Environmental Spillover of Foreign Direct Investment: Evidence From Policy Liberalisation in China

Yue Lu, Lijing Deng and Yue Hua

The World Economy, 2025, vol. 48, issue 8, 1776-1790

Abstract: Understanding the environmental spillover of foreign investment is critical for promoting sustainable development in the context of the global market. Relying on the liberalisation of a nationwide industrial FDI policy, this paper studies the domestic pollution effect of foreign direct investment. Using a fine‐scale sample of manufacturing firms in China, we robustly show that sectoral FDI liberalisation generates positive environmental spillover that effectively reduces the intensity of domestic firm's pollution emission. We further show that the pollution‐reduction effect varies across firm ownership, firm location and pollution status of firm's affiliated industry. Lastly, environmental spillovers of FDI are found to be realised via firms' reduced use of fossil fuels, improved treatment capacity of abatement devices and technological advancement. Our study provides novel evidence on the domestic pollution effects of FDI that adds to the broader research on FDI‐environment dynamics in large developing economies.

Date: 2025
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