Establishing a relationship between FDI and environment

The previous articles analysed the impact of foreign direct investment (FDI) on the economy of India in the post-reform period. However, one cannot make a systemic assessment of the foreign investment without looking at the cost. The reason is simple. Rapid industrialisation has cost India its environmental health. Economic and environmental performances are complimentary for development because the environment provides all the natural resources necessary for the production of goods and services. Production leads to growth but the by-products and wastes create pressure on the environment, resulting in pollution.

Studies connecting FDI and environment

The root of the problem is that with FDI comes the increased pressure to expand business operations, which when done impulsively leads to exploitation of natural resources. More often than not, the damage is irreparable. The business ecosystem affects the quality of air, water and soil in a country in the form of various “indicators”. These air pollution indicators and water pollution indicators are measured regularly so that when the levels seem out of hand, the government can levy measures to control them. Past studies have attempted to examine the relationship between FDI and the environment using these indicators empirically. Below is a review on some of them.

Empirical studies showing a relationship between FDI and environment

Study

Data and Study Period

Relationship studied

Findings

(Acharyya, 2009) Annual data for FDI, CO2 and GDP growth in India for 1980-2003 FDI, CO2 emissions and GDP Growth induced FDI inflows in the 1990s had a large and positive impact on CO2, established through Cointegration and time series regression analysis.
(Baek & Koo, 2009) Annual time series data for FDI, sulphur dioxide emissions and GDP in China for 1980-2002 and in India for 1978-2000 FDI, SO2 emissions and GDP in short and long run Existence of long-run relationship between FDI and SO2 in the short run in both China and India, established through cointegration analysis and vector error-correction model.
(Avazalipour et al 2013) Panel data for selected non-OECD countries for 1996-2007 FDI, biological oxygen demand (BOD), gross national income, value added of industries and energy consumption Significant impact of FDI on water pollution found through fixed effect estimation of panel data.
(Seker, Ertugrul, & Cetin, 2015) Data on FDI, GDP, energy consumption and CO2 emissions in Turkey for 1974-2010 FDI, CO2 emissions, energy consumption, GDP and square of GDP Positive but the small impact of FDI in the long run on CO2 emissions, found using ARDL model.
(Kostakis, Lolos, & Sardianou, 2017) Annual data for the period 1975-2010 in Brazil and Singapore FDI and environmental quality measured by CO2 emissions Adverse effect of FDI on environment in Brazil but not Singapore.
(Zheng & Sheng, 2017) Continuous data for 1997 to 2009 in all Chinese provinces FDI and CO2 emissions Positive impact of FDI on CO2 emissions with the effect declining due to market oriented reforms, established through panel data regression

Table 1: Empirical findings of the relationship between FDI and environment

Impact of FDI on the environment

Figure 1: Relationship between FDI and environment

Figure 1: Relationship between FDI and environment

Based on the empirical review of relevant studies, the above figure can be constructed to describe the relationship between FDI and the environment. In most of the studies, the effect is described to be an indirect one, accentuated through growth. Also, it is found in the literature that trade openness and FDI expansion have a complementary relationship with each other. This means that they cannot be substituted for one another and they rather go hand in hand. Both trade and FDI help in improving a country’s growth by increasing trade volumes and investments. But along with improved growth rate, the quality of environment deteriorates. The environment is degraded in a sense that the country is engaged in depleting the natural resources for the expansion in exports and also generates pollution through production activities.

The impact of FDI on the environment is uneven in general for different countries and largely depends on the strength of the environmental regulation and compliance. Sometimes the relation between environmental regulation and economic activities requires the use of the Pollution Haven Hypothesis (PHH).

References

  • Acharyya, J. (2009). FDI, Growth And The Environment: Evidence From India On CO2 Emission During The Last Two Decades. Journal of Economic Development, 34(1), 43–58.
  • Aizenman, J., & Noy, I. (2005). FDI and Trade -Two Way Linkages? (Working Paper No 598). University of California, Economics Department, Santa Cruz.
  • Avazalipour, M. S., Zandi, F., Saberi, R., Hakimipour, N., & Damakeshideh, M. (2013). The Impact of FDI on Environmental Resources in Selected Countries (Non- OECD). International Journal of Research and Reviews in Applied Sciences, 17(1), 111–115.
  • Baek, J., & Koo, W. W. (2009). A Dynamic Approach to the FDI-Environment Nexus: The Case of China and India. East Asian Economic Review, 13(2), 87–106. https://doi.org/10.2139/ssrn.3077770.
  • Dash, R. K., & Sharma, C. (2007). FDI, Trade and Growth in India: A Modified Causality Analysis. Journal of Indian School of Political Economy, 19(3), 451–467.
  • Jayachandran, G., & Seilan, A. (2010). A Causal Relationship between Trade, Foreign Direct Investment and Economic Growth for India. International Research Journal of Finance and Economics., (42), 74–88.
  • Kostakis, I., Lolos, S., & Sardianou, E. (2017). Foreign Direct Investment and Environmental Degradation: Further Evidence from Brazil and Singapore. Journal of Environmental Management and Tourism, 8(1), 45–59.
  • Zheng, J., & Sheng, P. (2017). The Impact of Foreign Direct Investment (FDI) on the Environment: Market Perspectives and Evidence from China. Economies, 5(1), 8.

Saptarshi Basu Roy Choudhury

Senior Research Analyst at Project Guru
Saptarshi has done his M. Phil in International Trade and Development and Masters in Economics from Jawaharlal Nehru University, New Delhi. His academic interests include issues related to economics of climate change, regulation and contemporary trade theories. He has a keen interest in current affairs and likes to read and travel in his spare time.
Saptarshi Basu Roy Choudhury

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