Environmental Regulation and FDI



  • GS Paper- 2

Why in news?

  • It has been analyzed whether foreign direct investment (FDI) is linked to easing environmental regulations in India.
  • The findings were published in a study titled ‘‘Does environmental governance matter for foreign direct investment? Testing the pollution haven hypothesis for Indian States’’ in the Asian Development Review.

What did the study say?

  • Environmental regulation has little impact on FDI.
  • FDI is instead dependent on other variables such as infrastructure and labor.
  • In terms of policy, it would help India if it is focused more on these factors  (infrastructure and labor) rather than on ease of environmental regulation.
  • The study dealt with pollution related expenditures of the manufacturing sector between 2002 and 2010. Higher costs in dealing with pollution from an industry show stricter environmental norms being in place.
  • Of the 28 States reviewed, 16 saw pollution abatement costs reduce (including Maharashtra, Gujarat, Tamil Nadu and Karnataka); while only in 11 States did the costs increase (undivided Andhra Pradesh, Odisha, Haryana, Madhya Pradesh and Kerala).
  • The study also dealt with industrial composition.
  • A State with a high number of chemical industries will have higher environmental costs despite the level of environmental regulations.
  • Thus, to adjust for this, Kathuria created a industrial-composition-adjusted abatement index using unit level data from the Annual Survey of Industries.
  • The index shows that Chandigarh, Odisha and Karnataka have the highest environmental stringency, while Bihar, Delhi and the northeastern States have the lowest.

Study also compared FDI inflow to :

  • control variables of per ca-pita income of 21 States,
  • manufacturing share of the State GDP,
  • installed electricity generation capacity,
  • transmission and distribution losses in the power sector (a reflection of industrial regulations),
  • literacy,
  • proximity to coast, and
  • the readiness of a State to accept investments.


  • The study concluded that the location of foreign firms decision is primarily based on infrastructure and market access-related factors rather than environment regulation.