1. Introduction
During the last few decades, foreign direct investment (FDI) has sped up the process of developing countries’ integration into the world. As restrictions on FDI have been drastically removed, China, which is the largest developing country, has grown to be the most attractive destination for investment. Since 2004, China has become the second largest FDI recipient around the world and the largest in the developing world. The utilization of FDI increased from USD 10.29 billion in 1990 to USD 179 billion in 2021. FDI brings advanced technologies and contributes to the economic growth of the host developing countries [
1,
2]. However, the literature on the environmental effects of FDI has failed to uncover conclusive evidence.
With China’s remarkable opening up to the world in the last three decades, the air quality has deteriorated. According to “The 2018 World Air Quality Report”, nearly two million people die each year in China from diseases caused by air pollution. In 2016, the average annual exposure concentration of PM 2.5 in China was four times higher than the value recommended by the World Health Organization (WHO). Then, should the inflow of FDI be responsible for China’s air pollution? In this paper, we will re-estimate this effect by focusing on the case of China and aim to identify the causal effects of FDI on air pollution by taking advantage of the plausibly exogenous relaxation of the FDI regulation policy and the unique database of Chinese Environmentally Extended Input–Output (CEEIO).
Early studies investigate the effects of FDI on the environment through two main potential but conflicting hypotheses. The most popular one is the “Pollution haven hypothesis” [
3], which states that multinationals reallocate to countries with looser environmental regulations and increase pollution in the host country. Some empirical studies support this and find a negative impact of FDI on environmental quality (for example, [
4,
5,
6,
7,
8,
9,
10]). Meanwhile, the other one is the “Pollution Halo Hypothesis”, which points out that FDI reduces pollution due to the transfer and spillover of advanced and clean technologies in the host country. Many empirical papers support this hypothesis, such as Antweiler et al. [
11], Wang and Jin [
12], Liang [
13], Eastin and Zenge [
14], Kim and Adilov [
15], Zugravu-Soilita [
16], and Jiang et al. [
17]. From the above, it can be seen that the impact of FDI on the environment is still controversial, and a unified conclusion has not yet been reached. This is partly due to the difficulty in addressing the endogeneity problem of FDI and environment. For example, studies about the case of China (such as [
6,
9,
17,
18,
19,
20]), generally use province- or city-level data, and the measure of FDI is a performance-based proxy, such as the actual or contract level of FDI. However, the decision taken by foreign multinationals to enter Chinese cities is endogenous, due to the fact that the FDI entry decision can be affected by cities’ stringency of environmental regulations, economic development status, geographic location, industrial agglomeration, infrastructure, and other factors [
18,
21], which partially explains the difficulty to identify the causal environmental effects of FDI and the mixed empirical results.
Our paper takes advantage of the plausibly exogenous FDI policy upon China’s World Trade Organization (WTO) accession at the end of 2001. Specifically, the National Development and Reform Commission (NDRC) conducted a significant revision of “the Catalogue for the Guidance of Foreign Investment Industries” (henceforth, the Catalogue) in March 2002, substantially relaxed the restrictions on foreign investment entry, and liberalized more industries for FDI. The 2002 revision was substantial and strictly in line with the commitments that the Chinese central government made during the negotiations with the WTO members before China’s WTO accession. Thus, in this 2002 version, the revision of the Catalogue was quite exogenous to China’s internal situation. Based on the changes in China’s FDI policy, using difference-in-differences (DID) methodology, we are able to compare the air pollution in the treatment group (industries in which FDI entry was encouraged) with that of the control group (industries for which the FDI policy did not change), before and after China’s entry into the WTO. When verifying the effectiveness of the FDI policy, we find that the liberalized industries experienced a fast increase in FDI inflow after 2002. We also check the exogenous nature of the FDI policy by investigating the determinants of FDI deregulation and find that the air pollution has muted effects on the FDI policy revision. To check the validity of the DID methodology, we investigated the pre-trend differences between the treatment and control groups and the randomization of time and liberalized industries.
Our paper provides evidence that FDI liberalization reduces the air pollution intensity in China. The results are robust to the alternative measures of air pollution, the multi-stage DID model, and the consideration of confounding policies. FDI improves the air quality in both the manufacturing and service industries and has stronger effects on sectors with higher levels of human capital. To explore the mechanisms of FDI impacts on pollution, we decompose the changes in air pollution intensity into within-industry effects and between-industry effects. The within-industry effects account for about 90% of the reduction in air pollution intensity in the manufacturing industry and dominate the positive impacts on air quality. Moreover, FDI improves air quality by increasing productivity mainly through technological efficiency. Thus, our paper provides evidence supporting the “Pollution halo hypothesis” in China.
This paper contributes to the literature in three aspects. First, based on industry-level pollution data of CEEIO and the plausible exogenous relaxation of the FDI policy upon China’s accession to the WTO, we are the first to identify the causal effects of FDI liberalization on pollution. Second, we move the typical decomposition of the effects on total pollution by scale, technology, and composition effects [
4,
22] and focus on the effects on pollution intensity by decomposing them into within-industry and between-industry effects. We find that the industries in which FDI was encouraged experienced a within-industry pollution intensity reduction effect. This is attributed to the fact that FDI inflows promote technological upgrading and improve resource utilization within the industries. Moreover, the promotion effect of FDI deregulation on TFP has also been verified, and this promotion effect is mainly driven by the technological efficiency change. Therefore, the domination of within-industry effects and the increasing of productivity support the “Pollution Halo Hypothesis” in China. Third, we also contribute to the literature on the effects of FDI on developing countries. A large number of studies have discussed the economic impacts of FDI, such as FDI and economic growth [
23], FDI and firms’ productivity [
24,
25,
26], FDI and the labor market [
27,
28,
29]. Our paper is an extension on the analysis of the relationship between FDI and the environment, with a focus on China’s air pollution.
The remainder of the paper is organized as follows:
Section 2 presents China’s FDI liberalization policy.
Section 3 introduces the empirical specification and data.
Section 4 analyzes the empirical results, which include baseline results, DID identification checks, robustness checks, and heterogeneous effects.
Section 5 discusses the relevant mechanisms, and
Section 6 concludes.
6. Conclusions
Increasing concerns about the impacts of FDI on the host country’s environment, along with the enriched literature on the technological transfer and spillover effects of FDI on developing countries, have led researchers to re-investigate whether FDI is a “Pollution Havens” or a “Pollution Halo” for developing host countries. In this paper, we take China as a case study, and estimate the causal effects of FDI on air pollution. This paper presents the empirical analysis by utilizing the relaxation of the FDI regulation policy upon China’s accession to the WTO using the DID methodology, via which we linked industry-level FDI regulation with the air pollution intensity to shed light on the impact of China’s FDI liberalization on air pollution.
We find that FDI liberalization significantly decreases air pollution intensity; evidence of this effect exists in both the manufacturing and service industries, and the effect is more pronounced in sectors with higher levels of human capital. The potential endogeneity issues and the validity of the DID settings have also been well addressed and examined. We also carry out a series of robustness checks, such as considering alternative measures of air pollution, introducing alternative measures of the FDI policy and controlling for other confounding policies, as evidence to support the robustness of our main findings.
Moreover, we also explore the channels through which FDI affects China’s air pollution. Firstly, by decomposing the changes in air pollution intensity into within-industry effects and between-industry effects, we find that the FDI-liberalization-based reduction in air pollution intensity is mostly driven by technological improvement within the industries. Secondly, FDI liberalization significantly increased TFP, and this promotion effect is mainly driven by technological efficiency changes rather than changes in returns to scale or technological progress. Such effects provide direct and clear evidence supporting the “Pollution Halo hypothesis”.
Therefore, the relaxation of China’s FDI policies can help promote more environmentally friendly technologies, reduce air pollution intensity, and achieve the goal of green development. Thus, the developing countries could serve FDI deregulation policy as a driver for promoting environmentally sustainable development (Burlea et al. [
54]). In our paper, we find that the mitigating effect of FDI on air pollution intensity is more pronounced in the services industry and in sectors with higher human capital. Thus, the FDI liberalization policy should also combine with human capital development and technology development to enhance the absorptive capacity of FDI spillover effects. Moreover, technological improvement within each industry dominates the reduction in pollution intensity according to our results. Thus, the more disaggregated data, such as the firm-level environmental data, as suggested by Cherniwchan [
55] and Cui et al. [
56], should be utilized to analyze the transmission mechanisms of FDI impacts on the environment.