Foreign-Funded Enterprises and Pollution Halo Hypothesis: A Spatial Econometric Analysis of Thirty Chinese Regions

China is one of the world’s major environmental polluters, therefore, Chinese environmental efficiency is an issue of global importance. In this study, we aim to identify economic factors affecting environmental efficiency scores in different regions of China from a spatial econometric perspective. We measure environmental efficiency scores, relative to the theoretically consistent production possibilities frontier estimated, according to a novel iterative methodology. As expected, we find that environmental efficiency scores are negatively affected by the prevalence of heavy industry sector in the economy, with a higher share of coal as a source of energy exacerbating the problem. We also find evidence that strongly support the pollution halo hypothesis, which credits foreign-funded enterprises with producing in a more environmentally-friendly way. Surprisingly, we find a negative association between the share of tertiary sectors in a regional economy and environmental efficiency—emphasizing the need to address the indirect effects produced on the environment by the seemingly innocuous sectors, such as the hotel sector. We encourage the creation of foreign-funded enterprises, and support formulating environmental protection policies that consider the indirect effects various economic sectors have on the environment.