FDI and the Environment: Examining the Pollution Haven Effect in China

Abstract

The issue of whether pollution-intensive industries in rich countries relocate to poor countries with less stringent environmental regulation, thereby turning them into “pollution havens,” has engendered considerable controversy. This paper estimates the strength of the pollution haven behavior in China by investigating the effect of environmental regulation on inward foreign direct investments on a provincial and industry level. Results suggest that there is evidence of a pollution haven effect. Weak environmental regulation attracts FDI inflows into the province and, in particular, inflows into the manufacturing sector. However, the size of the effect varies across the different industries within manufacturing and is dependent on the measure of environmental stringency. Overall, the pollution haven effect is relatively small and does not appear to be the most significant determinant for foreign investment location decisions.