The pollution haven hypothesis

The pollution haven hypothesis assumes that strict environmental regulations lead firms to offshore their polluting activities in poorer countries with laxer environmental standards. 

A Harvard Business Review study exposed that even though implementing tight domestic environmental regulations is effective with a 15% decrease in national emission levels it has unexpected negative repercussions. Indeed, firms contributing to most of the national CO2 emissions have deallocated to countries that have looser environmental standards, which results in a 43% increase in emissions abroad.

Offshoring the most polluting activity to countries such as China or central-eastern countries is a decision coming from the firm itself. This depends on various factors:  
  • The governance structure of the firm:The governance of a firm is in the hands of shareholders that have power over managers. The weaker the governance of the firm, the more inclined managers will be to pursue short-term goals and therefore save the costs associated with a clean production.
  • The industry the firm operates in: For instance, following environmental regulations for high polluting industries (such as electricity, gas, refineries, minerals) is comparatively more expensive. Therefore, they will tend to maintain their home emissions at a stable level while exporting more pollution abroad.
However, China’s recent environmental upgrade, as well as increasing labor costs, are progressively challenging the traditional understanding of the pollution haven hypothesis.
Because of lower labor costs, many foreign companies have implemented production units in China to support their economic development since the 1980s. This, in turn, has had a significant impact on the Chinese pollution level. Indeed, in 2017, out of the total Chinese CO2 emissions, almost 1/3 used to be generated by foreign companies, among which the United-States represented 21%

However, as the World Bank underlines, China has been shifting its economy from a double-digit growth, a low wage and low regulation model to an upper-middle-income country. China has, for instance, been implementing stricter environmental laws powered by innovation capacities, in particular regarding the electric vehicle market. As a result, China could now be joining the pollution haven model by externalizing its CO2 emissions to lower regulation countries.

A second effect of China’s remodeling lies in the increase in wages. In 2019, China had an average of $6.50 per labor hour, which is $1.50 higher than in 2016. As a consequence, foreign companies have now fewer incentives to produce and manufacture in China and tend to search for new pollution haven locations with lower costs.
More recently, the US-China trade war, as well as the Covid 19 crisis, have incentivized U.S. firms to leave the country. According to the American Chamber of Commerce, in 2018, 64% of U.S. companies in southern China were considering moving production elsewhere.

As a consequence, even Chinese firms are looking at new pollution havens. For instance, the Oman desert has been the target of a new Sino-Oman industrial project, with $10.7 billion injected in 2016. As the region has less strict environmental policy, high polluting projects will be developed, such as an oil refinery or a petrochemical complex. China is, in a way perpetuating the cycle of pollution haven all over the Middle East, Asia, and Africa with several similar projects.

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