Three New Empirical Tests of the Pollution Haven Hypothesis When Environmental Regulation is Endogenous

44 Pages Posted: 22 Aug 2011

See all articles by Daniel L. Millimet

Daniel L. Millimet

Southern Methodist University (SMU) - Department of Economics; IZA Institute of Labor Economics

Jayjit Roy

affiliation not provided to SSRN

Abstract

The validity of existing empirical tests of the Pollution Haven Hypothesis (PHH) is constantly under scrutiny due to two shortcomings. First, the issues of unobserved heterogeneity and measurement error in environmental regulation are typically ignored due to the lack of a credible, traditional instrumental variable. Second, while the recent literature has emphasized the importance of geographic spillovers in determining the location choice of foreign investment, such spatial effects have yet to be adequately incorporated into empirical tests of the PHH. As a result, the impact of environmental regulations on trade patterns and the location decisions of multinational enterprises remains unclear. In this paper, we circumvent the lack of a traditional instrument within a model incorporating geographic spillovers utilizing three novel identification strategies. Using state-level panel data on inbound U.S. FDI, relative abatement costs, and other determinants of FDI, we consistently find (i) evidence of environmental regulation being endogenous, (ii) a negative impact of own environmental regulation on inbound FDI in pollution-intensive sectors, particularly when measured by employment, and (iii) larger effects of environmental regulation once endogeneity is addressed. Neighboring environmental regulation is not found to be an important determinant of FDI.

Keywords: foreign direct investment, environmental regulation, spillovers, instrumental variables, control function, heteroskedasticity

JEL Classification: C31, F21, Q52

Suggested Citation

Millimet, Daniel L. and Roy, Jayjit, Three New Empirical Tests of the Pollution Haven Hypothesis When Environmental Regulation is Endogenous. IZA Discussion Paper No. 5911, Available at SSRN: https://ssrn.com/abstract=1913618 or http://dx.doi.org/10.2139/ssrn.1913618

Daniel L. Millimet (Contact Author)

Southern Methodist University (SMU) - Department of Economics ( email )

Box 750496
Dallas, TX 75275
United States
214-768-3269 (Phone)
214-768-1821 (Fax)

HOME PAGE: http:\\www.smu.edu\~millimet

IZA Institute of Labor Economics

P.O. Box 7240
Bonn, D-53072
Germany

Jayjit Roy

affiliation not provided to SSRN ( email )

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