4

0.0

-0.4
1980 1985 1990 1995 2000 2005 2010

CUSUM of Squares 5% Significance

Fig. 5. Plot of cumulative sum of squares of recursive residuals. The straight lines represent critical bounds at 5% significance level.
18 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21

III. Trade model

20

15

10

-5

-10

-15

-20
1980 1985 1990 1995 2000 2005 2010

CUSUM 5% Significance

Fig. 6. Plot of cumulative sum of recursive residuals. The straight lines represent critical bounds at 5% significance level.

1.6

1.2

0.8

0.4

0.0

-0.4
1980 1985 1990 1995 2000 2005 2010

CUSUM of Squares 5% Significance

Fig. 7. Plot of cumulative sum of squares of recursive residuals. The straight lines represent critical bounds at 5% significance level.

Table 7
Chow forecast test.

Chow forecast test: forecast from 2003 to 2011

F-statistic 1.6990 Probability 0.2404

Log likelihood ratio 2.1553 Probability 0.1318

The VECM Granger causality analysis development; capital, exports, imports and international trade. The uni-
If cointegration is confirmed, there must be uni- or bidirectional cau- directional causality running from energy use to financial development
sality among the series. We examine this relation within the VECM is consistent with Dan and Lijun (2009) in case of Guangdong (China)
framework. Such knowledge is helpful in crafting appropriate energy but contradictory with Islam et al. (2013) and, Shahbaz and Lean
policies for sustainable economic growth. Table 8 reports results on (2012b) who reported feedback effect between financial development
the direction of long and short run causality. The results suggest feed- and energy demand in case of Malaysia and Tunisia respectively.
back relation between financial development and economic growth; The causality from energy use, financial development, capital,
capital and economic growth, exports and economic growth, imports exports, imports and international trade to economic growth supports
and economic growth, and international trade and economic growth. the energy-led-growth, finance-led-growth, capital-led-growth, export-
The bidirectional causality is found between financial development led-growth, import-led and trade-led-growth hypotheses. The findings
and energy use; financial development and exports (imports), interna- suggest that economic growth, financial development, capital, exports,
tional trade; capital and financial development in China in long run. imports and international trade corroborate finance-led-energy, export-
In long run, energy use Granger causes economic growth, financial led-energy, import-led-energy, trade-led-energy and capital-led-energy
 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21 19

Table 8
VECM granger causality analysis.

Dependent variable Type of causality

Short run Long run

∑ Δ ln Yt − 1 ∑ Δ ln Et − 1 ∑ Δ ln Ft − 1 ∑ Δ ln Kt − 1 ∑ Δ ln EXt − 1 ECTt − 1

Δ ln Yt – 0.1991 [0.8206] 17.6942⁎ [0.0000] 25.0392⁎ [0.0341] 1.7900 [0.1855] −0.5142⁎⁎ [−2.9195]
Δ ln Et 0.5477 [0.5841] – 0.1734 [0.8416] 0.7906 [0.4631] 0.5103 [0.6065] –
Δ ln Ft 7.6713⁎ [0.0022] 0.3415 [0.7136] – 1.5172 [0.2368] 0.4960 [0.6142] −0.5764⁎ [−2.8777]
Δ ln Kt 19.3602⁎ [0.0000] 1.1915 [0.3187] 7.6470⁎ [0.0022] – 1.1836 [0.3210] −0.6765⁎ [−4.2189]
Δ ln EXt 3.2859⁎⁎ [0.0523] 0.7253 [0.4930] 2.9993⁎⁎⁎ [0.0610] 0.6314 [0.5392] – −0.2100⁎⁎ [−2.5529]

∑ Δ ln Yt − 1 ∑ Δ ln Et − 1 ∑ Δ ln Ft − 1 ∑ Δ ln Kt − 1 ∑ Δ ln IMt − 1

Δ ln Yt – 0.5194 [0.6004] 13.0776⁎ [0.0001] 25.5463⁎ [0.0000] 0.3637 [0.6848] −0.5244⁎⁎ [−2.6540]
Δ ln Et 1.0378 [0.3670] – 0.2032 [0.8172] 0.0128 [0.9872] 1.0253 [0.3713] –
Δ ln Ft 7.1989⁎ [0.0030] 0.0972 [0.9076] – 2.0422 [0.1486] 0.1405 [0.8695] −0.6334⁎ [−3.7959]
Δ ln Kt 14.6381⁎ [0.0000] 1.1555 [0.3294] 6.1307⁎ [0.0064] – 1.5405 [0.2119] −0.6218⁎ [−3.9466]
Δ ln IMt 1.3380 [0.2786] 0.5834 [0.5646] 0.7147 [0.4980] 0.3441 [0.6846] – −0.2761⁎⁎ [−2.2846]

∑ Δ ln Yt − 1 ∑ Δ ln Et − 1 ∑ Δ ln Ft − 1 ∑ Δ ln Kt − 1 ∑ Δ ln TRt − 1

Δ ln Yt – 0.7194 [0.4955] 10.0547⁎ [0.0005] 16.2805⁎ [0.0000] 0.2406 [0.7877] −0.3780⁎⁎ [−2.1581]
Δ ln Et 0.7566 [0.4783] – 0.2840 [0.7548] 1.3674 [0.2707] 0.4956 [0.6143] –
Δ ln Ft 7.8373 [0.0020] 0.2141 [0.8085] – 1.7297 [0.1958] 0.0489 [0.9523] −0.6471⁎ [−3.1462]
Δ ln Kt 15.9184⁎ [0.0000] 1.1987 [0.3167] 6.6438⁎ [0.0044] – 1.0528 [0.3623] −0.6603⁎ [−4.1762]
Δ ln TRt 4.3022⁎⁎ [0.0235] 0.3489 [0.7080] 2.1046 [0.1410] 0.0918 [0.9125] – −0.2230⁎ [−2.9598]

Note.
⁎ Denotes significance at 1% level.
⁎⁎ Denotes significance at 5% level.
⁎⁎⁎ Denotes significance at 10% level.

hypotheses. Our findings that energy use Granger causes economic Chinese economy is becoming more energy efficient over the years.
growth is supported by Wang et al. (2011), but Zhang and Xu (2012) To achieve sustainable growth with an ever increasing energy de-
and Shuyun and Donghu (2011) reported bidirectional causality. Yalta mand, the Chinese government taking steps that will bring energy
and Caker (2012) found neutral effect between energy use and economic use under control. A series of policies were put in place to support
growth in case of China but Soile (2012) reported that energy use is the realization of this goal (Zhou et al., 2010). One important step
Granger cause of economic growth. The bidirectional causality between has been the completion of the Three Gorges Dam in 2008, which is
exports and economic growth, imports and economic growth is consis- now the world's largest hydropower plant. China is taking steps to
tent with Hye (2012) and contradictory with Li and Wang (2009) who build dozens of new nuclear reactors over the next 20 years. The en-
reported feedback effect between both variables on in short run. ergy intensity in China have been below unity over the last decade,
In short run, bidirectional causality is found between financial de- which means one unit of energy use can support more than one
velopment and economic growth and same is drawn between capital unit of real GDP. Although the energy intensity has experienced
and economic growth once we used exports as an indicator of trade sharp decline in China, the energy intensity is still rather high than
openness. Economic growth and financial development Granger that of world average. Therefore, China should integrate advanced
cause exports. The unidirectional causality exists running from finan- technology in the production process of its industrial sector to reduce
cial development to capital. Using imports as an indicator of trade energy use. This will further decrease energy intensity.
openness, we find neutrality effect between imports and economic The Chinese government should make every effort to improve en-
growth and same conclusion can be drawn between financial devel- ergy efficiency and reduce pollutant emissions. Environmental issues
opment and imports. Finally, using international trade as an indicator will be a major factor influencing future energy policy in China.
of trade openness, we note unidirectional causality running from eco- China's energy policies should focus on supplying more clean and
nomic growth to international trade. Rest results are same with pre- low-carbon energy. China already is experiencing serious environ-
vious findings. mental problems through energy activities as coal accounts for
about 70% of total primary energy in China which is the dominant
6. Conclusion and policy issues source of carbon emissions. Chinese Government's energy policy
should diversify energy source to reduce its' reliance on coal. China
This paper examines the long run relationship among energy use, should take active measures to increase the utilization of cleaner
financial development, capital, international trade and economic energy sources such as wind, solar, natural gas, nuclear power and
growth for China. Prior to testing for causality, we applied the Zivot hydroelectric power.
and Andrews (1992) and Clemente et al. (1998) unit root tests, As the Chinese economy grows, environmental problems in general
which can accommodate structural breaks in the data. The ARDL will worsen with the projected rapid increases in energy use. To realize
bound test and Johansen and Juselies (1990) test were carried out China's sustainable development, the national energy development
to examine cointegration. Our results indicate that there is a unidirec- strategy should include an energy conservation priority policy, through
tional relationship running from energy use to real GDP. An increase development of renewable energy. A cleaner energy development strat-
in energy use would raise real GDP. Our empirical findings support egy is needed for all production processes. China should also focus on
the notion that there has been a decoupling of energy use and eco- developing less energy intensive service sector as the Western econo-
nomic growth. The growth of energy use does not have a direct mies did, which could lead to further energy conservation.
one-to-one correlation with GDP growth. Thus, the Chinese economy Financial development and economic growth Granger causes each
can grow without corresponding increase in environmental pressure. other in both in the short and long run. Financial development
20 M. Shahbaz et al. / Energy Economics 40 (2013) 8–21

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