Heterogeneous impacts of environmental regulation on foreign direct investment: do environmental regulation affect FDI decisions?

The industry selection effect occurring from the impact of environmental regulation on foreign direct investment (FDI) in China is heterogeneous. Based on the extended game theory model, and by using panel data of 35 Chinese industries from 2005 to 2014, this study constructs a system of simultaneous equations to explore the dynamic effect of environmental regulation on FDI in terms of industry selection decisions. Specifically, three-stage least square analysis method (3SLS) of simultaneous equations is utilized to check robustness of the results under different standards. Results reveal that environmental regulation promotes the technological innovation within the Chinese industry and attract larger foreign capital investment. While the influx of capital further boosts the technological progress, a benign interaction effect was observed between the technological innovation and foreign investment. Findings of our study show that the policy of market borrowing technology is more effective, and the implementation of the new environmental policy will intensify the strategies between managers and enterprises. Results of our study show a positive interaction between R&D funding and foreign capital flows. Enhanced coordination activity within industrial organizations will generate more effective organizational and technological innovation, and attract a large flow of FDI. In addition, industry sample results highlight that a compensation effect of technological innovation in the raw materials and manufacturing industry, though environmental regulation of high-tech industries will generate a balance effect with respect to technological innovation. The government should emphasize on the enhancement of execution and effectiveness of environmental regulation, enhancing FDI and enlightening the synergistic possessions of environmental regulation and FDI.