Financial Sector Development, Institutional Quality and Environmental Degradation in Namibia

1. Introduction

Environmental degradation as a result of climate change is at the forefront of policy discussions at the academic, scientific, and policy levels, as the impact of economic activities, especially land use and transportation, on climate change has reached unprecedented levels (IPCC, 2019). As such, the quality of the environment reflects the extent to which increased economic activities, especially dependence on natural resources and unsustainable energy sources, inflict danger to the environment (Amer et al., 2024). Ngarava (2021) argued that increased economic activity is a threat to environmental sustainability. For low-income countries, characterized by high levels of poverty, inequality, and unemployment, there is a need to accelerate economic growth. However, with limited systems and technology adoption for production, storage, transportation, and waste disposal, there is a threat to the environment (Hunjra et al., 2024).

Namibia, like many developing countries, has the least carbon emissions, yet is heavily impacted by climate change as a country with over 90% of it classified as hyper-arid, arid, or semi-arid, ranking second to the Sahara Desert in terms of aridity (World Bank Group, 2021). As a result, communities are prone to catastrophic events such as increased temperature, drought, and floods (World Bank Group, 2021; Government of the Republic of Namibia, 2023). As a result, Namibia faces immense pressure to control its ecological footprint, especially in terms of land use, which is the highest emitter of greenhouse gases in the country. Economic activities such as exploration of natural resources are the highest contributor to land use and contribute 14.4% to GDP, more than 50% to export earnings, and 55.9% to government revenue (Bank of Namibia, 2023; Chamber of Mines of Namibia, 2024). Therefore, although these resources are crucial for socioeconomic development, dependence on land-use activities has a consequential impact on the environment. Propelling growth through the extractive primary sector strains the environment (Aladejare, 2022). As such, increased economic activities, such as the use of fossil fuels, exploration, and industrialization, contribute to global warming and environmental degradation (Gutti, Aji and Magaji, 2012; Amer et al., 2024). This has prompted policymakers and governments to encourage sustainable land use management to protect the environment. Although resource rent and other economic activities are beneficial to the economy, they also pose a threat to the environment (Sadaoui et al., 2024). In addition, the financial sector, as an enabling division of the economy with its intermediating role, plays a role in transferring and managing climatic risk; hence, the development of these sectors matters in finding a lasting solution.

Environmental degradation is a result of increased economic activities, production, and exploitation of natural resources. However, it is believed not to be a result of capitalism and economic growth alone but also involves the absence of effective institutional frameworks and policies to deal with greenhouse gas emissions and climate change (Cohen, 2023). Thus, there are calls for institutional frameworks to address the global emission levels of greenhouse gases. According to Hussain and Dogan (2021); Warsame et al., (2022) increased governance, an indication of institutional quality plays an important role in environmental sustainability. Song et al., (2024) emphasized that environmental quality can be preserved through the implementation of stringent environmental policies that reduce the use of non-renewable energy sources that burden the environment. In the Namibian context, various laws have been implemented to avert environmental degradation, such as Article 95 of Namibia’s Constitution, Environmental Management Act 7 of 2007, the National Policy and Strategy on Climate Change 2011, and the Environmental Assessment Policy 1994. These policies were implemented to ensure sustainable environmental management and the mitigation of environmental degradation.

The advocacy for investment in green energy and technology to avert environmental degradation has been at the forefront of climate change talks at the United Nations Convention Conferences and Paris Agreement negotiations. Therefore, financial development is critical for investments in projects and technologies that preserve the environment (Imran et al., 2023; Gul and Hussain, 2024). This Kirikkaleli and Adebayo (2021) indicates that financial development is crucial for environmental sustainability, as it allows for a shift from traditional to more modern and sustainable practices. Given the importance of investment in clean energy, technology, and low-carbon development, Namibia has implemented initiatives such as the 2016 Green Climate Fund (GCF) through the Environmental Investment Fund established under Act 13 of 2001. The GCF has a portfolio of $ 640 million secured for grant and readiness support by 2023. These funds aim to finance climate change mitigation programs that allow for overall economic development and environmental protection.

While the literature acknowledges the impact of production and consumption on the environment, current views show that additional factors are responsible for climate change and environmental degradation. Despite the importance of environmental sustainability to our livelihoods, there is a lack of consensus on the influence of policies and finance on the environment. This study investigates the impact of financial sector development and institutional policies on environmental degradation in developing countries. finance and policies in developing countries, which are known to be dependent on developed economies for climate financing and have weak policies. Insight into the effectiveness of institutional frameworks and financing in dealing with climate change and its influence on environmental degradation provides guidelines for a holistic and comprehensive approach to create synergies between different variables to enhance environmental quality and sustainability.

The rest of the paper is structured as follows: Section 2 presents the literature review, Section 3 discusses the data and methods, and Section 4 presents the empirical results. Question 5 presents the conclusions and recommendations.

2. Related literature review

The treadmill of production theory highlights the relationship between increased economic activity, natural resource demand, and the environment (Schnaiberg, Pellow and Weinberg, 2002; Islam and Hossain, 2015). This suggests that the constant pursuit of economic growth and profit by countries creates an environment in which the economy seeks constant expansion without considering the impact on the environment (Islam and Hossain, 2015; Lewis, 2019). Thus, environmental degradation is due to the direct production demand of state organs, political actors, and the private sector (Curran, 2017; Lewis, 2019). This further explains that the expansion of economic activities leads the private sector to push for profit, which leads to the use of machinery to replace labor, leading to increased energy consumption and an increase in ecological harm while decreasing social benefits (Schnaiberg, Pellow and Weinberg, 2002; Islam and Hossain, 2015). In addition, the drive for economic development leads to the increased exploitation of natural resources, waste production, and environmental pollution (Lewis, 2019). Thus, to deal with social problems, the treadmill must increase its capacity and further deepen environmental problems. Therefore, the social and environmental benefits are inseparable.

Environmental Kuznets Curve is another prominent theory that explains the relationship between economic activities and the environment (Leal and Marques, 2022). This explains how the economy affects environmental sustainability at different stages of growth. The theory explains that as economic activities increase in the early stages of economic development, there is an increase in waste emissions, which harm the environment (Stern, 2014; Sajeev and Kaur, 2020). This harm to the environment is due to the rate of production and lack of sustainable practices for waste reduction and management. As the composition of the economy changes from the primary sector and industrialization to the service sector, pollution levels remain stagnant and decline over time (Sajeev and Kaur, 2020; Leal and Marques, 2022). Furthermore, with the implementation of environmental policies or institutional frameworks, the use of clean energy and technology, and improved waste management, environmental pressure declines and sustainability improves (Stern, 2014; Zuo et al., 2022). Therefore, the scale effect had a negative influence on the environment at the beginning of industrialization. Thereafter, as changes in the composition and introduction of technology have a positive influence on the environment, there has been an improvement in environmental quality (Sajeev and Kaur, 2020; Zuo et al., 2022).

3. Data and methods

This study used time-series data from 1990 to 2023 in Namibia to investigate the impact of institutional quality and financial development on environmental degradation. This study used carbon dioxide (CO₂) per capita as a proxy for environmental degradation, as it is the primary contributor to environmental degradation and has been used in different studies (Sida, 2011; Doğan, Saboori and Can, 2019; Tran et al., 2023; Gul and Hussain, 2024). This study used CO₂ as a proxy for the data constraints of variables, such as the ecological footprint index. The independent variable includes institutional quality (IQ) as a measure of the effectiveness of governance in the country, as strong institutions are important in effective environmental governance Li et al., (2022), and credit to the private sector as an indicator of financial sector development (FSD), adopted from studies such as (Amin et al., 2022; Awdeh, 2022; Khan, Weili and Khan, 2022). Other explanatory variables included renewable energy consumption (REC), GDP growth, and trade openness (TO). The model used in the study, informed/adapted from, Amin et al., (2022) and modified, is presented as follows:

Table 1 presents descriptive statistics of the variables used in this study. The standard deviations for all variables were low, indicating that they were normally distributed.

To select suitable estimation techniques for the study, a unit root test was adopted, as economic and financial data are not stable and thus contain outliers. Economic and financial data tend to be non-stationary and can lead to spurious estimations. Therefore, data must be stationary to produce reliable results. In addition, it allows us to choose a suitable estimation approach based on the order of integrations at levels I(0), first difference I(1), or second difference I(2). The study used the Dickey-Fuller, augmented Dickey-Fuller, and Phillips–Perron (P–P) methods.

This study used ARDL estimation techniques to examine the relationship between NRR, FSD, IQ, and environmental degradation. ARDL is preferred because it allows the use of a mixed order of integration of either I(0) or I(1). In addition, ARDL is recommended because it reduces the issue of misspecification, spurious, and random errors that can occur because of non-stationary data. Furthermore, ARDL allows for bound tests to assess whether cointegration exists as dependent and independent variables, even when integrated at different orders of integration. To examine the existence of cointegration, this study proposes the following hypothesis:

Pesaran, Shin and Smith (2001) provides critical values to be tested against the F-statistic. Lower bound I(0) and upper bound I(1). Pesaran, Shin and Smith (2001) indicate that when the F-statistic is below the lower bound, the null hypothesis indicates that no cointegration exists, and when it falls between the upper and lower bounds, the results are inconclusive, as none of the hypotheses are accepted. However, if? The F-statistic is larger than both critical values, and the alternative hypothesis is accepted, which indicates the presence of cointegration (Emeka and Kelvin, 2016). As such, if there is evidence of cointegration (long-run relationship), the ARDL-EC model is used to estimate the long-run. The ARDL model used in the study is specified below:

${\beta }_1-{\beta }_{13}$ are short- and long-run parameters, $∆$ is the difference operator, ${\epsilon }_t$ is the error term, and ECT is the Error Correction term. Given the dynamics of time-series data that tend to be serially correlated, this study has carried out serial correlation to ensure that the error terms are serially independent. In addition, the model was assessed for normality and if residuals were homoscedastic. To ensure that the model was stable, a stability test was performed using the CUSUM. The stability test is important in time series analysis, as we cannot predict the structural changes that may have occurred. The Ramsey RESETs test was used to assess the model specifications.

4. Empirical results and discussion

This section discusses the empirical results, which include unit root, cointegration analysis using ARDL, and presentation and discussion of the results for both the short and long coefficients. It also includes diagnostic tests.

4.3 Diagnostic tests

The diagnostic tests presented in Table 6 show that there is no serial correlation, and the error terms are homoscedastic. In addition, the model was correctly specified, and the residuals in the models were normally distributed according to the normality test. Furthermore, the stability for the mode is supported by the CUSUM and CUSUM of Squares, as shown in Figures 1 and 2; thus, the model is stable, as it remains between the critical limits of 5 percent.

Table 6. Diagnostics tests.

Test specification	Coefficient	Decision
LM Test	1.0854 (0.3578)	No serial correlation exists
Brush Pagan	1.3542 (0.2697)	No heteroskedasticity exists
Ramsey Reset Test	0.0108 (0.9914)	The model is correctly specified
Jarqa Bera Test	1.4168 (0.2432)	Residuals in the model are normally distributed

Figure 1. CUSUM.

Figure 2. CUSUM of Squares.

5. Conclusion

The essence of environmental sustainability and concerns regarding the impact of environmental degradation on humanity prompted the study to investigate Namibia. Namibia, like many developing countries, has the least carbon emissions, yet is heavily impacted by climate change as a country with over 90% of it classified as hyper-arid, arid, or semi-arid, ranking second to the Sahara Desert in terms of aridity (World Bank Group, 2021). As a result, communities are prone to catastrophic events such as increased temperature, drought, and floods (World Bank Group, 2021; Government of the Republic of Namibia, 2023). Therefore, this study examined the impact of financial sector development and institutional quality on environmental degradation. The following conclusions and recommendations were drawn:

While institutional quality negatively influences environmental protection, there is a need to empower institutions to ensure environmental protection. Although countries have implemented policies to deal with climate change, they have not been highly effective; thus, institutional reforms are needed to address environmental degradation issues. Developing countries must ensure that environmental protection is a policy priority to strengthen their environmental legislation. Furthermore, based on the findings developing countries must incorporate financial globalization into environmental protection frameworks to mitigate degradation. Given the impact of institutional quality on the environment, there is a need to link and reform environmental protection and investment policies to attract economic activities that will be beneficial to the environment.

Environmental sustainability relies heavily on access to finance for advanced technologies and means of production. Developing countries are most impacted by climate change; however, they have limited financial capacity. Thus, there is a concerted effort by developing countries to continue to persuade advanced economies to increase climate change financing, as they are the most impacted by environmental degradation. In addition, it is imperative that countries proactively invest in clean energy. This entails that the government, through the central bank, should provide climate loans with special conditions to commercial banks that provide financing for environmentally friendly technologies. Financial accessibility and inflow into clean energy investments are needed to reduce dependence on non-renewable energy. The research, therefore, offers insight and contributes to policy and literature by providing a view on the importance of finance and institutional frameworks in environmental protection and the need to create a balance between economic development and environmental sustainability.

The current study focuses on Namibia; however, its implications can be applied to other contexts. Therefore, future studies should incorporate other measures of environmental degradation, such as the ecological footprint or other forms of greenhouse gases. Further studies can apply asymmetric relationships, as the impact may be influenced by changes in a country’s economic or political atmosphere.

Ethics and consent statement

Ethical approval and consent were not required.