Pollution Havens and Foreign Direct Investment: Dirty Secret or Popular Myth?

The ‘pollution haven’ hypothesis refers to the possibility that multinational firms, particularly those engaged in highly polluting activities, relocate to countries with weaker environmental standards. Despite the plausibility and popularity of this hypothesis, the existing literature has found little evidence to support it. This Paper identifies four areas of difficulties that may have impeded the researcher’s ability to uncover this ‘dirty secret.’ This includes the possibility that some features of FDI host countries, such as bureaucratic corruption, may deter inward FDI, but are positively correlated with laxity of environmental standards. Omitting this information in statistical analyses may give rise to misleading results. Another potential problem is that country- or industry-level data, typically used in the literature, may have masked the effect at the firm level. In addition, the environmental standards of the host countries and pollution intensities of the multinational firms are not easy to measure. This study addresses these problems present in the earlier literature by taking explicitly into account corruption levels in host countries and using a firm-level data set on investment projects in 24 transition economies. With these improvements, we find some support for the ‘pollution haven’ hypothesis, but the overall evidence is relatively weak and does not survive numerous robustness checks.