Impact of Financial Development on the Circular Economy: empirical evidence from the European Union.

Abstract

In the context of growing environmental degradation and unsustainable resource use, the transition to a circular economy (CE) has become central to policy and academic discourse. While financial development is increasingly recognized as a potential enabler of sustainability, its empirical linkage to CE outcomes remains underexplored. This study investigates the relationship between financial development—measured by domestic credit to the private sector (% of GDP)—and municipal waste generation per capita across 28 European countries from 2000 to 2020. Using a robust empirical strategy that includes fixed effects, instrumental variables (IV) estimation, and panel quantile regression, we assess whether access to credit supports or undermines CE performance. Municipal waste per capita serves as an inverse proxy for CE, capturing material inefficiencies and the persistence of linear economic models. Results consistently show a positive and significant association between financial development and waste generation, suggesting that, in the absence of environmental targeting, expanded credit may reinforce consumption-driven waste. The findings underscore the importance of aligning financial sector growth with sustainability objectives through green finance instruments and regulatory incentives. This paper contributes to the emerging literature at the intersection of finance, environmental strategy, and circular economic transition.