The Welfare Effects of Opening to Foreign Direct Investment in Polluting Sectors

Xin Zhao (), Gregmar Galinato () and Tim Graciano
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Xin Zhao: University of Arkansas

Environmental & Resource Economics, 2019, vol. 74, issue 1, No 9, 243-269

Abstract: Abstract This article investigates how attracting foreign direct investment (FDI) in a polluting sector affects home-country welfare relative to a closed polluting sector scenario. A welfare-maximizing government sets environmental regulations while accounting for public infrastructure levels, environmental quality, and FDI in a polluting sector. We show that in a closed polluting sector, environmental regulations are increasing over infrastructure. With FDI, a similar relationship holds but the optimal environmental regulation is higher to account for the decrease in domestic producer surplus and increase in pollution damages. A critical infrastructure level exists where welfare under a closed polluting sector and welfare with polluting FDI are equal. Countries with underdeveloped infrastructure below the critical infrastructure level are better off deterring FDI entrance into the polluting sector. As infrastructure quality increases beyond the critical infrastructure level, welfare is higher with FDI than under a closed polluting sector because of an increase in consumer surplus from lower prices.

Keywords: Environmental regulations; Infrastructure; Foreign direct investment; Welfare; Heterogeneous firms (search for similar items in EconPapers)
JEL-codes: F64 O44 Q58 (search for similar items in EconPapers)
Date: 2019
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Citations: View citations in EconPapers (1)

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Working Paper: The Welfare Effects of Opening to Foreign Direct Investment in Polluting Sectors (2015)
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DOI: 10.1007/s10640-018-00316-5

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