Should China prefer more foreign direct investment inflows to environmental change?

• Published date: 01 May 2022
• Author: Ishfaq Hamid,Pabitra Kumar Jena,Dinabandhu Mukhopdhyay
• Date: 01 May 2022
• DOI: http://doi.org/10.1002/pa.2466

ACADEMIC PAPER

Should China prefer more foreign direct investment inflows to

environmental change?

Ishfaq Hamid

1

| Pabitra Kumar Jena

1

| Dinabandhu Mukhopdhyay

2

1

School of Economics, Faculty of

Management, Shri Mata Vaishno Devi

University, Katra, India

2

School of Business, Faculty of Management,

Shri Mata Vaishno Devi University, Katra, India

Correspondence

Ishfaq Hamid, ICSSR Doctoral Fellow, School

of Economics, Shri Mata Vaishno Devi

University, Katra, Jammu & Kashmir, 182 320,

India.

Email: bhatishfaq260@gmail.com

This study aims to investigate the impact of foreign direct investment (FDI) on environ-

mental quality in China over the period 1984–2014. Specifically, the research focuses on

the possibility of the effects of FDI on the quality of the environment in China. We

employ the bound test approach and found a significant cointegration among environ-

mental quality and other variables, the autoregressive distributed lag model (ARDL)

model used after finding a cointegration connection between environmental quality and

other independent variables to explore the short and long-run relationships among the

variables. The coefficient of the long-run (ARDL) model indicates that the impact of FDI

on the quality of the environment is positive, and it implies that better FDI inflows in

China, resulting in higher energy consumption and thus leading in the direction of higher

release of CO

2

emission. Moreover, in the short run the coefficient obtained by the error

correction mechanism shows that FDI does not improve the environmental quality, and

it leads to more environmental degradation in China. The causality approach specifies

that FDI and environmental quality have a unidirectional relationship. Therefore, the find-

ing suggests that China should foray balance between FDI inflows and environmental

quality, and encourage more FDI inflows, particularly in technology-intensive and

environment-friendly industries, to improve environmental quality.

JEL CLASSIFICATION

C32; F18; Q56

1|INTRODUCTION

China has achieved remarkable progress in FDI inflows due to economic

reform and open-door policy. The amount of FDI inflows into China

raised explosively, and now China became the world's second largest

recipient of FDI after the United States. Today FDI inflows are consider-

ing another factor of environmental quality due to their prospective effect

on pollution Lovely, M. E., & Huang, Z. 2018; Al-Mulali, U., & Tang, C. F.

2013). The opening of the economy to the outside world leads to the

installation of better business environment, better infrastructure and dis-

tribution of investment, and reduced poverty. It has mainly depended on

the accumulative participation of environmental resources. The quality of

the environment is a grave concern in China. FDI continuously shows an

upward trend in China from 133 billion in 2016 to 136 billion in 2017

(UNCTAD Report, 2018). However, on the one hand, it facilitates tech-

nology, skill, and financial resources; on the other hand, FDI may have a

worrying impact on the environment, which causes severe threats to

China's food, water, air, and biodiversity (Co, C. Y., Kong, F., & Lin, S.

2008). The effect of the ecosystem has increased during the past years,

which calls for attention to the policymakers of China. A few studies dur-

ing the last 5 years considered income as an important variable while

finding out the impact of environmental quality on FDI inflows. This clus-

ter of studies, by and large checks the authenticity of the “Environment

Kuznets curve”supposition. The supposition of EKC showed U-formed

EKC relationship among contamination of environment and income per

capita, which indicate that the increase in per capita income upsurges pol-

lution of environment up to a spiraling point and afterward begins to

diminish it afar that point. Though, this U-formed EKC, the association

among contamination of environment and earnings does not clench for

each circumstance.

The association between the deprivation of environment and FDI

inflows is undefined. In this way, two contrary thoughts concerning

Received: 17 March 2020 Revised: 15 June 2020 Accepted: 25 June 2020

DOI: 10.1002/pa.2466

J Public Affairs. 2022;22:e2466. wileyonlinelibrary.com/journal/pa © 2020 John Wiley & Sons Ltd 1of18

https://doi.org/10.1002/pa.2466

the connection between environment and FDI, the leading one is, pol-

lution haven hypothesis (PHH), which emphasizes that various regula-

tions of the environment between nations affect the area choice of

the firm or industries. In such a manner, Pollution-intensive industries

moved from developed to developing economies where the ecological

gauges are less harsh. On the second side, pollution hole hypothesis

throws attention to the environmental enactment of foreign firms

comparative to home equivalents, rather than business locality. This

contention advocates that FDI inflows of MNC's expected to enhance

environmental quality in developing countries due to operating the

best cleaner technology and better environmental management sys-

tem (Zarsky, 1999).

China, the largest influx of FDI inflows in developing countries,

where still the environmental standards procedures are very weak or

even infrequent in some sides, equatedwithotherdevelopednations.

Indeed, the environmental concerns of FDI can happen in several possible

ways. The first way is a technical upshot, which is more beneficial for a

better environment and also improves the quality of the environment by

permitting local firms to take benefit of spillover led by FDI and have

entry to the better cleaner that is less polluted. Secondly, it is the scale

impact, which is associated with the conditions where the development

of financial exercises driven by expanding FDI prompts progressively

environmental contamination. The third is the effect of income; that is

when income increases induced by FDI, the nation may want higher envi-

ronment benchmarks, increasingly stringent guidelines and better authori-

zation by the government, which are all advantageous to the

environment. Last is rivalry impact, by which we imply that nations or

regions inside a nation may contend deliberately to pull in and retain FDI

by racing down to the base of their environment standard (King, J. 2011;

Smarzynska,B.K.,&Wei,S.J,2001). Environmental deprivation impends

to weaken the country's growth and depletes public patience with the

pace of reform (Albert, E., & Xu, B, 2016).

China is the fastest-growing economy in Asia, and a comparatively

open economy signifies an idyllic case to explore the nexus between

FDI inflows and CO

2

emission for numerous causes. Firstly, China's

high growth based on resource-intensive manufacturing exports and

low paid labor has mostly reached its limits and has led to economic,

social, and environmental imbalances (World Bank Report, 2019). Sec-

ondly, rapid upsurge in FDI inflows in China over the previous years.

China is ranked the world'slargest FDI recipient after the UnitedStates

conferring tothe (2019) World Investment Report. The various reforms

were taken by China, such as liberalized plans, the rapid development

of the high technology prone sector, and the establishment of the free

trade zones. Accordingly, with steady growth for several years, FDI

inflows continued to increase between 2017 and 2018, from USD$

136 billion to139 billion (3.7%-all-time high).Thirdly, all three variables,

such as the income level, CO

2

emissions, and FDI inflows, have shown

a rising trend in China from the last few years. In this way, GDP per

capita has been enhancednearly from $113 in 1970 to $9,770 in 2018.

From the year 1970 to 2018, the economy of China raised an average

of 6% per year in the footingof GDP (World Bank).

Among South Asian countries, China has achieved remarkable pro-

gress in the growth rate of approximately 8% in 2019 and also the second

largest economy on the planet. The fourth point is that the expansion of

income in China is very fast, due to that its energy market is very fastly

growing around the world based on the (World Bank Report, 2019). One

of the critical opinions is that the level of CO

2

emission in China both as

far as total emission and emission per unit of GDP is exceptionally high

(International Energy Agency). Therefore, as the Chinese economy keeps

on rising at the fastest rate, it is expected that the expansion in energy

use will significantly affect the worldwide economy. China's environmen-

tal quality is one of the most persistent concerns to policymakers that

occur due to rapid industrialization. By 2020, CO

2

emissions in China are

predicted at about 18% of the total world emission. Therefore, it is an

urgent need of the hour to pay special attention to environmental quali-

ties and its impacts on China.

This article aims to provide the tools necessary to reach the

objectives introduced by the government, taking into account

the China FDI inflows and environmental quality. This article explores

the connection between FDI inflows and environmental quality.

Through this exploration, we intend to introduce FDI inflows that

have a significant influence on environment quality. This will provide

decision-makers in China with an understanding of which aspect need

extensive attention to reach the proposed level of better environment

quality. Thus using a descriptive and quantative analysis, this article

tries to address the following research questions: is there a relation-

ship between FDI inflows and environmental quality in China?

Whether FDI inflows affects the environmental quality in China.

There is a cogent need for research on the interconnection

between FDI inflows and environmental quality in China. According

to the review of the literature, few studies investing the effect of FDI

inflows on an environmental eminence. Also, the prevailing literature

delivers divisive results (Bao, Q., Chen, Y., & Song, L. 2011; Huang, J.,

Cai, X., Huang, S., Tian, S., & Lei, H. 2019; Yin, W., Kirkulak-Uludag, B.,

& Zhang, S. 2019). The primary purpose of the study is to scrutinize

the outcome of FDI Inflows composed of financial development,

energy consumption, carbon emission, trade openness, and gross

domestic product per capita. Therefore, this study extends existing lit-

erature in the following ways; first, the study integrates the new vari-

ables in the environmental quality model, which can permit us to

diminish omitted variables bigotry probably prevailing in the environ-

mental quality model description. Second, the study uses a bound test

which shows the cointegration relationship among the variables, after

that this study conducted an Autoregressive distributed lag model to

find the short and long-run relationships among the variables. This

study is also based on the Granger causality test, which shows the

causal relationship among the variables and even Impulses response

functions, which trace the response of one endogenous variable to

one standard shock in another variable. Finally, the variance decom-

position method is employed, which shows the explanatory contribu-

tions of the shock to the innovation of the variables. These results

help policymakers while designing environmental policies.

Therefore, regardless of whether and to what range, the access of

FDI is accompanied by a sequence of negative environmental issues is

a significant investigation yet to be responded. The rest of the study

discusses the previous studies carried out in the said area: Section 3

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