Environmental Protection versus Incentives for FDI Inflows: Abatement Technologies Matter

This paper examines how environmental regulation affects the FDI strategies of parent firms in developing countries (the South) and developed countries (the North) when there are differences in the emission abatement technology between these countries. More lenient environmental regulations of developing countries are likely to attract more foreign capital inflows with higher risks for being pollution haven. As long as the emission abatement technology of the multinational corporations is superior to that of the South, lenient environment regulation to induce foreign capital inflows turns out to be the optimal policy. Also when social concerns about pollution are higher than the critical value, there is a tougher environmental regulation. Moreover, the welfare of developing country is maximized with the foreign capital inflows as joint-venture, suggesting higher incentive policies for joint-ventures with higher abatement technology. We also demonstrate that stricter environmental regulation is applied if the foreign firm invests as a monopoly firm instead of joint-venture. The larger market size of the developing economy also induces stricter regulation.