Does Government Environmental Spending Crowd in Green Investment? The Role of Carbon Pricing and the Limits of Fiscal Policy Alone

Governments around the world are spending more on environmental protection, but it is far from obvious that this spending pulls private capital into green assets. This paper asks whether government environmental expenditure crowds in green investment at the country level, whether carbon pricing moderates this relationship, and through what channels it operates. Using an unbalanced panel of 33 countries observed from 2010 to 2021 and estimated with two-way fixed effects, we find that environmental spending on its own does not significantly predict green investment, proxied by the renewable energy share of generation capacity—a result that holds across multiple specifications, a dynamic system-GMM estimator, and an extensive battery of robustness checks. The interaction between fiscal spending and carbon pricing is positive—the marginal effect of government expenditure points from negative to positive moving from no-carbon-pricing to carbon-pricing country-years—but neither the interaction term nor either marginal effect, tested individually by a simple-slope test, is statistically distinguishable from zero, so this evidence is exploratory rather than confirmatory. Bootstrapped mediation tests show that government spending significantly deepens financial markets but this deepening does not automatically translate into green capital allocation, pointing to a gap between aggregate financial depth and green financial capacity. Azerbaijan, which hosted COP29 in 2024, is discussed as an illustrative policy case (Section An Illustrative Policy Case: Azerbaijan): its environmental expenditure is well below the sample average, it lacks carbon pricing, and its institutional quality score is below zero—a combination that helps illustrate why the country’s green investment lags behind its stated ambitions. The findings do not support a strong causal claim that fiscal spending and carbon pricing act as complements, but they are directionally consistent with that hypothesis, and they indicate that governments hoping to mobilise private green capital cannot rely on fiscal spending alone—they also need functioning green financial infrastructure.