US Environmental Regulation and FDI: Evidence from a Panel of US-Based Multinational Firms

Do tougher environmental regulations cause firms to flee the country? Although several studies document the impact of environmental regulation on domestic production, the question of whether firms increase foreign manufacturing in response to new domestic regulation has remained unanswered. Consequently, our understanding of the efficacy of environmental policy is limited, as is our understanding of the distributional impacts of “local” environmental policies. To offer evidence on this topic, this paper compiles detailed firm-level regulation data to investigate the link between regulation and a firm’s foreign production decisions. Specifically, I test whether the Clean Air Act Amendments (CAAA)—legislation that dramatically strengthened environmental regulation in the United States— resulted in increased foreign direct investment (FDI) by US based multinational firms. In addition, I evaluate claims that the regulations spurred firms to disproportionately increase manufacturing in developing countries, which would have important distributional effects.