North–South Investment Flows and Optimal Environmental Policies

• Published in: Journal of environmental economics and management 2000-11, Vol.40 (3), p.275-296
• Main Authors: Beladi, Hamid, Chau, Nancy H., Ali Khan, M.
• Format: Article
• Language: English
• Subjects: Capital flow; Developing countries; Economic incentives; Economic models; Energy policy; Environmental economics; Environmental management; Environmental policy; Foreign direct investment; Foreign investment; International trade; Monopolies; Pollution control; Studies; Trade relations
• ISSN: 0095-0696; 1096-0449
• DOI: 10.1006/jeem.2000.1123

In the context of a simple North–South model that focuses on the international movement of capital, we show how neglect of pollution-generating effects of foreign investment may lead to distorted and misleading policy recommendations. Such a neglect has recently received emphasis in the empirical literature on East Asian economies, as in Bello and Rosenfeld (1990, “Dragons in Distress: Asia's Miracle Economics in Crisis,” Food First, San Francisco), and was shown to overlook resulting tendencies in these economies toward specialization, away from agriculture and toward manufacturing. Our simple model formalizes this observation and allows us to show that even for an unspecialized capital-poor, resource-rich South, such pollution-generating effects provide incentives for the North to encourage, rather than to discourage, foreign investment abroad and strengthen Southern incentives to restrict foreign investment more sharply than is conventionally assumed. In a nutshell, it brings out the implications of Northern capital “creating its own demand” as a consequence of its adverse impact on the Southern resource base. Despite its simplicity, the model thus sheds light on three interrelated aspects of international trading relations: production asymmetry, incomplete markets, and monopolistic advantage.