Empirical Tests of the Pollution Haven Hypothesis When Environmental Regulation is Endogenous

The pollution haven hypothesis (PHH) posits that production within polluting industries will shift to locations with lax environmental regulation. While straightforward, the existing empirical literature is inconclusive owing to two shortcomings. First, unobserved heterogeneity and measurement error are typically ignored due to the lack of a credible, traditional instrumental variable for regulation. Second, geographic spillovers have not been adequately incorporated into tests of the PHH. We overcome these issues utilizing two novel identification strategies within a model incorporating spillovers. Using US state-level data, own environmental regulation negatively impacts inbound foreign direct investment. Moreover, endogeneity is both statistically and economically relevant. Copyright (c) 2015 John Wiley & Sons, Ltd.