Pollution Havens and Foreign Direct Investment : Dirty Secret or Popular Myth?

The "pollution haven" hypothesis states that multinational firms, particularly those in highly polluting industries, relocate to countries with weak environmental standards. Despite the plausibility and popularity of this hypothesis, Smarzynska and Wei find only weak evidence in its favor. The "pollution haven" hypothesis refers to the possibility that multinational firms, particularly those engaged in highly polluting activities, relocate to countries with weaker environmental standards. Despite the plausibility and popularity of this hypothesis, there is little evidence to support it. Smarzynska and Wei identify four obstacles that may have impeded researchers' ability to find evidence in favor of the "pollution haven" hypothesis: - The possibility that some features of host countries, such as bureaucratic corruption, may deter inward foreign direct investment and also be positively correlated with lax environmental standards. Omitting this information in statistical analyses may produce misleading results. - The possibility that country- or industry-level data, typically used in the literature, may have masked the effect at the firm level. - Difficulties associated with measuring environmental standards of the host countries. - Difficulties associated with measuring the pollution intensity of the multinational firms. The authors attempt to surmount these obstacles by explicitly taking into account corruption in host countries and using a firm-level data set on investment projects in 24 transition economies. With these improvements, the authors find some support for the "pollution haven" hypothesis, but evidence is still weak and does not survive numerous robustness checks. This paper - a product of Trade, Development Research Group - is part of a larger effort in the group to study the effects of foreign direct investment on developing countries. The study was funded by the Bank's Research Support Budget under the research project "Corruption, Pollution, and Location of International Capital Flows."