10.1.1.124.9068 - Does Foreign Direct Investment Harm the...

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Does Foreign Direct Investment Harm the Host Country’s Environment? Evidence from China Feng Helen Liang Haas School of Business, UC Berkeley This Version: April 12, 2006 Abstract As more manufacturing is moved to the developing countries, policy makers become concerned with the environmental consequence. Relatively lenient environmental policies in the developing countries may give them a comparative advantage in pollution intensive goods, and openness to trade and foreign direct investment might harm the host country’s environment. This study examines the relationship between the scale of foreign direct investment and local air pollution in China and suggests that the opposite might be true. Trade and foreign direct investment could have beneficial effect on a developing country’s environment when the multinationals crowd out inefficient local firms, when they change the industry composition, and when they bring more efficient technology into the host country and improve productivity and energy efficiency. We examine the environmental consequence of foreign direct investment using city level data on air pollution, industry composition, foreign direct investment, and other social economic factors. We exploit China’s half land-locked geographic feature and preferable trade policy granted to selected cities as exogenous variations in the cities’ access to foreign investment. We find a negative correlation between foreign direct investment and air pollution, suggesting that the overall effect of foreign direct investment may be beneficial to the environment. Key Words: Foreign Direct Investment, Environment, China Haas School of Business, University of California, Berkeley. fenliang@haas.berkeley.edu . Funding from the Fisher Center for Real Estate and Urban Economics and Institute of Business and Economics Research is gratefully appreciated.
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1. Introduction Are trade and growth good or bad for the environment? As competition becomes more global, people are concerned that relatively lenient environmental regulation and lax enforcement in developing countries give them a comparative advantage in pollution intensive goods. Lowering trade barrier may encourage a relocation of polluting industries from countries with strict environmental policy to those with lenient policy. These shifts may increase global pollution or lead to race-to-the-bottom environmental policy practices, as countries become reluctant to tighten environmental regulations due of their concerns over comparative advantage in international trade. On the other hand, some researchers argue that openness could improve developing countries’ environment by increasing local income, introducing more energy efficient production technology, and increasing competition and driving out less efficient factories. Grossman and Kruger initiated the research literature on trade, growth and pollution by
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10.1.1.124.9068 - Does Foreign Direct Investment Harm the...

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