Technology spillovers, strategic environmental policy, and foreign direct investment

Abstract

Empirical studies have so far failed to find conclusive evidence that a tightening of environmental regulation will shift foreign direct investment (FDI) to less regulated countries. In this paper, we provide an alternative explanation for the mixed results in the empirical literature and highlight the role of technological spillovers in explaining why FDI is not always attracted to low-regulation countries. In a Cournot duopoly with a foreign firm and a domestic firm, we show that the presence of technological spillovers may induce the foreign firm to relocate to the domestic country with stricter environmental regulation. This result holds for a wide range of values of technological spillovers. We also find that the domestic (foreign) country’s welfare is always higher (lower) with FDI.