Environmental Regulation and Foreign Direct Investment: Evidence from South Korea

Abstract

This paper studies how environmental regulation shapes the pattern of foreign direct investment (FDI), and thereby assesses the pollution haven hypothesis. Conflicting results exist in the case studies examining the most advanced countries, partly due to the deterrent effect of clean technology adoptions on industry migration. To minimize the clean technology effect, we examine the pattern of South Korean FDI over 2000–2007, the period that Korean firms relied on old production technologies despite facing rapidly strengthened environmental standards. A difference-in-differences type identification strategy circumvents other potential confounders. We find strong evidence that polluting industries tend to invest more in countries with laxer environmental regulations in terms of both the amount of investment (intensive margin) and the number of new foreign affiliates (extensive margin). A similar finding is obtained when imports are analyzed.

Keywords: Pollution Haven Hypothesis, Environmental Regulation, Comparative Advantage, Foreign Direct Investment, South Korea

JEL Classification: F18, F23, O44, Q56