Environmental Impact Assessment Review 77 (2019) 60–68

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Environmental Impact Assessment Review

journal homepage: www.elsevier.com/locate/eiar

The impact of FDI in the OECD manufacturing sector on CO2 emission: T

Evidence and policy issues
Pasquale Pazienza
University of Foggia, Department of Economics, L.go Papa Giovanni Paolo II n. 1, 71121 Foggia, Italy

A R T I C LE I N FO A B S T R A C T

Keywords: This work investigates the sign and the magnitude of the impact Foreign Direct Investment (FDI) inflowing in the
Carbon dioxide manufacturing sector of the countries from the Organisation for Economic Co-operation and Development
Economic growth (OECD) exerts on the environment and, specifically, on the amount of CO2 from sectoral fuel combustion. By
Environmental impact gathering data from various international institutions for those countries from 1989 to 2016, an equation model
Foreign Direct Investment
is built to take into separate account technique, scale and cumulative effects of FDI on CO2 and analysed through
Globalisation
the panel data technique. The positive relationships found for all these effects would highlight a detrimental role
JEL classification: of FDI on the environment. However, the very low magnitude of the estimated coefficients and the observation
C23
that the negative impact of FDI on CO2 decreases as the scale of its inflow increases, leads to a reconsideration of
F18
those arguments against the enforcement of international investment policies in the sector due to the environ-
F64
O44 mental implications generally assumed. This positive environmental spillover is explained by referring to FDI as
P33 a driving force of technology innovation and, consequently, a way through which the implementation of more
Q56 environmentally-friendly and cleaner production modes occurs. Results are consistent across different estimators
R11 and robust to a number of alternative specifications and additional co-variates.

1. Introduction
Over the last decades, increasing trends of environmental de-
gradation have been reported in several international documents (e.g.
UNEP, 2012). As generally thought, this is caused by the widespread
increase of economic activities resulting from globalisation (e.g.
Huwart and Verdier, 2013). These heavily rely on the use of energy
mainly produced from fuel combustion processes from which a sig-
nificant amount of greenhouse gases – and, particularly, CO2 among
these – are generated (e.g. IEA, 2007).1 The consideration that FDI is a
significant part of the globalisation phenomenon raises concerns about
its environmental implications.2 This becomes particularly important if
the global data showing the rapid and almost contemporary increase of
FDI and carbon dioxide is observed. FDI entering the world economies
has enormously increased since the beginning of its phenomenon in the
early 1970's. A focus on the last three decades shows us how FDI has
moved from 196,315 billion US$ in 1990 to 1461 trillion in 2000 and,
after a series of ample fluctuations, to 2437 trillion in 2016 (data.
worldbank.org). Besides this, an increase of the CO2 emission level can
also be appreciated; it has passed from 22.29 billion tones (Gt) in 1990
to 24.71 in 2000 and 33.5 in 2010 to reach 36.18 in 2016 (cdiac.ess-
dive.lbl.gov). The understanding of the link between FDI and the en-
vironment has caught the attention of various analysts and researchers
particularly since the mid-1990's. As will be seen later, the literature
highlights a significant amount of works producing different and con-
tradictory results. Therefore, whether and to what extent FDI can be
considered detrimental or beneficial for the environment is a question
yet to be answered and the possibility of contributing to this discussion
is the main motivation of this work.
Investigations in the FDI-environment relationship can be largely
clustered into the following areas: 1) the effects of FDI on the en-
vironment; 2) the effects on environmental standards resulting from the
competition for FDI; 3) the cross-border environmental performance.
The research activity produced on these three themes is copious.
Nevertheless, a general claim still exists that, so far, it has not yet
generated any conclusive evidence (e.g. Cole et al., 2017; Pazienza,
2014). This is particularly true for the first thematic area for which
further research is required (e.g. Shao, 2018; Zheng and Zheng, 2017;
McAusland, 2010; OECD, 2002).
As highlighted in the literature, one of the main aspects

E-mail address: pasquale.pazienza@unifg.it.

1
About a third of the consumption of the world's energy and more that 36% of CO2 emissions are produced by manufacturing industries (IEA, 2007, 2011, 2017).
2
To the specific purpose of this study, it is worth highlighting how in 2016 the total amount of FDI inflowing the OECD area is equal to 1.241.463 million US$, that
is about 63% of the World figure equal to 1.969.283 million US$ (www.oecd.org/investment/statistics).

https://doi.org/10.1016/j.eiar.2019.04.002
Received 27 November 2018; Received in revised form 11 March 2019; Accepted 4 April 2019
0195-9255/ © 2019 Published by Elsevier Inc.
P. Pazienza
characterising FDI is that it does not impact the environment in isola-
tion, but also interplays with a variety of other elements. For this
reason, by following Grossman and Krueger (1995), regarding the
analysis of the environmental impact of the North American Free Trade
Agreement, various works have developed their analyses while distin-
guishing the effects of FDI on the environment into the following three
groups: technique, scale and composition or structural effects (i.e. He,
2008; Liang, 2008; Cole and Elliott, 2003).
The first type of effect refers to the consideration that the emission
level per each unit of goods produced in the economy relies on the
existing production techniques, which can be modified via policy and/
or technological avenues. In a free market situation, the liberal circu-
lation of investment promotes allocative efficiency among countries
and, in turn, the development, transfer and diffusion of more updated
and efficient technology and/or the introduction of newer and tighter
environmental legislation. As a result, the technique effect is predicted
to be environmentally beneficial.
The scale effect, instead, is presumed harmful to the environment
since it is associated to the rise in the scale of the economy, which
implies that more production means higher pollution levels. It is worth
pointing out that the issue of the scale effect implicitly recalls the dis-
cussion on the Environmental Kuznets Curve (EKC). Various works have
observed how the environmental deterioration expected from an in-
crease in the scale of an economy is true but only up to a certain point.
As the “turning point” is overtaken, environmental quality improve-
ments are observed. Although the literature highlights the existence of
countervailing views expressed on this evidence at global, country and
local levels (e.g. Gill et al., 2018; Farhani et al., 2014; Aslandis and
Iranzo, 2009; Stern, 2004), the general justification refers to the fact
that wealthier countries are more capable of opting for newer and more
efficient technologies. At the same time, their populations develop
major levels of environmental sensitiveness for which they require
tighter environmental rules.
Finally, the composition (or structural) effect refers to a conversion
of the industrial organisation of an economy resulting from a change in
the order of its economic activity. It is envisaged to be environmentally
advantageous considering that, in a free market context, investment
pushes towards the allocative efficiency of resources among countries
(OECD, 2001). By lowering tariff and non-tariff barriers, indeed, eco-
nomic liberalisation decreases the relative prices of import-competing
goods. In a given economy, this very likely leads to progressively sub-
stituting more polluting activity sectors with less polluting ones and the
total emission level to fall. The literature on this issue also refers to the
existence of counterviews. Cole and Elliott (2003), for example, show
how in the situation of free trade, the sign characterising the compo-
sition effect can be negative or positive. This would depend on the
competitive advantages of a considered country and its productive
specialisation.
The analysis of the literature also shows that the link between FDI
and the environment has prevalently been analysed using aggregate
data of FDI only. The development of analyses focusing on data dis-
aggregated at the level of each specific single sector of activity to in-
vestigate the FDI-pollution relationship, instead, has been disregarded
with the consequence that the evidence achieved so far might result
hazardously deceptive. However, two are the arguments raised in the
literature. On the one hand, FDI is considered to play a positive role for
the environment of host countries. On the other hand, there is also
evidence that FDI generates negative spillover effects on the environ-
ment of receiving countries. For example, through the employment of a
three stage least square method to analyse, among other things, the
impact of economic growth and the inflow of FDI on CO2 emission in
Pakistan over the period from 1980 to 2014, Bakhsh et al. (2017) have
found FDI positively related to CO2. Similarly, in analysing 99 hetero-
geneous (hig-, middle-, and low-income) countries over the period
1975–2012, through the fully modified ordinary least square method,
Shahbaz et al. (2015) find evidence of the existence of a bidirectional
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Environmental Impact Assessment Review 77 (2019) 60–68
casuality between CO2 and FDI. In the same direction goes the evidence
achieved by Kivyiro and Arminen (2014), who analyse a time series
from 1971 to 2009 for six sub-Saharan African countries and observe
that CO2 emissions and FDI (together with economic development and
energy consumption) move along the same path in the long-run. Omri
et al. (2014) also find – among other things – a bidirectional casuality
between CO2 emissions and FDI while analysing a panel data of 53
countries over the period 1990–2011 through a dynamic simultaneous-
equation model. Further evidence of the positive relationships char-
acterising the nexus between FDI and air pollution come from another
couple of works focusing on China from the same author. In the first,
the analysis of a simultaneous equation model built on data for the 29
Chinese provinces from 1994 to 2001 shows that FDI impacts positively
on SO2 (He, 2006). In the second, the analysis with the GMM estimator
of a simultaneous equation model based on data for 80 Chinese cities
from 1993 to 2001 also proves the existence of a positive impact of FDI
on the two pollutants considered (SO2 and total suspended particles),
although for a small quantity (He, 2008). Bae et al. (2017) also find that
FDI increases CO2 in their analysis of the determinants of CO2 emissions
for 15 countries from the ex-Soviet region over the period 2000–2011.
As for the opposite evidence, some other works find that FDI can be
beneficial for the environment. It is the case of Liang (2008) who
concludes her investigation of the Chinese city level data from 1996 to
2002 by suggesting that the overall effect of FDI on air pollution may be
beneficial to the environment. In another work analysing a panel data
containing statistics of the FDI inflow and air pollution for 286 Chinese
cities between 2001 and 2007, a significant causal effect showing the
beneficial role FDI plays in reducing air pollution is observed (Kirkulak
et al., 2011). Acharyya (2009) reaches a similar conclusion in her work
on India where the relationship between the FDI inflow and CO2
emission is analysed over the period from 1980 to 2003. It is the case to
note that Shahbaz et al. (2015), already mentioned above, find that FDI
is beneficial for the environment although only in high-income coun-
tries. More recently, working on a panel data with statistics from 2002
to 2015 of CO2 emission and FDI inflowing 28 subsectors of Chinese
manufacturing, Sung et al. (2018) observed that FDI is positively cor-
related to the improvement of environmental quality.
In the attempt to over-ride the hazardous limitation characterising
all these works and represented by the use of aggregate data of FDI,
here we proceed by following an investigation approach based on the
sectoral analysis framework. Here, we analyse how FDI inflowing the
“manufacturing” sector of the countries from the Organisation for the
Economic Co-operation and Development (OECD) area impacts on the
amount of CO2 emission caused by fuel combustion in the same sector.
To this aim, an equation model considering technique, scale and cu-
mulative effects is developed and econometrically analysed to under-
stand the sign and magnitude of the impact.
The work is structured as follows. Sections two is devoted to the
presentation of the data and the method of the analysis. Section three
reports on the results of the empirical analysis. Finally, in section four
the findings of this work are discussed, and some conclusions drawn.
2. Data and method of the analyses
By taking inspiration from He (2006, 2008), our analysis of the
FDI3-CO2 relationship in the manufacturing sector of the OECD area
relies on a purpose-built database containing 24 variables (mostly de-
rived from our own computations on data gathered from the statistical
databases of various international organisations) observed in relation to
3
FDI is here considered in terms of flow and not stock. The stock refers to the
FDI book value that is the direct investment position on a historical cost.
Cantwell and Ballack (1998) highlight how the employment of the book value is
not functional in international comparisons, since stock age distribution is not
taken into consideration.
P. Pazienza
30 OECD countries4 over a period of 28 years (from 1989 to 2016).5
Considering the country and time units in our database, the empirical
development of our investigation is based on the use of the panel data
econometric technique (Greene, 2012; Wooldridge, 2002). The 24
variables have all been tried in numerous estimation attempts, but only
some of them have been found statistically useful. The functional form
that best fits the relationships subject of our attention is represented by
the following log-log type and with variables in first-differences6:
CO2 sctrit = α + β1 GDPsctrit + β2 GDPsctr 2 it + β3 FDIsctrit + FDIsctr 2 it
+ β4 GCFit + β5 SCTRrelit + β6 MKTopn it + β7 PROTit
+ β8 EDUC + β9 CRprit + εit
where i is the cross-sectional units in the analysis; t is the time units; ε is
the error term. Table 1 reports a more specific description of each single
variable in the model.
For the identification in our model of the induced-GDP and the in-
duced-FDI technique, scale and composition effects, we continue as
follows.7 Starting from the induced-GDP effects, its technique effect
occurs because of income variations and, therefore, it can be observed
via the coefficient estimated for the per-capita GDP isolated variable
(β1). The induced-GDP scale effect represents the growth of a con-
sidered country's economy. It is observed through 2β2 GDP, taken from
the partial derivative of our equation with respect to GDP. The en-
vironmental-economic meaning of these two effects highlights how the
percentage of the considered type of CO2 varies when GDP fluctuates by
1% (e.g. He, 2008; Liang, 2008; Cole and Elliott, 2003; Antweiler et al.,
2001).8 Finally, the induced-GDP composition or total effect comes
from taking into consideration both the technique and scale effects and
is achieved by taking the partial derivative, with regard to GDP, of our
equation. Its measure can be seen via the coefficients of β1 + 2β2
GDPsctr and calculated, as in our specific case, by substituting GDP with
the mean income of our OECD countries in Table 2 (e.g. Managi et al.,
2008; Liang, 2008; Cole and Elliott, 2003; Antweiler et al., 2001). The
environmental-economic meaning of this highlights how the level of
CO2 fluctuates as a percentage when there is a 1% variation of GDP.
As we have done so far, we also observe the coefficients of the
4
The database considers the whole set of the OECD countries except Chile,
Estonia, Israel and Slovenia. Their statistics lacks an adequate time series, since
their accession only occurred in 2010.
5
The end year is set on the availability of the FDI data, which is taken from
the OECD international investment database (accessed through http://stats.
ukdataservice.ac.uk) up to 2012 and the International Trade Centre (http://
www.intracen.org/itc/market-info-tools/foreign-direct-investment) up to
2016, both last checked on 20th October 2018.
6
All the variables are considered in natural log because of the exponential
series and the different units of measures characterising the regressors in our
model. It achieves the variables' coefficients in terms of elasticities (percen-
tages), which represent a more unbiased measure. In addition, as will be
highlighted in footnote 12, the variables are considered in first-differences [i.e.
log(xit) – log(xit-1)] to repair the non-stationarity problem affecting the panel
dataset.
7
It is worth noting that, technique and scale effects appear different from a
theoretical point of view. In reality, they are alike and difficult to distinguish.
Therefore, empirical analysts tend to refer to the specific variable (GDP or FDI
as for our case study) taken in isolation to observe the technique effect and the
same variable contemporarily considered with its square for the “scale” effect.
8
Antweiler et al. (2001) separately measure technique and scale through two
different identities: the per-capita GDP for the earlier and the GDP per squared
km for the scale. Cole and Elliott (2003) only use, instead, the per-capita GDP to
catch both effects. By following these latter, only the sectoral GDP per-worker is
considered in this work. The GDP per squared km., also used in the various
estimation attempts, turns out to be insignificant. Furthermore, the considera-
tion of the various versions of the GDP variable in exponential terms beyond the
square generates insignificant results and reduces or invalidates the significance
of other variables.
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Environmental Impact Assessment Review 77 (2019) 60–68
induced-FDI technique, scale and cumulative effects on our considered
type of CO2 through β3, 2β4 FDIsctr and β3 + 2β4 FDIsctr respectively.9
The composition or total effect is observed in our model through the
consideration of two different variables: the first is represented by the
capitalisation levels of the considered economies and the second refers
to the relevance of their “manufacturing” sector. Specifically, these
respectively refer to the capital-labour ratio and to the sectoral-total
GDP ratio (variables 6 and 7 in Table 1).
A cross-product is also employed in our model to consider an ad-
ditional nonlinear function in our analysis with the aim of empowering
the test for the detection of ignored nonlinearities in our estimation
(Wooldridge, 2002).
3. Results of the analysis
The empirical analysis is developed by using Stata 14 software.
Table 2 summarises the main statistics of the model variables.10
The model specification is tested for heteroskedasticity, auto-
correlation and stationarity. By following Greene (2012), hetero-
skedasticity is tested by employing a LR test. This generates a
chi2 = 1164.62 with a p-value = .0000 which confirm our model is
heteroskedastic. Autocorrelation is verified via the test by Wooldridge
(2002) for panel data. Its result shows a F value = 16.466 and a p-
value = .0004, which highlight the presence of autocorrelation pro-
blems in the considered model specification. A stationarity check is also
performed through a Fisher test up to three lags (Maddala and Wu,
1999). Apart from the FDI variable, it highlights all the others as non-
stationary.11
The table below (Table 3) reports on the analysis result and shows
Ordinary Least Squares (OLS), Fixed Effects (FE) and Random Effects
(RE) estimates corrected for heteroskedasticity and autocorrelation.12
On the consideration of the chi2 = 0.00 and the p-value = 1.0000
obtained from the Brush-Pagan test to choose between OLS versus RE/
FE models, we accept the first which becomes the reference for com-
ments.13
We first observe the high statistical significance (p-value = .000)
and the positive correlation (0.0223) between our considered type of
CO2 and GDP. GDP also shows statistical significance (p-value = .041)
and is positively related (0.0032) to CO2 even when considered in its
squared form. As previously highlighted, these two results are respec-
tively associated to the induced-GDP technique and scale effects on the
pollutant considered as our dependent variable.14 Specifically, while
9
Even for FDI it is observed that the exponential conversion beyond the
squared form produces statistically insignificant outcomes.
10
For the majority of the variables in the dataset, the number of observations
is smaller than what could be normally expected. This is due to the lacunas in
the source databases. For this reason, in agreement with Greene (2012), the
dataset is handled as strongly unbalanced.
11
According to Engle and Granger (1987), a two-step procedure is used for
cointegration analysis. The test is run in the OLS model with all the variables in
level to check for stationarity among them and assess its residuals as a measure
of disequilibrium. The ADF test on the residuals shows a p-value of the residuals
equal to 0.0853, which induces the acceptance of the null hypothesis of no-
cointegration. As anticipated in footnote 6, this is the reason why the variables
in the equation model are considered in first-differences.
12
This is done by following the estimation procedure proposed by Hoechle
(2007). It generates standard errors, which are robust to forms of temporal and
spatial dependency.
13
It is worth highlighting that this estimation shows a very high level of joint
significance of the model variables since it performs a F-test with a p-
value = .0000. The joint significance of GDP and FDI with their respective
squared forms is also tested. The joint significance of GDP and GDP square is
confirmed by the p-value = .0065. FDI and FDI square are also jointly sig-
nificant showing a p-value = .0027. This implies that also the joint considera-
tion of these variables makes our model correctly specified.
14
The estimation result of the induced-GDP technique and scale effects
P. Pazienza Environmental Impact Assessment Review 77 (2019) 60–68

Table 1
Variables specification.a
No. Variable Description Data sourceb

1 CO2sctr (dep. var.) Ratio = quantity of CO2 in mln. tons from sectoral fuel combustion / work force in the sector. UN, IEA
2 GDPsctr One-year lag ratio = sectoral GDP (in real US$) / work force in the sector. UN, OECD
3 GDPsctr2 Square of the ratio above at line no. 2. UN, OECD
4 FDIsctr One-year lag ratio = sectoral inflow of FDI (in real mln. of US$) / work force in the sector. UN, OECD and ITC
5 FDIsctr2 Square of the ratio above at line no 4. UN, OECD and ITC
6 GCF Ratio = Gross Capital Formation (in real US$) / total work force (in thousands). WB, ILO
7 SCTRrel Ratio = sectoral GDP (in real US$) / total GDP (in real US$). UN
8 MKTopn Ratio: (f.o.b. export + f.o.b. import) in real US$ / total GDP (in real US$) considered in absolute terms. IMF, UN
9 PROT Protected area (in Km2). UN
10 EDUC Average year of school. WB
11 CRpr Cross-product = GCF (in real US$) x total inflow of FDI (in real mln. US$). WB, OECD

a
The financial data are in US$ and converted from current into real terms by recurring to the use of USA Gross National expenditure Deflator (base year = 2000)
sourced from World Bank (http://databank.worldbank.org).
b
UN = United Nations; IEA = International Energy Agency; OECD = Organisation for the Economic Co-operation and Development; ITC = International Trade
Centre; WB = World Bank; ILO = International Labour Organisation; IMF = International Monetary Fund.

Table 2 the estimated β1 (0.0223) represents the first type of effect, 2β2 is the
Summary statistics of the variables. elasticity coefficient of the scale effect, which results positive and equal
Variable Obs Mean Std. dev. Min Max
to about 0.0064.
A first comment on the CO2-GDP relationship would make us note
Id 840 – – 1 30 that a rise in environmental degradation is the result of an early stage of
Year 840 – – 1989 2016 income increase. Further improvements in the income level, however,
EDUC 840 2.13624 0.2841542 1.029552 2.544327
would still be detrimental to the environment but with a lower mag-
CO2sct 720 −12.54982 0.5267211 −13.56774 −10.20213
(dependent nitude. The cumulative or total effect of such a relationship comes out
var.) equal to +0.1377 which is obtained through β1 + 2β2 LnGDP (namely
MKTopn 712 −1.746345 3.174612 −14.79736 4.415158 0.0223 + 0.0064 LnGDP) while considering the mean value of the
GCF 707 22.68547 0.6428644 20.43952 23.76584
GDPsctr variable (18.0264 as reported in the table giving the descriptive
SCTRrel 721 1.833355 0.2544623 −0.7751537 2.504032
CRpr 658 31.9994 11.38852 −36.13124 40.98755 of the statistics). As already mentioned, the environmental-economic
GDPsctr2 641 333.3453 125.524 231.4395 874.4762 meaning of the estimated coefficients for the technique, scale and cu-
GDPsctr 640 18.0264 2.880987 15.21384 29.64395 mulative effects refers to the percentage variation of the CO2 emission
FDIsctr2 531 2.635225 4.245652 0.0000862 40.3875 as a result of a 1% variation of GDP.
FDIsctr 530 −0.4833648 1.643241 −5.067981 6.42674
The main investigated relationship between FDI and CO2 emission is
PRTarea 530 −7.110229 1.917673 −9.219765 −1.7551
found significant (p-value = .003) and positive (+0.0058) when FDI is
isolation.15 FDI squared also appears to be significant (p-value = .010)
Table 3 and highlights a positive correlation (0.0008) with CO2. Here again, we
Panel data estimation results. identify the technique effect of FDI on the dependent variable in the
estimated coefficient (+0,0058) of the FDI in isolation. The coefficients
CO2sctr dep. var. OLS FE RE
of the scale and the cumulative effects are, instead, identified in
GDPsctr 0.0223* 0.0242* 0.0223* +0.0016 LnFDI and + 0.0058 + 0.0016 LnFDI respectively with the
(0.0049354) (0.0072641) (0.0061841) cumulative effect computed at +0.0050 by using the sample mean of
GDPsctr2 0.0032** 0.0036** 0.0032** the FDI variable. As done before, the environmental-economic meaning
(0.0012883) (0.0014164) (0.0013941)
of these coefficients represents the percentage variation of the CO2 level
FDIsctr 0.0058* 0.0062* 0.0058**
(0.0018812) (0.0016632) (0.0031742) in response to a change of FDI of 1%.
FDIsctr2 0.0008*** 0.0008*** 0.0008*** The relationship between the capitalisation level (namely, the GCF
(0.00932432) (0.0098567) (0.0092693) variable) of the considered countries' economies and CO2 is also found
GCF 0.1673** 0.2024*** 0.1673
significant (p-value = .021) and positive (0.1673). While highlighting
(0.07553164) (0.0761431) (0.1044384)
SCTRrel −0.1462** −0.1641* −0.1462**
that this variable is used to catch one out of the two facets of the
(0.065599) (0.0532784) (0.0612884) composition effect in our model, it is observed how an increase of the
MKTopn 0.0924*** 0.1175** 0.0924 capitalisation degree produces an increase – although of low magnitude
(0.0582324) (0.0451927) (0.0661523)
PROT 0.0067 0.0198 0.0067
(0.0648771) (0.0561642) (0.0646735)
EDUC 0.2644 0.0755 0.2644 (footnote continued)
(0.2513252) (0.05622549) (0.2545501)
confirm the observation by Cole and Elliott (2003): in reality, the scale effect is
CRpr 0.0002 0.0002 0.0002
(0.0004244) (0.0002537) (0.0001991)
synchronous, and the technique effect the result of an anterior dynamic. As a
Constant −0.0153* −0.0184* −0.0153* result, the diversification of their associated variables by using lagged forms is
(0.0046424) (0.0059426) (0.0057731) suggested. In agreement with this approach, in this analysis the coefficients of
the induced-GDP technique and scale effects are found significant when con-
N. obs. 407 407 407
sidering the variable of the earlier at time t-1 and the variable of the latter at
N. groups 27 27
R-squared 0.2459 Rho 0.3074 Rho = 0 time t. The same is observed for the induced-FDI technique and scale effects as
Adj. R-squared – will be highlighted later.
15
In addition to what has been anticipated in the previous footnote, this FDI
Robust standard errors in parenthesis; P-value: * ≤ 1%, ** ≤ 5%; *** ≤ 10%. variable is considered with a lag of one year for a better response of the model
estimation. The justification for this might lie in the time needed by investment
to get up to speed and produce its actual impact on the considered pollutant.

63
P. Pazienza Environmental Impact Assessment Review 77 (2019) 60–68

– of the level of our considered pollutant.

The coefficient of the relationship between the relevance of the
“manufacturing” sector and the dependent variable is also significant
(p-value = .011), but negative (−0.1462). This result, representing the
second facet of the composition effect in the equation would imply that
a 1% growth of the sectoral relevance produces a decrease of CO2
emissions by 0.14%.
The correlation between market openness and CO2 is also significant
(p-value = .068) and positive (+0.0924), this implying that a 1% in-
crease in the degree of openness would make the level of CO2 grow by
about 0.1%.
The surface of the protected area and the education characterising
our set of countries are found statistically insignificant as well as the
cross-product used in our model.

4. Discussion of the results

To discuss the findings achieved from our analysis, we structure the

following sub-sections for a more organised and clearer presentation of
the insights we have produced.

4.1. The induced-FDI effects

The analysis of the induced-FDI effects on CO2 emissions from the

sectoral fuel combustion shows positive relationships. The coefficients
of the technique, scale and cumulative effects achieved in our estima-
tion are respectively equal to +0.0058, +0.0016 and + 0.0050. If we
only focus on the signs of the coefficients, we would highlight the
detrimental impact of FDI on the considered environmental feature. By
looking at the magnitude of the coefficients, however, we should ap-
preciate how FDI impacts minimally on CO2. Additionally, observing
technique and scale effects together highlights that scale effects impact
at a slower pace than technique effects. This means that, as the scale of
the FDI inflow increases, the CO2-FDI relationship is still marginally
positive but the impact of FDI on CO2 is reduced. Graph 1 illustrates the
tendency of the induced-FDI technique, scale and cumulative effects on
CO2 from sectoral fuel combustion and helps observe more clearly the
dynamic of the CO2-FDI relationship derived from our estimation result.
Once again, we observe that after an initial increase of a certain
magnitude, the FDI-CO2 relationship tends to flatten at a later stage. At
the beginning, CO2 increases in response to the rise of the sectoral in-
flow of FDI. Afterwards, CO2 still increases but at a slower pace with a
significantly reduced magnitude. The cumulative effect reflects, of
course, the same dynamic being the result of the first two.
This evidence makes us go beyond what is generally reported in that
part of the literature considering FDI as detrimental to the environment Graph 1. Induced-FDI technique, scale and cumulative effects on CO2.
and of which some works have already been recalled in the introduc-
tion. However, if this is true (and our analysis confirms this at the initial
decrease in air pollution.
stage of the FDI flow increase although with coefficients of very low
magnitude), it is also true that FDI helps to reduce the environmental
degradation as the scale of its inflow grows. In this other sense, our 4.2. The induced-GDP technique, scale and cumulative effects
result also confirms what is reported in those other works – some of
which are also recalled in the introductory section – where the en- The CO2-GDP relationship shows a technique effect equal to
vironmentally positive role of FDI is highlighted. This is explained +0.0223, a scale effect equal to +0.0064 and cumulative effect equal
through the arguments that technology advances implicitly live in the to +0.1377. In broad terms, the positive signs of the investigated re-
investment activity and that FDI is, di per sé, a driver of technology lationships would make us highlight that an increase of GDP is detri-
innovation. This relevance of technology in FDI is confirmed in other mental for the environment. More specifically, we observe that in a first
analyses. In a recent work, Melane-Lavado et al. (2018) look at a sample phase (that corresponding to the consideration of the technique effect)
of 4667 Spanish Small and Medium Enterprises (SMEs) and statistically the impact of the GDP growth on the environment is detrimental. This
prove how FDI generates positive spillovers especially by enhancing would make it impossible for us to accept the validity of those analyses
innovation and competition. They also observe how FDI makes the which look at the technique effect as a driver of environmental quality
investigated set of SMEs more oriented to develop innovation based on improvement because of the consideration of the technological in-
sustainability principles. A similar conclusion is also reached by Xin- novation and diffusion generally associated to increases in wealth.
gang et al. (2019), who observe that FDI inflowing in 30 Chinese pro- However, when GDP further increases (that is when the scale effect is
vinces over the period from 2005 to 2014 has brought more updated considered), the impact on CO2 remains detrimental but its magnitude
technologies, thus generating a higher level of energy intensity and a is considerably lower. The cumulative effects bring to a synthesis the

64
P. Pazienza
Graph 2. Induced-GDP technique, scale and cumulative effects on CO2.
dynamic of the technique and scale effects and shows how CO2 initially
increases in response to an increase of GDP. At a further stage, when
GDP further increases, CO2 still rises but at a slower pace because of the
low magnitude of the coefficient of the scale effect. The graph below
(Graph 2) helps to picture what we have just said.
Although we are aware of various studies confirming the
Environmental Kuznets's Curve (EKC) hypothesis,16 our result does not
16
In this sense, for instance, Shafik and Bandyopadhyay (1992) and Mazzanti
et al. (2007) prove its validity while working on different sets of pollutants
(with CO2 among these). In another work focusing on France, the GDP-CO2
relationship in the EKC sense is found statistically significant while using the
autoregressive distributed lag (ARDL) approach to cointegration (Iwata et al.,
2010). Some other studies find evidence to support that both the existence and
inexistence of the EKC hypothesis depend on the geographical scale (whether
local or global) at which a considered pollutant is taken into consideration (e.g.
Lieb, 2003). Another recent work highlights the existence of an unconventional
N-shaped EKC while analysing 17 OECD from 1990 to 2012 (Alvarez-Herranz
et al., 2017).
65
Environmental Impact Assessment Review 77 (2019) 60–68
allow us to argue in its favour. Our finding supports those analyses
which find it hard or even impossible to confirm its validity. By using a
variety of econometric techniques, for example, various authors have
analysed the relationship between different pollutants and GDP without
reaching any useful evidence to validate the EKC hypothesis (i.e. Stern,
2004; Perman and Stern, 2003; Yandle et al., 2002). With specific re-
gard to the OECD countries, a work using a semi-parametric estimation
method on data from 1960 to 2003 did not find any useful evidence to
justify the GDP-CO2 relationship in the sense of the EKC. Its authors
develop a model to account for technique, scale and composition effects
and find that the technique effect is insufficient in reducing CO2
emissions, except for high-income countries (Tsurumi and Managi,
2010). Another analysis focused on Canada employed both semi-para-
metric and flexible non-linear parametric modelling estimation tech-
niques without reaching any useful statistical support validating the
EKC hypothesis in the CO2-GDP relationship (He and Richard, 2010).
Aslandis and Iranzo (2009) also arrive at a similar conclusion in their
investigation of a panel data containing CO2 emission data of non-
OECD countries between 1971 and 1997. They employ a smooth
transition regression technique and do not find any evidence of EKC.
Similarly, a further work on Japan and China investigates, among other
things, the GDP-CO2 relationship over a period of 30 years and finds no
evidence of EKC (Yaguchi et al., 2007). The validity of the EKC is also
rejected in a more recent study where MIKTA countries are analysed
over the period from 1982 to 2011 (Bakirtas and Cetin, 2017).
Apart from the development of a discussion strictly related to the
validation or not of the EKC hypothesis – which incidentally arises in
this work but is now its main aim – our finding shows that a GDP in-
crease is beneficial for the environment, since its continuous increase
impacts on the level of CO2 with a decreasing magnitude. This induces
us to argue in the same terms as before for FDI and recognise the
economic growth – namely, the increase of GDP – as a carrier of
technological innovation and technology diffusion through which a
more effective and efficient use of natural resources is pursued.
4.3. The composition effect
In this work the consideration of the composition effect is twofold.
On the one hand, we consider it in terms of economic systems com-
position and is proxied by the capital-labour ratio, namely the ratio
composed of the Gross Capital Formation (GCF) and the number of
workforces in the economy. On the other hand, we consider it as the
relevance of the manufacturing sector in the whole economy re-
presented by the sectoral GDP and the total GDP ratio.
The correlation resulting from the first way of intending the com-
position effect, that is the CO2-GCF relationship, is equal to +0.1673.
This outcome would imply that the more the capitalisation level of the
considered economies increases, the more the detrimental impact on
CO2. This agrees with those works which have observed that the in-
crease and accumulation of fixed assets (plants and machinery, ve-
hicles, buildings, etc.) turns out in higher production levels, more
consumption and more pollution. Various authors have observed a
positive correlation between capital and emission intensities while
modelling with different pollutants (e.g. Mazzanti et al., 2007; He,
2006; Cole and Elliott, 2005). Antweiler et al. (2001) postulate a Factor
Endowment Hypothesis (FEH) and investigate the environmental im-
pact deriving from trade liberalisation. By working at a city-level panel
data on ambient SO2 concentration, they find that a 1% growth in the
capital-labour ratio of a country generates a 1% increase of SO2. In their
view, the FEH predicts that liberalisation of trade leads to a rise of
polluting emissions in those countries characterised by capital abun-
dance and vice-versa. Later, Cole and Elliott (2003) replicate the ana-
lysis and take into consideration CO2, NOX and Biological Oxygen De-
mand (BOD). They also find positive correlations confirming that the
higher the capital-labour ratio is, the higher the pollution intensity.
Put in this way, the generally referred view for which capital
P. Pazienza
accumulation brings technological advances which, in turn, generate
beneficial effects on the environment loses its full validity. While it is
hard or impossible to deny the positive role technological progress
plays on the environment and pollution abatement, our result can find
its explanation in the consideration of the speed at which technological
advances are absorbed in capital accumulation. If capital accumulation
proceeds at a faster pace than its actual capability of absorbing tech-
nological advances, then its contribution to pollution abatement is
slackened.
In relation to the second way we have intended the composition
effect in this work (namely, the relevance of “manufacturing” in the
economies of the considered countries), our result displays a negative
relationship (−0.1450) with the considered type of CO2. It highlights
the beneficial role the manufacturing sector plays in reducing the
emission of CO2. This result can be explained by the fact that, in a free
trade and investment situation, countries are pushed towards a re-
location process of their production factor endowments. From this, they
develop comparative advantages among themselves and are induced
towards an efficient specialisation of their economies. Consequently,
they are expected to be less polluting as they employ reduced inputs per
unit of output (OECD, 2001). In this sense, we should understand that
the greater the specialisation in the “manufacturing” sector of the
analysed countries the cleaner (in terms of CO2 reduction) are their
economies as a result of some comparative advantages in the same
sector.
A recent study of the Indian manufacturing sector confirms our re-
sult. By using firm-level from 2009 to 2013, it finds a decline of 11% in
CO2 emission intensity with a major contribution to this positive result
coming from large and capital-intensive firms (Goldar et al., 2017).
Besides this evidence, however, it is useful to recall Cole and Elliott
(2003), who highlight that the environmental impact of the composi-
tion effect derives from the comparative advantages of countries. It can
be beneficial or detrimental as a result of the economic specialisation
each single country pursues. If the expanding sectors of economic ac-
tivity are less polluting than those shrinking, then beneficial effects on
the environment can be observed and vice versa.
4.4. Other evidence
The other variables in our model referring to the surface of the
protected area, the education level and the cross-product are not found
statistically significant and, therefore, no comment is delivered.
The only result worthy of comment in this section is represented by
the market openness variable, which is found significant and positively
correlated (+0.0924) to CO2. This positive sign would suggest that
those countries having a higher trade openness are also those with a
greater impact on our considered dependent variable. A similar con-
clusion is made by authors such as Feridun et al. (2006) and Hill and
Magnani (2002), who have found positive correlations between pollu-
tion and market openness while analysing developed and developing
countries. However, we can additionally observe that the result we have
achieved is characterised by such a very low magnitude that the other
view expressed in the literature is not gainsaid at all. In other works,
belonging to the mainstream thinking, a virtuous circle in the re-
lationship between market openness and environmental pollution is
observed (e.g. Zhang et al., 2017; Ghosh, 2007; OECD, 2002). As al-
ready mentioned, this is explained by referring to the fact that free
trade and investment pushes economies towards specialisation paths,
which result in a major efficiency in the allocation of resources and a
minor environmental impact (Akin, 2014; OECD, 2002; Lucas et al.,
1992). The plotting of our estimation result helps to clarify what we are
saying. In the graph below (Graph 3), it can be appreciated how the
environmental impact of market openness is severe at an initial stage;
afterwards it significantly reduces its magnitude and the trend of the
impact flattens.
Considering the strong correlation between trade and investment
66
Environmental Impact Assessment Review 77 (2019) 60–68
Graph 3. Impact of market openness on CO2.
(e.g. Ghosh, 2007; OECD, 2002), it is worth stressing how the evidence
achieved for the market openness variable would confirm the positive
relationship between the FDI inflow and CO2. Although, in very general
terms, this can be a valid association, the opportunity of keeping the
reading of these two outcomes separated must be highlighted. In fact,
the first outcome (the relationship between the FDI inflow and CO2) is
associated to a sectoral dynamic. The second (the relationship between
the level of market openness and CO2) considers the broader picture
given by the total figures of import and export and does not specifically
represent any sectoral dynamics.
5. Policy considerations
From what has been highlighted in the discussion developed in the
sub-sections above, we can derive the following policy considerations.
Firstly, in relation to what has been said for the induced-FDI effects, we
should focus on the capacity of FDI to transfer more modernised and
environmentally-friendly technology and stress how this can help to
exert a beneficial impact of FDI on the environment. As for a policy
implication, then, we should reject those arguments expressing a po-
sition against the enforcement of FDI in the considered sector.
Secondly, the discussion on the induced-GDP effects, which highlights
that also economic growth – as FDI – can be considered as a transfer of
technology innovation, should suggest the adoption of the same pre-
scription derived from the EKC analysis, that is the increase of a country
or population wealth per sé can be seen as a driver for pollution
abatement. Thirdly, moving onto considering what has been discussed
in relation to the composition effect, a policy indication should be
formulated with a specific focus on the two different ways we have
looked at it in our analysis.
On the one hand, from the discussion developed for the composition
effect intended as a capital-labour ratio, we should understand and
recognise that capital accumulation can happen in ways which can be
either advantageous or damaging for the environment. As we have al-
ready said, this might depend on the speed technology innovation is
absorbed in capital accumulation processes. In the case this goes slowly,
we cannot avoid considering the occurrence of negative externalities,
which induces us to call for the adoption of environmental taxation
mechanisms, despite the difficulty of monetising the environment
broadly referred to in environmental economic studies. In other terms,
attention should be paid to the importance of adopting schemes for the
correct pricing of environmental assets and externalities (e.g. the se-
lective business tax incentive) when implementing investment activities
aimed at increasing the capitalisation level (namely, the accumulation
of fixed assets) of countries. More specifically, the adoption of appro-
priate taxation mechanisms can ensure a more effective use of resources
and orienting trade and investment towards more sustainable paths
while avoiding their move in the direction of environmentally-dama-
ging sectors. On the other hand, the discussion on the composition
P. Pazienza
effect intended as the relevance of the manufacturing sector in the
whole economy would induce us to recognise that the manufacturing
sector holds comparative advantages which make its production cleaner
(in terms of reduction of CO2 from fuel combustion). This consideration
should push us towards encouraging the enforcement of investment in
the sector once again.
Lastly, the discussion developed on the other evidence achieved in
this study and related to the impact of market openness on CO2 broadly
reflects what we have already said about the FDI-CO2 relationship. Even
in this case, the formulation of a policy indication should start from the
consideration that free trade (and investment as a correlated phenom-
enon) pushes economies towards specialisation, resulting in a better
efficiency of resources allocation and minor levels of environmental
impact. Once again, we find a policy argument which is pro free trade
and investment.
6. Concluding remarks
By referring to a self-composed dataset with information on 30
OECD countries from 1989 to 2016, in this work we have developed an
analysis to primarily understand how and with what magnitude FDI
impacts on the environment. To this aim, a novel approach of analysis,
based on the consideration of a specific sector of activity, has been used
in the attempt to overtake the hazardous limitation represented – as can
be widely seen in the literature produced insofar – by recurring to the
use of aggregate data of FDI rather than disaggregate at the specific
level of single activity sectors with the risk of producing misleading
results. Our analysis of the technique, scale and cumulative effects of
the FDI inflow in the manufacturing sector of OECD countries on the
level of CO2 emission from the sectoral fuel combustion highlights
positive relationships (+0.0058, +0.0016 and +0.0050 respectively).
Apart from the observation of the positive signs of the relationships,
which would lead us to speak in terms of the detrimental role of FDI on
the environment, the very low magnitude of the coefficients together
with the observation that the impact of FDI even decreases as the scale
of its inflow increases, induce us to highlight the beneficial role FDI
plays on the environment.
The generation of positive environmental spillover from FDI is ex-
plained through its capability of being a driving force of technology
innovation and, consequently, a tool through which the implementa-
tion of more environmentally-friendly and cleaner production modes
occurs. This result induces us to reconsider those arguments which, by
appealing to the negative effects of FDI on the environment, express an
ideological position against the enforcement of international invest-
ment policies and, particularly, of those related to our considered
sector.
From an economic policy perspective, the main aspects character-
ising our finding induce us to stress the following. Firstly, the promo-
tion of a free investment context would represent a necessary – al-
though insufficient – condition to ensure that FDI exerts a positive
impact on the environment, basically due to the technology innovation
implicitly living in investment activities from which a more efficient
allocation of resources and a minor negative environmental impact is
derived. Secondly, whenever this is not the case because, as we have
said in the discussion section, the investment activity contributes to a
capital accumulation process, which is not accompanied by an appro-
priate absorption of technology innovation, then the need to adopt a
Pigouvian taxation mechanism becomes the policy approach to be fol-
lowed for the internalisation of negative externalities. We shape this
conclusion while being aware of some limitations of this study. For
example, although the dataset of the OECD countries we have analysed
contains three developing countries (i.e. Korea Republic, Mexico and
Turkey), no reflections have been developed to understand the speci-
ficities of their FDI-CO2 nexus. This, however, could be the subject of
further research.
67
Environmental Impact Assessment Review 77 (2019) 60–68
Funding
This research did not receive any specific grant from funding
agencies in the public, commercial, or not-for-profit sectors.
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