📈 economics

The Role of Institutional Quality on Fiscal Policy, Natural Resources, and Islamic Finance Channels in Driving Green Growth across D-8 Countries

This study utilizes panel data from 2000 to 2024 across D-8 Muslim-majority economies to demonstrate that while natural resource use and Islamic banking significantly promote green growth, fiscal policy currently hinders it due to fossil-fuel subsidies, a dynamic that is critically shaped by institutional quality and income levels.

Original authors: MD AMIRUL ISLAM

Published 2026-07-02

📖 6 min read🧠 Deep dive

CC BY 4.0

Original authors: MD AMIRUL ISLAM

Original paper licensed under CC BY 4.0 (https://creativecommons.org/licenses/by/4.0/). ✨ This is an AI-generated explanation of the paper below. It is not written or endorsed by the authors. For technical accuracy, refer to the original paper. Read full disclaimer

The Big Picture: A Team of Eight Trying to Grow Without Breaking the Planet

Imagine a team of eight neighbors (the D-8 countries: Bangladesh, Egypt, Indonesia, Iran, Malaysia, Nigeria, Pakistan, and Türkiye). They are all Muslim-majority nations trying to get richer (economic growth). But they have a big problem: getting richer usually means polluting more, cutting down trees, and burning fossil fuels.

This study asks: How can these eight neighbors grow their wealth without destroying their shared garden?

The researchers looked at data from the year 2000 to 2024 to see which tools worked best. They tested four main "tools" (or channels) and one "referee" (Institutional Quality) to see how they influenced "Green Growth" (getting rich while keeping the environment healthy).

The Four Tools Tested

1. The Government's Wallet (Fiscal Policy)

The Analogy: Think of the government as the head of a household managing the family budget. They can choose to spend money on things that help the future (like solar panels) or things that hurt it (like cheap gas subsidies that encourage wasteful driving).
What the Study Found: In the short term, the government's spending was actually hurting green growth.
- Why? The "family" was spending too much on fossil fuel subsidies (making dirty energy cheap) and not enough on green projects. It's like trying to lose weight while eating a giant cake every day.
- The Twist: In richer neighbors (like Malaysia and Turkey), the government spending started helping once they had better rules in place. But in poorer neighbors, the spending was still mostly hurting the environment.

2. The Treasure Chest (Natural Resources)

The Analogy: Imagine the countries have a gold mine or a forest in their backyard. They can dig it up and sell it for quick cash, or they can be careful, sell some, and use the money to build schools and factories so they don't have to rely on the mine forever.
What the Study Found: Surprisingly, using natural resources was helping green growth overall.
- Why? It seems these countries are taking the money from their resources (like oil or minerals) and reinvesting it into the economy. It's like selling a piece of land to buy a better tractor that makes the farm more efficient.
- The Catch: In the richest neighbors, digging up too many resources actually started to hurt them again (the "Resource Curse"), but in the poorer ones, it was still a lifeline.

3. The Special Bank (Islamic Finance)

The Analogy: This is a bank that follows strict religious rules. It doesn't just lend money for anything; it has to be ethical, share risks, and back loans with real assets. Think of it as a bank that only lends money to build a house, not to gamble on a horse race.
What the Study Found: This bank is a hero for green growth, but only in the long run.
- Why? Because these banks are ethical, they are naturally better at funding green projects (like wind farms) and avoiding risky, dirty industries.
- The Result: In the short term, the effect was quiet. But over 25 years, Islamic banking became a powerful engine for green growth, especially in countries with big Islamic banking sectors like Malaysia and Indonesia.

4. The Special Bond (Sukuk)

The Analogy: If Islamic Banking is the bank, Sukuk are like special "green bonds." They are IOUs that a government or company sells to raise money specifically for a project (like a solar farm). The money must be used for that project.
What the Study Found: These bonds are helpful, but they are still growing up.
- They are starting to show positive results, but they aren't as powerful as the banks yet. They are like a new startup that has a great idea but needs more time to get big.

The Referee: Institutional Quality (IQ)

The Analogy: Imagine a referee in a sports game. If the referee is strict, fair, and stops cheating, the game runs smoothly. If the referee is asleep or corrupt, players cheat, and the game falls apart.
What the Study Found: The referee is crucial.
- When the "referee" (good governance, low corruption, strong laws) is strong, the government's spending actually helps the environment.
- When the referee is weak, the government's spending often goes to waste or fuels pollution.
- The Bad News: In the poorest countries of the group, the referee is often too weak to stop the bad habits, so the tools don't work as well there.

The "Inverted U" Story (The EKC Hypothesis)

The study tested a famous theory called the Environmental Kuznets Curve (EKC).

The Analogy: Imagine a rollercoaster.
1. Going Up: When a country is poor, it gets richer by polluting a lot (climbing the hill).
2. The Peak: At a certain point, it gets rich enough to afford cleaner technology.
3. Going Down: Once it passes the peak, it starts getting richer while cleaning up the mess (going down the other side).
The Finding: The D-8 countries are generally on the rollercoaster. The richer ones (like Malaysia) are starting to go down the other side (getting rich and cleaner). The poorer ones are still climbing the hill (getting rich but still dirty).

The Final Verdict: What Should the Neighbors Do?

The paper concludes with a simple recipe for the D-8 countries:

Fix the Budget: Stop giving free money to fossil fuels. Start spending on clean energy and research.
Use the Money Wisely: If you sell oil or minerals, don't just spend the cash. Invest it in schools, technology, and other industries so you don't run out of resources later.
Lean on the Ethical Bank: Use Islamic banks and Sukuk bonds to fund green projects. They are naturally good at this.
Hire a Better Referee: You can't have green growth if corruption is high. You need strong laws and honest officials to make sure the money actually goes to green projects.

In short: To grow green, these countries need to stop subsidizing pollution, start investing their resource wealth wisely, use their unique ethical banking system, and make sure their governments are honest and strong enough to enforce the rules.

Technical Summary: The Role of Institutional Quality on Fiscal Policy, Natural Resources, and Islamic Finance Channels in Driving Green Growth across D-8 Countries

Problem Statement and Research Context
This study addresses the critical challenge of achieving green growth (GG) within the Developing-8 (D-8) bloc, a group of eight Muslim-majority economies (Bangladesh, Egypt, Indonesia, Iran, Malaysia, Nigeria, Pakistan, and Türkiye) representing over one billion people. While global economic growth has historically incurred high environmental costs, the D-8 nations face unique structural constraints, including a heavy reliance on fossil-fuel rents, constrained fiscal policy (FP), and nascent environmental policies. Although the D-8 possesses advanced Islamic financial markets and a commitment to sustainable development via the D-8 Decennial Roadmap, there is a lack of empirical research examining these economies as a cohesive analytical bloc.

The paper seeks to resolve three specific research questions:

What are the short- and long-run linkages between natural resource (NR) use, fiscal policy, Sukuk, Islamic banking, and green growth in the D-8?
Does Institutional Quality (IQ) moderate the fiscal-policy and natural-resource channels, and is the Environmental Kuznets Curve (EKC) hypothesis supported?
How do these relationships differ between high-income and low-income D-8 members?

Methodology and Data
The study utilizes a panel dataset covering the D-8 member states from 2000 to 2024. The dependent variable, Green Growth, is operationalized using the World Bank's Adjusted Net Savings (ANS) indicator, which accounts for education expenditure, resource depletion, and CO₂ damage.

The research employs a dual-estimator approach to capture both short-run dynamics and long-run equilibrium relationships:

Short-Run: First-Difference Generalized Method of Moments (FD-GMM) is used to address endogeneity and dynamic panel bias, utilizing lagged levels of the dependent variable as instruments.
Long-Run: Fully Modified Ordinary Least Squares (FMOLS) is applied to estimate cointegrating relationships, correcting for serial correlation and endogeneity in the cointegrating regression.

Prior to estimation, the study confirms cross-sectional dependence (using the Pesaran CD test) and mixed integration orders (I(0) and I(1)) among variables, validating the use of these specific estimators. The model incorporates interaction terms to test the moderating role of Institutional Quality (IQ) on fiscal and resource channels.

Key Results
The empirical findings reveal distinct short-run and long-run dynamics, as well as significant heterogeneity based on income levels:

Fiscal Policy (FP): In the short run, FP exhibits a statistically significant negative effect on green growth ( $\beta = -0.019, p < 0.05$ ). This is attributed to fossil-fuel subsidies and limited green expenditure. However, in the long run, this effect becomes statistically insignificant. Income-group analysis shows a divergence: FP positively impacts GG in high-income members (Indonesia, Malaysia, Türkiye) but negatively affects low-income members due to fiscal constraints and subsidy structures.
Natural Resources (NR): NR use shows a positive association with GG in the short run ( $\beta = 0.022, p < 0.05$ ) and a strong positive effect in the long run ( $\beta = 0.182, p < 0.01$ ), suggesting that rent reinvestment and diversification prevail over time. Conversely, in high-income sub-samples, NR use negatively impacts GG, reflecting a threshold effect consistent with EKC dynamics.
Islamic Finance:
- Islamic Banking: Shows a significant positive long-run effect on GG ( $\beta = 0.124, p < 0.01$ ), though it is insignificant in the short run.
- Sukuk: Exhibits a marginally significant positive long-run effect ( $\beta = 0.009, p < 0.10$ ).
- Heterogeneity: Islamic finance channels are statistically significant and robust in high-income D-8 members but weak or insignificant in low-income members, reflecting market depth disparities.
Institutional Quality (IQ): IQ significantly moderates the fiscal policy channel ( $\beta = -0.017, p < 0.01$ ), though its capacity to moderate remains limited in the least developed members. The study finds that the EKC inverted-U hypothesis is broadly supported, with higher-income economies demonstrating stronger environmental performance.

Key Contributions
The paper claims several distinct contributions to the existing literature:

Integrated Framework: It is the first study to empirically test the nexus of Fiscal Policy, Natural Resources, Islamic Finance (both Sukuk and banking), and Institutional Quality moderation within a single model specifically for the D-8 bloc.
Methodological Rigor: The study distinguishes between short-run (FD-GMM) and long-run (FMOLS) effects, providing a more nuanced understanding of temporal dynamics often obscured in aggregate analyses.
Income Heterogeneity: By splitting the sample by income levels, the study reveals that policy mechanisms (such as fiscal spending and Islamic finance) function differently across the development spectrum, offering a more granular view than previous OIC-wide studies.
Policy-Coherent Bloc: Unlike broader OIC studies, this research focuses on the D-8 as a policy-coherent group committed to a specific sustainable development roadmap, allowing for a more specific test of the EKC hypothesis in a Muslim-majority context.

Significance and Claims
The authors position this work as a unique assessment of green economic growth across the D-8 through an integrated framework. The study claims to contribute to the Organization of Islamic Cooperation (OIC) literature by focusing on a sub-group that emphasizes South–South cooperation.

The findings imply that D-8 governments must prioritize:

Environmentally friendly fiscal measures and fossil-fuel subsidy reforms.
Credible governance frameworks to enhance the effectiveness of fiscal and resource channels.
Alignment of Islamic banking lending with environmental risk management standards.
Differentiated policy priorities: targeting high-income members for carbon pricing and transition Sukuk, while focusing low-income members on efficiency measures and blended concessional financing.

The paper concludes that while the D-8 faces challenges, the integration of Islamic finance instruments with improved institutional quality offers a viable pathway toward sustainable development, provided that capacity building in regulation and disclosure is addressed.