Pollution Haven and Corruption Paradise

Abstract

In this paper, we propose a new perspective to analyze the impact of institutions, environmental standards, and globalization on relocations of polluting firms in countries with lax environmental regulation (called pollution havens). Via a simple theoretical extension from the Economic Geography literature, we characterize the main features of pollution havens: a good market access to high-income countries and corruption opportunities. Using structural and reduced-form estimations, we analyse these determinants by exploiting a unique database on the number of European affiliates located abroad. A 1% increase in access to the European market from a pollution haven fosters relocation there by 0.1%. We also find that corruption in these countries lowers environmental standards, which strongly attract polluting firms: a 1% increase in this indirect effect of corruption fuels relocation by 0.28%. We test the economic significance of these empirical findings via simulations. The protection of the European market (e.g., a carbon tax on imports) to stop relocations to pollution havens must be high (a decrease of the European market for Morocco and Tunisia equivalent to 13%) not to say prohibitive (31% for China).

Keywords: FDI, Environmental Regulation, Europe, Trade

JEL Classification: F12; Q5; Q53