Environmental Regulation and the Pattern of Outward FDI: An Empirical Assessment of the Pollution Haven Hypothesis

This paper studies how environmental regulation plays a role in shaping the pattern of outward foreign direct investment, and thereby assesses the pollution haven hypothesis. Empirical evidence for the pollution haven hypothesis has been inconsistent in the literature, possibly due to data aggregation across industries, clean technology innovation in advanced countries, factor endowment effects, unobserved heterogeneity, or endogeneity of environmental policies. To circumvent these problems, we exploit highly disaggregated industry-level panel data from South Korea along with an identification and estimation strategy that has been rarely used in prior studies. After dealing with such issues, we find strong evidence that polluting industries tend to invest more in countries with laxer environmental regulations. As a complementary evidence, we also find that environmentally lax countries tend to specialize in polluting industries when the same strategy is applied to South Korean import data covering the same sample countries, industries, and time periods. Theoretically, our findings are in line with a chain proposition of comparative advantage, also called the Quasi-Heckscher-Ohlin prediction.