Does Productivity Growth Promote Environmental Sustainability? The Role of Financial Development

ABSTRACT This study investigates whether total factor productivity (TFP) promotes environmental sustainability and examines the moderating and mediating roles of financial development in shaping this relationship. Using balanced panel data for 92 countries from 2000 to 2023, the analysis employs dynamic two‐step Generalised Method of Moments (GMM), Lewbel's 2SLS, and panel threshold regression techniques to address endogeneity and capture nonlinear dynamics. Environmental degradation is measured using the ecological footprint and CO 2 emissions. The findings indicate that productivity growth significantly reduces environmental degradation by improving resource‐use efficiency and fostering cleaner production processes. Financial development and financial institutions further strengthen this effect by facilitating investment in green technologies and sustainable infrastructure. However, financial markets exhibit mixed environmental impacts, reflecting short‐term profit incentives. Threshold estimations reveal that TFP initially intensifies environmental pressure at low levels of financial development but becomes environmentally beneficial once critical financial thresholds are surpassed. The mediation analysis identifies energy efficiency as the dominant transmission channel through which TFP reduces environmental degradation, while industrial expansion partially offsets these gains. Additional channels include technological innovation and trade openness, though their mediating roles are relatively modest. Overall, the results highlight the importance of well‐developed and well‐regulated financial systems in converting productivity gains into environmental benefits. The study provides policy‐relevant insights for designing integrated productivity, financial, and environmental strategies to support sustainable development.