Does Foreign Direct Investment Harm the Host Country’s Environment? Evidence from China

Abstract

As more manufacturing jobs are 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 foreign direct investment might harm the host country’s environment. This study examines the relationship between the inflows 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, change the industrial composition, and bring better technology and improve productivity and energy efficiency. Using city level data on air pollution, industry composition, foreign direct investment, and other social economic factors, this study finds 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.

Keywords: Foreign Direct Investment, Environment, Pollution, China

JEL Classification: F21, L60, O13