Environmental Regulation: An Incentive for Foreign Direct Investment

Abstract

Empirical evidence has so far failed to confirm that lenient environmental regulation attracts investment from polluting firms. In a Cournot duopoly with a foreign firm and a domestic firm, we show that the foreign firm may want to relocate to the domestic country with stricter environmental regulation, when the move raises its rival domestic firm's cost by sufficiently more than its own. The domestic (foreign) country's welfare is (usually) lower with foreign direct investment.

Environmental Regulation Induced Foreign Direct Investment

“…1 More recently, a small number of papers has emerged that model the process by which more stringent environmental regulations may not deter FDI (Dijkstra et al 2011) or induce local firms to relocate (Sanna-Randaccio and Sestini 2012). Dijkstra et al (2011) demonstrate in a Cournot duopoly setting (with an exogenous duopoly market structure in the host country) that FDI is more likely if higher regulation costs raise the costs for the domestic firm over and above those for the foreign firm. Sanna-Randaccio and Sestini (2012) show that when the market size of the home country is large, more stringent environmental regulation does not necessarily induce firms to relocate to foreign countries with lax environmental regulations.…”

Does FDI Bring Environmental Knowledge Spillovers to Developing Countries? The Role of the Local Industrial Structure

“…To date, the majority of existing studies have focused on exploring the environmental impact of FDI on economic growth, the determinants of FDI-led pollution, and the stringency of the environmental regulations in host countries to support or repudiate the existence of FDI environmental benefits (Copeland and Taylor 2004;Dean et al 2009;Dijkstra et al 2011;He 2006). The empirical evidence on the role of FDI on recipient countries' environmental performance however remains ambiguous and inconclusive (Erdogan 2014;Pazienza 2014).…”

Unilateral Climate Policy and Foreign Direct Investment with Firm and Country Heterogeneity

“…Their results indicate that …rms in developing countries are signi…cantly more emissions-intensive than competitors 6 Another strand of theoretical literature shows that restrictive unilateral climate measures may attract strategic inward FDI. This is considered as one of the mechanism explaining the lack of satisfactory evidence on the PHH (Elliot and Zhou, 2013;Dijkstra et al, 2011 Mulatu et al (2010), this last strand of literature does not really test the "pollution haven" hypothesis. However, in a recent study Aichele and Felbermayr (2014) conclude that the Kyoto protocol has been ine¤ective or possibly even harmful for the global climate.…”

“…A large market asymmetry coupled with a small technology gap is the only con…guration in which unilateral climate policy will certainly lead to a fall in world emissions, irrespective of the optimal location choice. 13 Moreover, a small emissions technology gap plays also a crucial role in bringing about an increase in social welfare as a whole.…”