Environmental Policy Stringency and Foreign Direct Investment

This paper examines empirically whether countries with relatively more lax environmental regimes have a comparative advantage in their competition for foreign direct investment. It seeks to contribute to the literature in several important ways. First, we use a measure of environmental stringency which is based on managers’ perceptions of the stringency in a given country and which gives us the opportunity to analyse a broad sample of both source and host countries. Second, an important strength of the technical analysis is the non-linear modeling of the impact of policy stringency on FDI. Third, we use a ‘state-of-theart’ FDI modelling strategy, which allows us to differentiate between different models of production fragmentation. Support is found for the effect of relative environmental policy stringency on foreign direct investment patterns. However, the effect is relatively small in comparison with other factors, including more general regulatory quality. Moreover, the relationship appears to be non-linear with the effects of increased relative environmental policy stringency in the host country decreasing after a certain threshold.