Foreign direct investment, environmentally sound technology and informal sector

Abstract

The paper examines the linkages between foreign direct investment, informal sector and transfer of environmentally sound technology (EST) in a developing economy in terms of a three-sector, full-employment general equilibrium model with an informal sector that produces a non-traded input for the formal final good producing sector. The same input is produced by another division of the formal sector, which generates less pollution than the informal sector since the former uses a different type of capital that embodies EST. The formal sector has to pay a penalty for using the output of the excessively polluting informal sector. In this scenario, the analysis finds that foreign capital inflow in the formal sector may accentuate pollution, even if it involves transfer of EST. This result can at least question the favorable environmental impact of FDI in a developing economy even if it involves transfer of EST.