The Impact of Foreign Direct Investment on CO2 Emission: Evidence From Selected G-20 Countries

The Impact of Foreign Direct Investment on CO2 Emission: Evidence From Selected G-20 Countries

Oguzhan Aydemir (Namık Kemal University, Turkey) and Feyyaz Zeren (Namık Kemal University, Turkey)
DOI: 10.4018/978-1-5225-2245-4.ch005
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In the literature, the impact of Foreign Direct Investment (FDI) on carbon dioxide (CO2) emissions is explained by two different hypotheses: Pollution Halo and Pollution Haven Hypothesis. While Pollution Halo hypothesis states that FDI provides advanced technology to countries and accordingly decreases CO2 emissions, Pollution Haven Hypothesis indicates that there is a positive relationship between FDI and CO2. In this regard, in this study, the impact of FDI on CO2 emissions in the selected 10 of G-20 countries in the period of 1970-2010 is investigated by using panel data analysis. The empirical findings show that panels have cross-section dependence and these two panels are stationary in different levels. Moreover, the existence of long term relationship between panels is found by using Durbin Hausmann panel cointegration test. The results of the study also show that while Pollution Halo Hypothesis is valid for USA, France and Argentina, Pollution Haven Hypothesis is valid for UK, Canada, Australia, South Africa, Italy, Mexico and Saudi Arabia.
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Global warming, environmental deterioration and pollution have been increasing along with globalization and increasing international trade. In this regard, the determination of the impact of foreign direct investment on environmental pollution has become more popular issue in the world (Hao and Liu, 2015). Although, the relationship and causality between foreign direct investment (FDI) and carbon dioxide (CO2) has preoccupied the minds of academicians and policy makers for a long time, there is no consensus about this issue. In the literature, this nexus is explained by pollution haven hypothesis and pollution halo hypothesis. Pollution haven hypothesis posits that pollution-intensive firms transfer their investment from developed countries to developing countries in order to avoid from high environmental regulations in developed countries. In other words, low environmental regulations and high environmental pollution in developing countries stimulate the FDI inflows of pollution-intensive firms, which emit more CO2 emissions. As a result, FDI increases the CO2 emissions and causes environmental degradation in these countries, which indicates that there is a bidirectional causal relationship between FDI and CO2 emissions. On the other hand, according to pollution halo hypothesis, FDI inflows can decrease the CO2 emissions and thereby environmental degradation when foreign direct investment brings advanced and environment-friendly technologies to host country with low environmental regulations (Yıldırım, 2014; Shahbaz et al., 2015; Ren et al., 2014; Tang, 2013). Generally, foreign companies have same advantages of technology and management relative to domestic firms in developing countries since they can make large investment in research and development. Therefore, domestic firms can learn and copy of foreign companies’ technologies and standards. Thus, FDI will decrease the environmental pollution supporting pollution halo hypothesis (Zarsky, 2006).

There are many factors affecting FDI inflows such as political instability, country risk, interest rate etc.. Although there is a low environmental regulation in a country, other factors can affect the FDI inflows negatively. In this situation, low environmental regulations will not increase FDI inflows. (Yıldırım, 2014; Shahbaz et al., 2015). On the other hand, since high environmental regulations decreases the profit of firms, these firms can transfer their investment to countries with relatively low environmental regulations due to lower environmental compliance costs (Tang, 2013; Gallagher, 2003).

Environmental pollution is an important problem for both developed and developing countries and FDI is usually accused of this problem (Hassaballa, 2014). On the other hand, host country gets some benefits from FDI inflows such as capital, advance technology and management, know how, export promotion etc. (Acharyya, 2009). Projections of FDI flows, by group of economies are presented in Table 1. According to the table, growth rate projections of FDI for developed economies are higher than those for developing and transition economies (UNCTAD, 2015).

Table 1.
Projections of FDI flows, by group of economies (Billions of dollars and per cent)
Global FDI Flows1397135914671228136814841724
Developed economies917718697499634722843
Developing economies421561671681707734850
Transition economies608110048454753
Average Growth RatesGrowth RatesGrowth Rate Projections
Global FDI Flows40.13.14.6-16.311.48.416.2
Developed economies48.23.02.7-28.423.813.916.7
Developing economies26.
Transition economies48.0-1.117.0-51.7-2.35.312.3

Source: UNCTAD, 2015.

Note: Excludes Caribbean off shore financial centers.

Key Terms in this Chapter

Pollution Halo Hypothesis: It demonstrates that FDI supplies advanced technology to countries and accordingly causes lower carbon emissions.

Pollution Haven Hypothesis: It shows that FDI raises carbon emissions by locating less environmental standards to countries it invest.

Foreign Direct Investment: A managing ownership in a firm enterprise in one country by an entity based in another country.

Cointegration: It point outs whether two variables have long-run relationship or not.

Cross Section Dependency: It shows there is relationship between cross sections in panel.

Panel Data Analysis: It is the method of estimating the economic relations using cross-sectional with time dimension.

CO2 Emission: The primary greenhouse gas spread outed through human activities.

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