North–South Capital Movement and the Global Environment

The paper re-examines the hypothesis: free movement of capital from capital-rich “Northern” to capital-poor “Southern” countries worsens the global environment. Assuming that national governments regulate the pollution level optimally, by trading off the marginal benefit of pollution against its marginal cost, it is found that, North is generally a larger polluter. Also, a zero to positive level of foreign direct investment worsens the global environment but a higher level of investment is not necessarily associated with more global pollution. As countries move from non-cooperation to cooperation in setting environment policies, world environment quality improves, and there is more foreign direct investment. With foreign direct investment, the welfare implications for the North are not clear and the South unambiguously gains. These results are derived assuming environment to be a neutral good. When environment is a normal good, a move from autarky to non-cooperative FDI equilibrium entails that even South may lose in welfare as the North, and in absolute terms, North will pollute less than the South. Further, in general, there is little rationale for harmonisation of environmental policies across countries.