Does environmental regulation drive away inbound foreign direct investment? Evidence from a quasi-natural experiment in China

This paper investigates whether environmental regulation affects inbound foreign direct investment. The identification uses the Two Control Zones (TCZ) policy implemented by the Chinese government in 1998, in which tougher environmental regulations were imposed in TCZ cities but not others. Our difference-in-difference-in-differences estimation explores three-dimension variations; specifically, city (i.e., TCZ versus non-TCZ cities), industry (i.e., more polluting industries relative to less polluting ones), and year (i.e., before and after the TCZ policy). We find that tougher environmental regulation leads to less foreign direct investment. Meanwhile, we find that foreign multinationals from countries with better environmental protections than China are insensitive to the toughening environmental regulation, while those from countries with worse environmental protections than China show strong negative responses.