The Effectiveness of Environmental Regulation in E7 and G7 Countries: Revisiting the Pollution Halo and Pollution Haven Hypothesis

This study examines the environmental impact of foreign direct investment (FDI) in E7 and G7 countries from 2005 to 2020 using ecological footprint as a comprehensive indicator. Employing both linear and nonlinear dynamic panel models, the findings reveal that the environmental effects of FDI are contingent upon the stringency and type of environmental regulation. In E7 countries, FDI tends to worsen environmental degradation under weak regulatory frameworks, providing partial support for the Pollution Haven Hypothesis (PHV). In contrast, in G7 countries, FDI contributes to environmental improvement when market-based and technology-oriented policies surpass certain thresholds, aligning with the Pollution Halo Hypothesis (PHL). The study disaggregates the OECD Environmental Policy Stringency (EPS) index and identifies regime-dependent effects of FDI across different policy types. It is asserted that while non-market-based policies are more effective in E7 countries, market-based instruments have a larger influence on environment in G7 economies. Our paper also acknowledges theoretical limitations of PHV and PHL, including assumptions of industry mobility, and suggests alternative mechanisms such as technology spillovers. Overall, the results emphasize the importance of context-sensitive policy design to ensure that FDI supports environmental sustainability goals.