Heterogeneous impacts of environmental regulation on foreign direct investment: do environmental regulation affect FDI decisions?

Abstract

The industry selection effect arising from the impact of environmental regulation on Foreign Direct Investment (FDI) in China is heterogeneous. Based on an extension of the principal-agent Game Theory, this paper constructs a system of simultaneous equations to study the dynamic effect of environmental regulation on Chinese FDI in terms of industry selection decisions, by utilizing panel data from 2005 to 2014 in China. Results of this study show that environmental regulation promotes the technological innovation within the Chinese industry and attract greater foreign capital investment. While the influx of capital will furthermore boost technological progress, a benign interaction effect may be observed between technological innovation and foreign capital. The implementation of the new environmental policy will intensify game strategies between managers and enterprises. Enhanced co-ordination activity within industrial organizations will generate more effective organizational and technological innovation, thereby attracting a large flow of FDI, Phase analysis suggests that the policy of market borrowing technologies is more effective. In addition, industry sample results highlight a compensation effect of technological innovation in the raw materials and manufacturing industry, though environmental regulation of high-tech industries will generate an offset effect with respect to technological innovation. Industries that show the strongest technological and innovative prospects will prove the most attractive for foreign capital investment.

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