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How Does Foreign Direct Investment Affect 

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The scope of this study is to investigate the FDI impact on the environmental quality of Central and Eastern European (CEE) transition economies during the period 1995-2014, using a panel data approach. Economic growth and energy consumption are used as additional environmental determinants and relevant hypotheses (pollution haven-pollution halo) are being tested. In addition, it is investigated a possible non-linear effect of FDI on environmental quality as suggested by the Environmental Kuznets Curve (EKC).

The context of this empirical analysis besides first generation panel techniques includes the second generation CADF and CIPS unit root tests and the Westerlund-Edgerton cointegration test. The PMG estimator of dynamic heterogeneous panels is furtherly used to identify the long-run relationship between the involved variables. The results show that FDI leads to environmental degradation in CEE countries supporting the pollution haven hypothesis, but the relationship between FDI and environment is not monotonic, following the formation of an inverted U-shaped curve. The increase in energy consumption leads to environmental degradation, while the economic growth of CEE countries has a positive effect on the environmental quality which is attributed to sustainable development in the long run. The empirical findings provide valuable policy implications concerning the implementation of environmental policies related to FDI inflows and sustainable development in the CEE region.

Introduction

One of the main characteristics of open economies is the growing interaction and interdependence through the establishment and development of economic relations among them (Archibald et al, 2004; Bengoa, Sanchez-Robles, 2003; Popescu, 2014). A critical factor in this direction is the flows of Foreign Direct Investment (FDI), which contribute to the economic development of host countries. Multinational Corporations (MNCs) are the primary vehicles of the FDI flows, which constitute direct capital inflows into the host country and generate positive externalities (Lee, 2013). As a consequence they lead to economic growth through technology transfer and diffusion, increased productivity, the introduction of innovative methods of production and managerial practices, thus creating a competitive economic environment. However, FDI also causes problems and disadvantages for the countries where it flows.

One of the most important problems is the increase in energy consumption and the environmental degradation in host countries, due to the absence of effective rules and environmental legislation to protect it. In recent years, environmental pollution has been observed at an accelerated pace, mainly consisting of the greenhouse effect, deforestation and biodiversity loss. One of the controversial issues is whether FDI affects the quality of the host countries natural environment or not. To limit climate change, the United Nations Framework Convention on Climate Change (UNFCC, 1992) was the first international agreement of the United Nations (UN) member states, which took place at the Rio Summit. In 1997 was adopted the Kyoto Protocol, which is the most known international treaty on environmental protection for greenhouse gas (GHG) emissions and climate change. According to this protocol, during the first period 2008-2012, 150 countries committed to reduce GHG emissions including CO2, by 5. 2% compared to 1990 levels ( in EU region by 8%). In the second period 2013-2020, where all the EU-28 members participate, there is a commitment by the parties to reduce GHG emissions by at least 18% (20% for the EU) below 1990 levels.

The Paris Climate Change Agreement is a recent agreement which was reached in 2015 and includes an action plan to overcome the global warming problem and keep its temperature rise well below 2°C. This agreement ratified by all EU Member States and its main difference with the Kyoto Protocol is that the participating States have also drawn up national action plans to achieve the stated commitments. Also as described in the new agreement, the requirements for the developing and developed countries are similar, in contrast with the Kyoto Protocol where they were differentiated. Among the main atmospheric pollutants, sulfur dioxide (SO2) and carbon dioxide (CO2) are considered as the primary indicators of air pollution, but CO2 is the most important anthropogenic GHG (IPPC, 2007).

The average temperature of the atmosphere on the surface of the earth has grown, because of increased CO2 concentration which is owed to human economic activity that cannot be absorbed by nature. Its annual emissions increased by 80% between 1970 and 2004, that is from 21 to 38 gigatonnes (Gt) and accounted for 77% of the total human-induced GHG emissions in 2004. Many researchers have studied the relationship between economic growth and environmental quality. First, Kuznets (1955) referred to an inverted U-shaped curve, which indicated the relationship between income inequality and economic growth. Grossman and Krueger (1991) found that an inverted U-shaped curve depicts the long-term relationship between economic growth and environmental quality. Panayiotou (1993) referred to a systematic inverted U-shaped relationship between environmental degradation and economic growth, which he called the “Environmental Kuznets Curve” (EKC).

According to the EKC, in the early stages of economic growth, the environmental degradation curve moves upward as the scale effect increases. But when the per capita income exceeds a limit, the curve reaches a maximum point after which it turns downward. Economic growth is accompanied by structural changes that lead to technological innovations, reducing energy consumption and improving the environmental quality.

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