The Effect of Environmental Regulations on Foreign Direct Investment

International Trade Flows in particular Foreign Direct Investment

(FDI) depend on numerous factors such as socio- or political stability,

environmental standards which must be met, imposed taxes or

labor conditions. Measuring these effects is not as straight forward as

it might seem and various studies have been conducted in this field.

The following paper focuses on the pollution haven hypothesis stating

that lax environmental regulations increase Foreign Direct Investment

inflow since investing firms experience significant cost efficiencies and

comparative advantages.

The data set is mainly chosen from the World Data Bank and eleven

explanatory variables and one instrument variable are used to investigate

their influence on FDI inflow (as percentage of GDP). The variables

can be grouped intro three parts starting with country characteristics,

then environmental standards and finally controlling for several

factors expressing governmental quality and standards. The empirical

analysis will start with some simpler models only investigating the influence

of environmental regulation on FDI and later on the model is

expanded by included several governmental variables to improve the

quality of the empirical results.

During the empirical analysis a pivotal factor will be the OECD membership

even if several environmental standards as well as governmental

standards are controlled. Assuming that OECD member countries

do have tighter environmental regulation which according to the pollution

haven hypothesis lead to less FDI inflow, a significant empirical

difference in FDI inflow between OECD members and non-members

would be a qualified result supporting the pollution haven hypothesis.

In this paper we expect to see some significant determinants of

Foreign Direct Investment inflow in order to either agree or reject the

pollution haven hypothesis.