UNIVERSITY OF GHANA 

COLLEGE OF HUMANITIES 
 

 

 

 

 

ENVIRONMENTAL RISK AND FOREIGN DIRECT 

INVESTMENT: THE ROLE OF FINANCIAL SECTOR 

DEVELOPMENT AND TAX POLICIES 

 

BY 

  

 

ERIC BOACHIE YIADOM 

 

 

 

 

 THIS THESIS IS SUBMITTED TO THE UNIVERSITY OF 

GHANA, LEGON IN PARTIAL FULFILLMENT OF THE 

REQUIREMENT FOR THE AWARD OF PHD FINANCE 

DEGREE 

 

 

 

DEPARTMENT OF FINANCE 

JULY 2022

University of Ghana http://ugspace.ug.edu.gh 



UNIVERSITY OF GHANA 

COLLEGE OF HUMANITIES 
 

 

 

 

 

ENVIRONMENTAL RISK AND FOREIGN DIRECT 

INVESTMENT: THE ROLE OF FINANCIAL SECTOR 

DEVELOPMENT AND TAX POLICIES 

 

BY 

 

 

ERIC BOACHIE YIADOM 

(10508310) 

 

 

 

 THIS THESIS IS SUBMITTED TO THE UNIVERSITY OF 

GHANA, LEGON IN PARTIAL FULFILLMENT OF THE 

REQUIREMENT FOR THE AWARD OF PHD FINANCE 

DEGREE 

 

 

 

DEPARTMENT OF FINANCE 

JULY 2022

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DECLARATION 
 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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CERTIFICATION 
We hereby certify that this thesis was supervised under procedures laid down by the University. 

 

 

 

  

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ACKNOWLEDGEMENTS 
Even though I take full responsibility for the content of this work, the completion of it is a result 

of the prayers, financial support, encouragement, critics, and efforts from amazing people and 

organizations. Foremost, I am most grateful to God Almighty for His awesome grace and unfailing 

love towards me throughout the study period. 

I am grateful for the financial support of the GNPC Foundation for awarding me a scholarship for 

the first three years of my PhD program. I also appreciate the Carnegie Corporation of New York 

for funding the 4th year tuition fees and the research cost through the BANGA-Africa Thesis 

Completion Grant Project. I graciously acknowledge the unflinching support and guidance from 

my supervisors without them this work would not have seen the light of day. First, to Prof. Lord 

Mensah, for recommending me for the PhD program and giving me numerous opportunities to 

excel both locally and internationally. And Prof. Godfred A. Bokpin, for giving me my first 

opportunity to study MPhil-Finance at the Business School. The six-year journey has been fun 

with the two of you: Two years for MPhil and Four years for PhD. If I have to choose supervisors 

again, I will choose you over and over again! 

I am indebted to all faculty members of the Department of Finance who prepared me during the 

course work and offered valuable critics at the seminar presentations. Special mention is made of 

Prof. A.Q.Q. Aboagye, Prof. Elikplimi K. Agbloyor, Prof. Charles Andoh (Head of Department), 

Dr Patrick Asuming, and Dr Saint Kuttu. To all my PhD Finance colleagues, I truly appreciate 

your wise contributions. 

Special appreciation goes to all my friends at the University of Professional Studies, Accra who 

assisted me in diverse ways: Lawrence Boadi, Godwin Musa, Abubakar Musa, Mark Edem and 

Prof Raymond Dziwornu, God bless you all. 

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All pastors at the First Love Church, especially Bishop Joshua Heward-Mills and Bishop 

Emmanuel Amartey, I am grateful for the love and the many prayers. 

To my beloved wife, Mrs Favour Boachie-Yiadom, you are indeed the BOMB (bone-of-my-bone) 

and the springs in my feet to sprint to this height. Thanks for stabilizing our home during my many 

absences. To my two amazing daughters Sikapa and Akyedeepa, Daddy still loves you so much 

despite driving you out several times from his study to concentrate on this thesis.  

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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DEDICATION 
This work is dedicated to:  

God Most High.  

My Supervisor, Professor Lord Mensah, for believing in me and inspiring me to come this far. 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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ABSTRACT 
Responding to climate change is at the forefront of policy and research at this crucial moment of 

the earth’s history. A two-pronged approach has emerged: mitigation and adaptation. This study 

relates to both the climate mitigation and adaptation strategies to resolving climate change. 

Specifically, the thesis contributes to the literature by (i) examining the moderating role of 

financial sector development on the effect of foreign direct investment (FDI) on environmental 

risk, (ii) decomposing financial sector development into its subcomponents: access, depth and 

efficiency, and examining the extent to which they aid or prevent foreign direct investment from 

harming the environment, (iii) exploring whether countries with ‘weak’ or better still low tax rate 

attract ‘dirty’ FDI to deteriorate their environment, (iv) investigating the impact of carbon tax 

adoption on foreign direct investment. The study employs standard approaches namely the 

generalized method of moments (GMM), dynamic panel threshold models, fixed effects, random 

effects, sample splitting, and partial effects computations to examine the linkages.  

 

The results from the various estimation strategies show that, the unmitigated effect of FDI on 

environmental risk is detrimental. However, FDI conditioned on the local financial sector 

development minimizes environmental risk. This means that countries that have a well-developed 

financial sector is able to channel FDI into green projects that improve the quality of the 

environment. Further, the dynamic panel threshold model reveals that financial development 

increases environmental risk at low regimes of the threshold but high regimes of financial 

development have the ability to reduce it. This means that the level of financial sector development 

matters in accounting for its impact on environmental risk. Therefore, assuming a linear 

relationship between the two variables could be problematic.  This brings clarity to the literature 

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on why some studies report positive effect of financial development on environmental risk and 

others show negative effect.  

We further decomposed financial development into its subcomponents to help examine their 

behaviours and recommend specific policy directions. The findings reveal that financial deepening 

and efficiency reduce environmental risk and can overturn the negative impact of FDI on the 

environment. However, financial access worsens environmental risk especially at lower levels and 

cannot make the FDI – environment nexus any better. But then again, high levels of financial 

access has the ability to reduce environmental risk.  

 

Also, after splitting the dataset into high and low financially developed economies, we report that 

FDI is more environmentally depressive among low financially developed economies. Third, on 

the effect of tax policies on the FDI-environmental risk nexus, the study finds support that the tax 

channel is the main medium through which FDI worsens environmental risk. By discomposing tax 

policy into low and high regimes, the study reports that countries that deliberately reform tax policy 

to bait FDI have higher environmental risk. Therefore, using tax policy to lure FDI amount to 

short-changing capital risk for environmental risk. Finally, We set up the Dynamic Stochastic 

General Equilibrium (DSGE) model to estimate the effect of carbon tax adoption on FDI. The 

findings from this exercise show that the direct effect of the carbon tax on FDI is repressive. 

However, if the revenue from the carbon tax is recycled into the economy, the carbon tax will have 

a significant positive effect on FDI. Hence, the study corroborates the double dividend theory. The 

findings further suggest that a carbon tax of around US$8.5/ton is reasonable to enhance inward 

FDI but a carbon tax either above US$25/ton or below US$3/ton will be detrimental to the African 

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region. Also, the entrenched negative relationship between FDI and taxes is worsened if the 

additional carbon tax is levied among high tax regime countries than their counterparts. 

The findings of this thesis churn out several contributions to knowledge and literature. The African 

context in the environmental economics and carbon tax policies are marginalized in the existing 

literature. This study opens up the frontiers to the discussions on the implications of carbon tax 

introduction on the free movement of international capital. As a forerunner on the subject of carbon 

tax’s effect on FDI in both Africa and the globe, this study offers reasons why many countries 

have not implemented a carbon tax despite the numerous benefits associated with it.  

 

This study also leads the way in advancing that the finance and the tax channels are the yet-to-be-

explored factors that account for the impact of FDI on the environment. The existing literature 

associates the negative effect of FDI on the environment with institutional quality. However, 

institutional quality is broad and encompasses almost everything in the administration of a country. 

This leaves policymakers helpless as the specific aspect of institutions that can mitigate the 

harmful environmental effects of FDI. This thesis brings finality to this policy debacle and 

recommends that retooling tax policies and enhancing financial deepening and efficiency could 

improve the effect of FDI on the environment. 

 

Keywords: environmental risk, foreign direct investment, financial sector development, carbon 

tax, tax policies, and generalized method of moment. 

 

 

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TABLE OF CONTENT 
DECLARATION……………………………………………………………………………..……i 

CERTIFICATION .......................................................................................................................... ii 

ACKNOWLEDGEMENTS ........................................................................................................... iii 

DEDICATION ................................................................................................................................ v 

ABSTRACT ................................................................................................................................... vi 

TABLE OF CONTENT ................................................................................................................. ix 

LIST OF TABLES ....................................................................................................................... xiii 

LIST OF FIGURES ...................................................................................................................... xv 

LIST OF ABBREVIATIONS ...................................................................................................... xvi 

CHAPTER ONE ............................................................................................................................. 2 

INTRODUCTION .......................................................................................................................... 2 

1.1 Background to the Study .................................................................................................. 2 

1.2 Problem Statement ......................................................................................................... 11 

1.3 Research Objectives ....................................................................................................... 17 

1.4 Research Hypothesis ...................................................................................................... 17 

1.5 Significance of the Study ............................................................................................... 18 

1.6 Scope and Limitations of the Study ............................................................................... 19 

1.7 Structure of the Thesis.................................................................................................... 20 

1.8 Chapter Summary ........................................................................................................... 21 

CHAPTER TWO .......................................................................................................................... 23 

LITERATURE REVIEW ............................................................................................................. 23 

2.1 Chapter Introduction ...................................................................................................... 23 

2.2 Environmental Risk and Economic Activities ............................................................... 23 

2.3 The Pollution-Income-Relationship (PIR) and EKC ..................................................... 25 

2.4 Capital needs, FDI and Economic Activities in Africa .................................................. 28 

2.5 FDI and Environmental Risk.......................................................................................... 32 

2.6 Financial Sector Development (FSD) and Economic Growth ....................................... 37 

2.7 Financial Sector Development and Foreign Direct Investment ..................................... 40 

2.8 The role of FSD in the relationship between FDI and Environmental Risk .................. 44 

2.8.1 Positive effect of FSD on Environmental Risk ....................................................... 45 

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2.8.2 Negative effect of FSD on Environmental Risk ..................................................... 47 

2.8.3 Can FSD moderates the effect of FDI on Environmental Risk? ............................. 49 

2.9 Measurement of Environmental Risk and Financial Sector Development .................... 52 

2.10 The role of Access, Depth and Efficiency in the FDI-Environment nexus .................... 59 

2.15 Chapter Summary ........................................................................................................... 71 

CHAPTER THREE ...................................................................................................................... 73 

FOREIGN DIRECT INVESTMENT AND ENVIRONMENTAL RISK: THE ROLE OF 

FINANCIAL SECTOR DEVELOPMENT .................................................................................. 73 

Abstract ......................................................................................................................................... 73 

3.1 Introduction .................................................................................................................... 74 

3.2 Brief Literature Review .................................................................................................. 78 

3.3 Methodology .................................................................................................................. 81 

3.3.1 A Case for GMM .................................................................................................... 81 

3.3.2 Empirical Models, Data, Variables, and Measurements .............................................. 85 

3.4 Results and Discussions ................................................................................................. 90 

3.4.1 Summary Statistics.................................................................................................. 90 

3.4.2 Empirical Results and Discussions ......................................................................... 93 

3.4.3 The Marginal effect and Turning Point analysis of Financial Sector Development

 100 

3.4.4 The Effect of High Levels of Financial Sector Development on the FDI and 

Environmental Risk nexus ................................................................................................... 101 

3.4.5 Control Variables .................................................................................................. 101 

3.4.6 The Dynamic Panel Threshold Regression Analysis ............................................ 102 

3.4.7 Robustness checks: The Traditional Measurement of  Financial Sector 

Development ........................................................................................................................ 104 

3.5 Conclusions and Policy Implications ........................................................................... 109 

3.6 Chapter Summary ......................................................................................................... 110 

3.7 Appendix ...................................................................................................................... 111 

CHAPTER FOUR ....................................................................................................................... 116 

ENVIRONMENTAL RISK AND FOREIGN DIRECT INVESTMENT: THE ROLE OF 

FINANCIAL DEEPENING, ACCESS AND EFFICIENCY ..................................................... 116 

4.1 Introduction .................................................................................................................. 117 

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4.2 Brief Literature Review ................................................................................................ 121 

4.3 Methodology ................................................................................................................ 123 

3.3.3 Panel Threshold Estimation .................................................................................. 126 

4.4 Results and Discussions ............................................................................................... 127 

4.4.1 Summary Statistics ..................................................................................................... 127 

4.4.2 Can Financial Depth, Access and Efficiency improve the impact of FDI on 

Environmental Risk? ........................................................................................................... 132 

4.4.3 The Dynamic Panel Threshold Regression Analysis ............................................ 137 

4.4.4 Robustness checks, Control Variables and Validity of the Results ...................... 140 

4.5 Conclusions and Policy Implications ........................................................................... 148 

4.6 Chapter Summary ......................................................................................................... 149 

4.7 Appendix ...................................................................................................................... 149 

CHAPTER FIVE ........................................................................................................................ 155 

ENVIRONMENTAL RISK, FOREIGN DIRECT INVESTMENT AND TAX POLICIES: 

SHOULD WE WORRY? ........................................................................................................... 155 

Abstract ....................................................................................................................................... 155 

5.1 Introduction .................................................................................................................. 156 

5.2 Brief Literature Review ................................................................................................ 159 

5.3 Methodology ................................................................................................................ 163 

5.4 Empirical Results ......................................................................................................... 166 

5.4.1 Summary Results .................................................................................................. 166 

5.4.2 Environmental Risk: Does FDI and Tax Policy matter? ...................................... 168 

5.4.3 Environmental Risk and FDI: Tax Policy as a channel ........................................ 169 

5.4.4 Environmental Risk: Does Tax rate levels matter? ............................................... 172 

5.5 Conclusions .................................................................................................................. 175 

5.6 Chapter Summary ......................................................................................................... 177 

5.7 Appendix ...................................................................................................................... 177 

CHAPTER SIX ........................................................................................................................... 181 

ASSESSING THE IMPACT OF CARBON TAX ADOPTION ON FOREIGN DIRECT 

INVESTMENT ........................................................................................................................... 181 

Abstract ....................................................................................................................................... 181 

6.1 Introduction .................................................................................................................. 182 

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6.2 Brief Literature Review ................................................................................................ 186 

6.3 Method and Data .......................................................................................................... 192 

6.3.1 Estimation Strategy ............................................................................................... 192 

6.3.2 Measurement of the Carbon Tax and Carbon Tax Revenue ................................. 195 

6.3.3 Data Source and Description ................................................................................ 196 

6.4 Results and Discussions ............................................................................................... 197 

6.4.1 Summary Statistics................................................................................................ 197 

6.4.2 The effect of Carbon Tax and Carbon Tax Revenue of FDI ................................ 201 

6.4.3 Robustness Check ................................................................................................. 206 

6.5 Conclusions .................................................................................................................. 207 

6.6 Chapter Summary ......................................................................................................... 209 

6.7 Appendix ...................................................................................................................... 210 

CHAPTER SEVEN .................................................................................................................... 213 

SUMMARY, CONCLUSION AND RECOMMENDATIONS ................................................. 213 

7.1 Introduction .................................................................................................................. 213 

7.2 Summary of Findings and Conclusions ....................................................................... 213 

7.2.1 Foreign Direct Investment and Environmental Risk: the role of Financial Sector 

Dev’t 214 

7.2.2 Environmental Risk and Foreign Direct Investment: the role of Financial 

Deepening, Access and Efficiency ...................................................................................... 215 

7.2.3 Environmental Risk, Foreign Direct Investment and Tax Policies: should we 

worry? 216 

7.2.4 Assessing the impact of Carbon Tax Adoption on Foreign Direct Investment .... 217 

7.3 Contributions to Knowledge ........................................................................................ 218 

7.3.1 Contributions to Empirics ..................................................................................... 218 

7.3.2 Contributions to Theory.............................................................................................. 219 

7.3.3 Contributions to Methodology .............................................................................. 221 

7.3.4 Contributions to Practice (Policy Recommendations) .......................................... 222 

7.4 Suggested Areas for Further Research ......................................................................... 223 

REFERENCES ........................................................................................................................... 224 

 

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LIST OF TABLES 

 

TABLE NUMBER AND TITLE               PAGE 

Table 2.1: Measurement of financial sector development and environmental  

risk in the empirical    literature ……………………………………………….……….………..55 

Table 3.1: Variables Description and Sources ………………………………….……………….88 

Table 3.2: Summary Statistics …………………………………………………………………..92 

Table 3.3: Results for the composite index for financial sector development …………………..94 

Table 3.4: Alternative measures of Financial Sector Development …………………………...107 

Table 3.5: Variables in the FD Index Computation (Adapted from Sahay et al., 2015) …........111 

Table 3.6: Results of Roodman (2009) and Bond et. al. (2001) GMM selection Criteria ……..112 

Table 3.7: Breusch-Pagan / Cook-Weisberg test for heteroscedasticity ……………………….113 

Table 3.8: Levin-Lin-Chu unit-root test …….……………………………………..…………...113 

Table 3.9: Test for Threshold existence …….……………………………………..…………...113 

Table 3.10: Dynamic Panel Regression Results.…………………………………..…………...114 

Table 4.1: Descriptive Statistics …………..….………………………………………………..128 

Table 4.2: Correlation Matrix ………………………………………………………………….128 

Table 4.3: System GMM Results – full sample ……………………………………….……….142 

Table 4.4: System GMM Results – high FD nations …………………………………………..144 

Table 4.5: System GMM Results – Low FD nations …………………………………………..147 

Table 4.6: Variables in the FD Index Computation ……………………………………………149 

Table 4.7: Breusch-Pagan / Cook-Weisberg test for heteroscedasticity …………………….…150 

Table 4.8: Levin-Lin-Chu unit-root test ……………………………………………………......150 

Table 4.9: Results of Roodman (2009) and Bond et. al. (2001) GMM selection criteria............151 

Table 4.10 Test for the existence of threshold……...………………………………………......152 

Table 4.11 Dynamic Panel Threshold Regression Results…………………………………......153 

Table 5.1: Description of Variables and Sources ………………………………………………165 

Table 5.2: Descriptive Statistics..………….…………………………………………………...167 

Table 5.3: Matrix of correlations ………….…………………………………………………...168 

Table 5.4: Environmental Risk: Does FDI and Tax Policy matter? Dependent Variable: CO2..172 

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Table 5.5: FE Results. Environmental Risk and FDI: Tax Policy as a channel. Dependent 

Variable: CO2…………………………………………………….……………………………..174 

Table 5.6: Environmental Risk: Does the level of Tax rate matter? Dependent Variable: CO2..175 

Table 6.1: Variable definitions and computations ……………………………………………..197 

Table 6.2: Summary Statics ……………………………………………………………………200 

Table 6.3: Breusch-Pagan / Cook-Weisberg test for heteroscedasticity ……………………….201 

Table 6.4: Levin-Lin-Chu unit-root test ………………………..………………………………201 

Table 6.5: Effect of carbon tax index and carbon tax revenue index on FDI ………………….203 

Table 6.6: Effect of  different carbon tax values on FDI ……………………………………....206 

Table 6.7: Effect of carbon tax and carbon tax revenue on FDI among Low tax regime 

countries………………………………………………………………………………………...210 

Table 6.8: Effect of carbon tax and carbon tax revenue on FDI among High tax regime 

countries………………………………………………………………………………………...211 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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LIST OF FIGURES 

 

FIGURE NUMBER AND TITLE               PAGE 

 

Figure 2.1: Africa’s financing options …………………………………………………………..31 

Figure 2.2: Global Regions' share of FDI (pre-post 2007) …………………………………...…42 

Figure 2.3: Components of greenhouse gas ……………………………………………………..54 

Figure 2.4: Trends in Financial Development Indicators in sub-Saharan Africa………………..63 

Figure 4.1: Trends in FDI and CO2 Emission in Africa …………………………………...…..118 

Figure 4.2: Bivariate relationship between CO2 and FDI ……………………………………...129 

Figure 4.3: Bivariate relationship between CO2 and access, depth and efficiency……………..130 

Figure 4.4: Bivariate relationship between FDI and access, depth and efficiency……………..130 

Figure 4.5: Trends in Financial Development Components …………………………………...150 

Figure 5.2: Toxic Taxes, Dirty FDI Model………………………………………………….….162 

Figure 5.1: Trend in the Tax rate, FDI and CO2 emission in Africa and the World……………179 

Figure 6.1: Trends in Key Variables…………………………………………………………...199 

 

 

 

 

 

 

 

 

 

 

 

 

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LIST OF ABBREVIATIONS 
 

ARDL      Autoregressive Distributed Lag 

APEC     Asia Pacific Economic Cooperation 

BRIC     Brazil, Russia, India and China  

CGM     Computable General Equilibrium 

CO2     Carbon Dioxide 

CUP-FM    Continuously Updated Full Modified  

CUP-BC    Continuously Updated Bias-Corrected 

DOL     Dynamic Ordinary Least Square  

DSGE     Dynamic Stochastic General Equilibrium 

EKC      Environmental Kuznet Curve 

FDI     Foreign Direct Investment 

FEP     Foreign Equity Portfolio 

FE     Fixed Effects 

FMOLS    Fully Modified Ordinary Least Square 

GDP     Gross Domestic Product 

GHG     Greenhouse Gas 

GMM     Generalized Method of Moment 

HIPC     Highly Indebted Poor Countries 

IMF     International Monetary Fund 

IV-GMM    Instrumental Variable Generalized Method of Moment 

MBI     Market Based Instruments 

MNC     Multinational Corporation  

NARDL    Nonlinear Autoregressive Distributed Lag 

NASA     National Aeronautics and Space Administration 

OBOR     Belt and Road Initiative 

ODA     Official Development Assistance 

OECD     Organisation for Economic Co-operation and Development 

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OLS     Ordinary Least Squares 

OPEC     Organization of the Petroleum Exporting Countries 

PHH     Pollution haven hypothesis 

PMG     Pooled Means Group  

PNDC     Provisional National Defence Council 

RE     Random Effect 

RTB     Race-To-the-Bottom  

SSA     Sub Saharan Africa 

UNCTAD    United Nations Conference on Trade and Development 

UNFCCC    United Nations Framework Convention on Climate Change 

US     United States 

VECM     Vector Error-Corrected Model 

WDI     World Development Indicators  

2SLS     Two-Stage Least Square 

 

 

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1 
 

 

 

 

 

CHAPTER ONE 

 
INTRODUCTION 

 

 

 

 

 

 

 

 

 

 

 

 

 

 

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CHAPTER ONE 

INTRODUCTION 
 

1.1 Background to the Study 

“We are currently way off track to meeting either the 1.5° C or 2° C targets that the Paris 

Agreement calls for. We need to reduce greenhouse gas emissions by 45% from 2010 levels by 

2030 and reach net zero emissions by 2050. And for that, we need political will and urgent action 

to set a different path.” [Anthónio Guterres (2020), Secretary-General of the United Nations]  

 

The problem of climate change and in this case environmental risk has become an albatross on the 

neck of the local and international communities and may not be out of the economic discussions 

anytime soon. The last five years have been the warmest half-decade in human history with 

unprecedented earth temperature exceeding 1.0° C. This sudden upshoot in earth temperature is 

wreaking havoc on human lives. The hurricanes, wildfires, pandemics and other life-threatening 

diseases in recent times, have been attributed to the changing patterns in the climate (World 

Meteorological Organization, 2020). The World Economic Forum (2019) has labelled climate 

change as the greatest threat to the world today. The Intergovernmental Panel on Climate Change 

(2019) on the other hand has indicated that the worst impacts of climate change could be 

irreversible by 2030. The earth is almost on a collision course and investigating the causes of 

climate change and offering solutions to mitigate them at this point is imperative. Moreover, 

Scientists have advanced that in this Anthropocene era, the rising earth temperature is more social, 

than natural (NASA, 2019). This means that climate change and its effects are more anthropogenic 

than an act of God. Hence, we cannot continue to blame the sufferings from extreme weather 

events on divinity when human activities are the primary cause.  

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Additionally, the anthropogenic nature of climate change makes it appropriate to examine those 

human activities in the economy that is reducing precipitation on earth. The probability that a 

particular human activity may hurt the environment is termed an environmental risk (Liverman, 

2001). Xu and Liu (2009) further explain environmental risk as the risk that an organization’s 

(human) activities may emit toxic gasses or deplete resources in such a way that it will bring actual 

or potential negative effects on the ecological system. One human activity identified as a major 

cause of environmental risk is economic growth (Stern, 2002; Dasgupta, Laplante, Wang, & 

Wheeler, 2002; World Commission on Environment and Development, 1987). The environmental 

impact of economic activities is popularized by Grossman and Krueger (1991) in their 

Environmental Kuznet Curve (EKC) hypothesis. They empirically showed that economic 

activities reduce air quality in 42 countries and concluded that an increase in per capita income 

worsens environmental risk.  Panayotou (1993) expounded on this frontier to show how the various 

stages of economic development deteriorate the environment.  

 

Furthermore, there is a strong relationship between economic activities and capital availability; 

thus, countries with more capital resources grow faster. Studies such as McKinnon (2010); 

Borensztein, De Gregorio and Lee (1998); Khan and Reinhart (1990) affirm that the extent of 

economic development in a country indeed hinges on capital resource accessibility. So, it is almost 

the case that the richer a country, the greater the economic activities and the higher the level of 

emissions which worsen the environmental risk. This perception is supported by the fact that 

developed nations emit more Green House Gases (GHGs) than developing countries. Capital 

resources are almost becoming bad for the climate, especially in the post-industrial era. This is the 

more reason why the empirical literature is tilting toward investigating the effect of capital 

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resources on environmental risk (Frutos-Bencze, & Kulvanich, 2017; Zheng & Sheng, 2017; Zhu, 

Duan, Guo, & Yu, 2016; Acharyya, 2009; Jorgenson, Dick, & Mahutga, 2007).  

 

Undoubtedly, Africa lacks the capital to finance its desired growth agenda (Sachs et al, 2004; 

Collier and Dollar, 2002; Burnside and Dollar, 2000). The capital constraints in Africa translate 

into fewer economic activities which subsequently account for the low emission of greenhouse 

gases (Panayotou, 1993). It can be inferred that Africa’s lack of capital is the main reason for the 

low greenhouse gas emissions and therefore if the capital constraints are removed, Africa like any 

other global region may increase its greenhouse gas emissions. However, it is estimated that a 

capital investment of at least US$1 trillion can help achieve Africa’s industrialization dream (Leke 

& Signé, 2019). This capital target is anticipated to turn the region from an exporter of primary 

products into a global manufacturing hub.  

 

Nevertheless, raising the US$1 trillion is a major challenge in Africa. Domestic revenue 

mobilization is not enough to cover the financing deficit. The total domestic revenue in the region 

has averaged 21% of GDP in the last five years (Boly, Nandelenga, & Oduor, 2020). Foreign 

capital may augment the poor performance of domestic revenue collection but certainly not 

through borrowing. External borrowing in Africa is rising speedily at an annual average rate of 

5.3% in the last decade and may return to the pre-HIPC debt levels soon. Data from the 

International Debt Statistics shows that the external debt to the region stood at US$702.41 billion 

as of 2020, indicating a 208% increase since 2011 (World Bank, 2021). The rising debt levels 

coupled with high interest rates are badly affecting the region and exploiting other forms of foreign 

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capital is a necessity. Foreign equity portfolio (FEP) and foreign direct investment (FDI) are the 

other two components of foreign capital Africa is tapping into to fill its investment deficit. The 

annual contribution of FEP to Africa’s growth has been sluggish, accounting for less than 0.5% of 

GDP in the last 10 years as compared to 4% of FDI (World Bank, 2021). The contribution of FDI 

to Africa’s economic growth has been well researched with favourable conclusions (Sunde, 2017; 

Agbloyor, et. al., 2014; Alfaro et al., 2004; Durham, 2004; Li & Liu, 2005; Borensztein et. al., 

1998). FDI is different from the other forms of foreign capital in several ways. First, unlike debt 

and other official development assistance, FDI does not come with immediate repayment 

conditions on the central government. Second, there are no prior open stringent requirements to 

meet before hosting FDI. Third, there are also no third parties to review and approve a country’s 

economic performance before FDI is granted. Fourth, FDI comes with more flexibility relative to 

the other forms of foreign capital. Although, FDI is not free capital it brings mutual benefits to 

both the home and the host economy.  

Li and Liu (2005) assert that even in cases where FDI does not result in explicit capital financing, 

it influences positively the host nation’s technological transfer, managerial competencies, raw 

materials availability, and production processes, among others. FDI forms a significant part of 

Africa’s economic growth. In 2019 alone, the region recorded an 11% increase in FDI despite the 

global downturn in inward FDI (UNCTAD, 2019). The relevance of FDI in Africa’s growth 

struggles is evidenced in the region’s attempt to restructure its taxes, trade laws, governance, 

infrastructure, and human capital, among others to be a key host to inward FDI (Odusola, 2016). 

Despite the numerous positive spillovers from FDI to host nations, concerns have been raised about 

the effect of inward FDI on environmental risk. Some studies attribute the rise in carbon emission 

to the rise in FDI inflows; hence, making the Africa a “pollution haven” for multinational 

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enterprises (MNE) who want to pay less for damaging the environment (Nepal, et. al., 2021; 

Frutos-Bencze, K., & Kulvanich, 2017; Zheng & Sheng, 2017; Bokpin, 2017; Omri, Nguyen, & 

Rault, 2014; Sbia, Shahbaz, & Hamdi, 2014; Acharyya, 2009; Jorgenson, Dick, & Mahutga, 2007; 

Antweiler et al., 2001). Contrarily, a section of the literature believes that FDI improves the host 

nation’s environment through the deployment of advanced climate-resilient technologies (Kim & 

Adilov, 2012; Perkins & Neumayer, 2008; Hoffmann et al., 2005; Hines & Rice, 1994). This 

makes the impact of FDI on the environment still a thorny question for research and policy to 

unravel.  

Albeit, whether the effect of FDI on environmental risk is favourable or not, it is overly simplistic 

to study the relationship between the two without considering other interconnected economic 

developments (Sarkodie, Adams, & Leirvik, 2020; Bokpin, 2017). We suspect that whether FDI 

enhances or deteriorates the environment, it is reinforced by local factors in the host nations. 

Consequently, local factors within the host nations cannot be discounted in accounting for the 

effect of FDI on the environment.  

Moreover, empirical studies have argued that for FDI to be growth-enhancing, the host nation 

should have access to key factors such as the level of financial sector development (Osei & Kim, 

2020; Agbloyor et. al., 2013; Alfaro, Chanda, & Kalemli-Ozcan, 2004), the quality of institutions 

or governance (Agbloyor, 2019; Agbloyor et, al, 2016; Busse & Groizard, 2008), and the level of 

human development (Shahrivar & Jajri, 2012; Borensztein, De Gregorio, & Lee, 1998; De-Mello, 

1997). The relevance of these local factors are not limited to ensuring that FDI promotes economic 

growth but also determines the extent to which FDI improves or retard environmental quality. 

Subsequently, Bokpin (2017) investigated the moderating role of institutional quality on the impact 

of FDI on the environment. Unfortunately, human development is not a catalyst for environmental 

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quality. Rather, there is an adverse reverse causality running from environmental risk to human 

development (United Nations, 2015; Chaudhry & Ruysschaert, 2008). What is left hanging in the 

literature is the role of financial sector development in the FDI – environmental risk nexus. 

Besides financial sector development, one key local factor which influences the location of inward 

FDI and the likely effect of FDI on the environment is the tax policy. Mostly, countries use 

lucrative tax regimes to woo foreign investors into their economies. An array of tax incentives in 

the form of exemptions and low tax rates are often used to bait investors. For instance, in Ghana, 

the introduction of the Investment code (PNDC Law 116, 1985) brought a range of incentives to 

foreign investors. The code offers tax rebates as high as 40%. Damgaard, Elkjaer, and Johannesen, 

(2019) observed that FDI locates countries with favourable or weak tax regimes. It is therefore not 

surprising to have 10 countries in the world with the most lenient tax policies hosting more than 

85% of global FDI inflows (Damgaard et al., 2019). In an attempt to receive more FDI inflows in 

Africa, the corporate tax rate for the past one and half decades has fallen from over 75% to less 

than 40% averaged (Figure 4.1). Mauritius, Namibia, Zambia, and Lesotho which host the largest 

bloc of FDI in Africa have a mean total corporate tax rate below 20% (World Bank, 2021).  

 

Cole et. al. (2006) and Prakash and Potoski (2006) observed that FDI does not only move towards 

a conducive tax climate but also targets countries with weak environmental laws. One channel of 

strengthening environmental laws is through the tax system. Effective tax systems impose punitive 

measures to slow the rate at which businesses degrade the environment. If tax laws are not 

sufficiently punitive, FDI inflows may be invested in environmentally damaging sectors of the 

economy. It is of no surprise that a greater portion of FDI inflows to Africa is invested in oil and 

gas and natural resource extractions sectors (Asiedu, 2013). We acknowledge the reality of 

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developmental and capital deficits in Africa. However, deliberately reforming tax laws to attract 

more FDI could be trading one risk for the other. Hunting for more FDI through tax reforms could 

close the gap between capital and developmental shortfalls; but where the FDI goes matters to 

safeguarding sustainable development. 

Meanwhile, the containment of carbon dioxide and other harmful emissions has become necessary 

in the attempt to reduce global warming. Several solutions have been proposed both in research 

and practice on how to cut down global emissions. These solutions as championed by the United 

Nations Framework Convention on Climate Change (UNFCCC) can be categorized into two: 

regulatory policies and fiscal policies (United Nations, 2021). Regulatory policies comprise 

government bureaucracies and legal systems that fashion specific environmental technology, 

standards, and laws to mitigate climate change. The United Nations Committee of Experts on 

International Cooperation termed these “command-and-control” instruments (United Nations, 

2021).  

Regulatory policies define strict pathways to achieving the desired compliance and do not consider 

the resource implications such rules have on the firms. They are punitive and often reactive 

mechanisms and do not offer incentives for climate actors to voluntarily comply with 

environmental standards (Lanoie et al., 2011). Regulatory instruments demand high resource 

investment to monitor and ensure compliance. Some studies have examined the effect of regulatory 

instruments on climate change mitigations and adaptations (Rhodes, Scott, & Jaccard, 2021; 

Goulder, Hafstead, & Williams, 2016). The general conclusions are that, although regulatory 

policies could be an effective tool for climate change mitigation; however, the prescriptive nature 

makes them too rigid for entities to choose appropriate compliance pathways. It is the more reason 

why Rhodes et. al. (2021) advocate for a diluted version of the prescriptive command-and-control 

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policies, called the flexible regulations, which allow market participants to determine how to meet 

the regulatory needs on their terms. 

Fiscal policies, on the other hand, use taxes, subsidies, emission trading schemes, deposit refunds, 

and central government spending to influence climate change. Fiscal policies are part of the broad 

market-based instruments (MBI) that focus on reducing emissions through financing decisions 

(United Nations, 2021). Unlike regulatory policies, fiscal policies are two-sided that offer 

incentives for voluntary compliance on one hand and at the same time punish offenders through 

high taxes or fees. Baumol and Oates (1988) stressed that both regulatory and fiscal policies are 

effective at mitigating climate change; however, fiscal policies do so at a relatively cheaper social 

cost. Numerous tools within the fiscal policy framework are in use in various countries to mitigate 

carbon emissions.  

But one key policy dominating the fiscal policy-emission cut debate is the carbon tax. Gaspar et. 

al. (2019) think that carbon tax is a climate change mitigation catalyst and estimate that its full 

implementation can reduce emissions by up to 32% by 2030. Lin and Li (2011) examine the effect 

of the carbon tax on carbon emissions on European countries that first adopted carbon tax. Their 

findings show that carbon tax significantly reduces emissions. In a related study, Conefrey et. al 

(2013) found that carbon tax has a double-dividend effect on the domestic economy by reducing 

emissions and increasing economic growth, especially if the revenue from the carbon tax is 

recycled.  

According to Gaspar and Amaglobeli (2021), the carbon tax is the most powerful and efficient 

means to address rising earth temperatures. Recent empirical evidence confirms the existing 

findings that indeed carbon tax reduces emissions (Fu et. al., 2021; Tiwari et. al., 2021; Sun, et al., 

2021; Jia & Lin, 2020). Despite the glowing tributes to the carbon tax, only 30 countries have 

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implemented it as of 2020 ( (Metcalf, 2021). Meanwhile, two-thirds of all submitted Nationally 

Determined Contributions (around 100 countries) to the UNFCCC consider the use of carbon tax 

to achieving their emission reduction targets (United Nations, 2021). Gaspar et. al. (2019) bemoan 

that even countries that have implemented carbon taxes largely shy away from the recommended 

rates. Currently, the average global carbon tax is just US$3 per ton which is not near the 2015 Paris 

Agreement recommendation of US$50 and US$25 per ton for developed and developing countries 

respectively (United Nations, 2021). The slow pace in the adoption of the carbon tax and its related 

emission reduction policies require further interrogation. The big question is why are countries 

reluctant in implementing a policy that can mitigate emissions and at the same time mobilize 

revenue for economic growth? Perhaps, carbon tax implications are more complex than the current 

focus and need to be thought through thoroughly.  

Again, advanced countries are introducing various environmental policies to make carbon 

emissions expensive and undesirable ventures. Very soon polluting firms in these economies may 

relocate into jurisdictions that have minimal to zero environmental policies. The implementation 

of the carbon tax is worse in Africa which makes the sub-region a potential haven for dirty 

industries. So far, it is only South Africa that has implemented a carbon tax at the rate of $8 per 

ton as of 2019 (Gaspar et. al., 2019). The lack of enthusiasm among policymakers in Africa 

towards the introduction of carbon taxes raises concern and the need to holistically assess the 

wholesale recommendation of the carbon tax. Several factors account for the slow implementation 

of carbon tax adoption in Africa. Although corporate taxes have fallen in the last decade, they are 

high relative to global averages. The African region is still home to countries with high corporate 

taxes. The informal nature of economies in the region narrows the tax bracket to only a few formal 

sector taxpayers. As a result, firms in the region pay high corporate taxes to make up for non-

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taxpayers. For instance, Africa houses nine of the twenty countries in the world with the highest 

corporate taxes and has the highest average corporate tax rate of 28.5% (OECD, 2021). Introducing 

additional tax in the form of the carbon tax on the already burdened taxpayer has complex 

implications.  

To this end this thesis explores the financial sector developments and tax channels used by FDI to 

worsen environmental risk and investigates why recommended mitigating factors such as carbon 

taxes are not being implemented especially in Africa. 

1.2 Problem Statement 

The financial sector is the first entry point that receives, distributes, and directs FDI into the various 

sectors of the economy (Alfaro, Chanda, & Kalemli-Ozcan, 2004). Where the FDI goes matters in 

influencing economic activities and environmental risk. Schumpeterians argue that a well-

developed financial sector facilitates capital accumulation and advanced technologies to spur 

economic activities. Thus, the financial sector plays an intermediary (moderator) role between FDI 

and the environment. In the natural sense, a weak moderator can easily be compromised. 

Therefore, a weak financial sector mimics the type of FDI received; hence, if the FDI is toxic it 

will adversely affect the environment. On the contrary, if the level of financial sector development 

is robust, it corrects market failures and the impact of FDI on the environment may no longer be 

hurtful. 

Several studies have investigated either the relationship between FDI and the environment 

(Bokpin, 2017; Omri, Nguyen, & Rault, 2014; Sbia, Shahbaz, & Hamdi, 2014; Acharyya, 2009; 

Jorgenson, Dick, & Mahutga, 2007; Antweiler et al., 2001) or financial sector development and 

the environment (Ntow-Gyamfi, et. al., 2020; Osei & Kim, 2020; Acheampong, 2019; Shahbaz, 

Nasir, & Roubaud, 2018; Riti, Shu, Song, & Kamah, 2017; Shahbaz, et. al., 2016; Tamazian, 

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Chousa, & Vadlamanna, 2009) with disjointed conclusions. The first two empirical chapters of 

this thesis consolidate the fragmented literature by examining the role of financial sector 

development in the relationship between FDI and environmental risk in Africa. Our study is 

different in several ways.  

First, we correct the misconception in the literature that the effect of FDI on the quality of the 

environment is isolated from the financial sector that carries it (Ntow-Gyamfi, Bokpin, & 

Aboagye, 2020; Acheampong, 2019; Shahbaz et. al., 2016). Second, the present study shows that 

the level of financial sector development matters in accounting for the impact of FDI on the 

environment. This has been largely ignored by the existing studies (Shahbaz, Nasir, & Roubaud, 

2018; Riti, Shu, Song, & Kamah, 2017; Tamazian, Chousa, & Vadlamanna, 2009). Particularly, 

our study posits that at low levels of financial sector development, FDI can ‘bulldoze’ its way to 

deteriorate the quality of the environment; however, the results may be different in a highly 

developed financial sector. Third, the measurement of financial sector development in the 

available literature is highly contentious and, in most cases, the measurements used are 

inappropriate to capture the full complexity and efficacy of the financial system.  

In the existing literature, financial sector development has been narrowly measured with domestic 

credit to the private sector, stock market value traded, the ratio of deposit money to bank assets, 

stock market turnover and broad money (Ntow-Gyamfi, et. al., 2020; Osei & Kim, 2020; 

Acheampong, 2019; Shahbaz, Nasir, & Roubaud, 2018; Riti, et. al., 2017; Shahbaz, et. al., 2016; 

Tamazian, Chousa, & Vadlamanna, 2009). A careful examination of these variables show that they 

are largely financial depth measurements and do not reflect the whole financial system as 

evidenced in Sahay et al. (2015). Suffice it to say that earlier studies only considered financial 

depth to represent the entire financial system in their analysis, their variables are still inadequate 

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to capture the full complements of the financial depth. This is because Sahay et al. (2015) explained 

that the domestic credit to private sector variable often used in the literature represents less than 

25% of the overall composition of the financial depth itself (see Table 3.5 in the Appendix). In 

rare cases, a few studies have constructed principal component analysis to determine financial 

development measurements. An evaluation of their variables shows that financial access is crudely 

missing (Xing et al., 2017; Shahbaz, et. al., 2016). This study departs from the current trend and 

employs a more robust and comprehensive measurement for financial sector development. The 

study uniquely adopt the IMF’s financial index data compiled by Sahay et al. (2015) to examine 

the relationship among the research constructs. 

Furthermore, this study measures the behaviour of FDI in the presence of the three determinents 

of financial sector development – access, depth and efficiency. By decomposing the financial 

sector development index into its subcomponents, the study can address which particular aspect of 

the financial development indicators drive environmental risk or can mitigate the negative effect 

of FDI on the environment. Subsequently, this research avoids the wholesale recommendations on 

financial sector development in the existing literature.  

 

Additionally, Shahbaz et al. (2016) and Sehrawat et al. (2015) investigated the effect of financial 

sector development on carbon dioxide emissions and conclude that a highly developed financial 

sector increases emissions. Again, their financial development variables which are domestic credit 

to the private sector, stock market value traded and the ratio of deposit money to bank assets are 

mainly financial deepening indicators. It is therefore problematic to generalize that the whole 

financial sector worsens carbon emissions. We correct this distortion in the literature by examining 

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the separate effect of the three components (access, depth and efficiency) of the financial sector 

development on environmental risk.  

The third empirical chapter of the thesis examines the role of tax policies in accounting for the 

effect of FDI on environmental risk. The effect of FDI on environmental quality and the effect of 

tax policies on FDI are well documented in the literature. The main conclusions are that FDI harms 

the environment (Omri, et. al., 2014; Sbia, et. al., 2014; Acharyya, 2009; Jorgenson, et. al., 2007) 

and favourable tax policies attract more FDI (de Mooij & Ederveen, 2003; Scholes & Wolfson, 

1991). The literature is, however, malnourished on the channels through which FDI affects the 

quality of the environment. Most part of the literature attempts to offer solutions to the FDI-

environmental problem by suggesting governance or institutional quality as a panacea (Bokpin, 

2017; Corfee-Morlot, et. al., 2009). However, this approach overly simplifies the menace and 

makes it difficult and ambiguous in offering specific policy direction.  

The existing literature is skewed towards the negative effects of FDI on the environment (Omri, 

et. al., 2014; Acharyya, 2009; Jorgenson, et. al., 2007) without paying attention to the channels 

through which FDI toxifies the environment. These oversights culminate into the wholesale 

recommendations of most studies in this area. We fill this lacuna by introducing the tax policies 

of developing economies into the debate. The current study explores the tax channel as one of the 

main channels through which FDI influences environmental outcomes. We suggest that loosening 

tax policies to attract more FDI could amount to shooting the economy in the foot because FDI 

takes advantage of the same tax policy to harm the environment.  

In Figure 5.2 we develop a simple “Toxic Taxes, Dirty FDI Model” based on the “tax haven” and 

“pollution haven” hypothesis (Dinda, 2004). The model shows that lenient tax regimes attract more 

FDI inflows. FDI, on the other hand, affects the host nation’s economy in three dimensions; 

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technology, scale and structure (Antweiler et al., 2001). The model supports the hypothesis that 

tax haven economies attract pollution haven FDI. FDI takes advantage of the weak tax system to 

increase environmental risk. This study, therefore, uses empirical data to investigate the assertion 

that tax reforms may provide a convenient channel through which FDI worsens environmental 

risk. 

In the empirical chapter four of the thesis, we examine the effect of adopting caebon tax on FDI in 

Africa. Carbon tax is a efficient in addressing environmental risk. But one key implication of 

carbon tax introduction in Africa is its effect on the competitiveness of the domestic economy. 

Zhang and Baranzini (2004) review the impact of the carbon tax on firm competitiveness and 

conclude that carbon tax can impair the international competitiveness of countries in comparative 

terms. The reduction in the competitive advantage according to Zhang and Baranzini (2004) is the 

major reason why many countries are reluctant in implementing a carbon tax. In a related study, 

Marron and Toder (2014) argued that carbon tax indeed rolls back international competitiveness 

and can increase local consumers’ demand for cheaper imported goods. Although imported goods 

can equally be taxed at higher rates to restore the imbalances in the local economy, Marron and 

Toder (2014) contend that firms will find it difficult to expand in the international markets. The 

harsh impact of the carbon tax on the domestic economy will be minimized if there is a global 

consensus to implement the tax in every country and almost at the same rate. Although it is near 

impossible to achieve such a recommendation, the global introduction can wipe out the 

competitive disadvantages to the countries that have unilaterally introduced the carbon tax.  

Consequently, it will minimize firm relocation.  Voßwinkel and Birg (2018) study the effect of the 

carbon tax on the relocation decisions of firms within a two-country scenario. They report that if 

two countries simultaneously set carbon taxes, it reduces the chances of relocation. However, if 

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the carbon tax is set unilaterally or one country’s marginal tax rate is higher than the counterparty, 

chances are that firms in the carbon tax economy will relocate to a foreign country with minimal 

or no carbon tax. Previous studies including Hudson (1993) and OECD (1993) lend support to 

these findings that unilateral imposition of the carbon tax is a recipe for firm relocation. 

Additionally, the carbon tax literature is malnourished in the African context. Carbon tax 

introduction and its effect in the African region are almost missing in the vast literature reviewed 

for the present study. But Africa possesses unique characteristics in the carbon tax and climate 

change mitigation debate that need considerable attention. It will be interesting to know how a 

capital-trapped economy with a high corporate tax rate will implement a policy perceived to be 

damaging to the local economy.  

In this chapter of the thesis, we examine the effect of carbon tax introduction on foreign direct 

investment in Africa. We argue that imposing a carbon tax may deter foreign investors, hence, the 

study recommends a pragmatic approach to the implementation of the carbon tax in Africa. The 

debate on the carbon tax is skewed towards its deterrent nature and the ability to cut down 

emissions without analyzing the implications of additional taxes on the local economies. It is 

surprising to note that despite the deterrent nature of carbon tax and the possibility of raising 

revenue for local and international governments, policymakers are hesitant in implementing it. 

This study thinks that if carbon tax externalities are not addressed, its implementation will continue 

to be stalled.  

Again, foreign direct investment is critical to Africa’s developmental agenda. FDI provides jobs, 

technology, and private capital to the region. There is a strong relationship between FDI and taxes 

(Gao & Liu, 2021; Xu & Wu, 2021; Damgaard, Elkjaer, & Johannesen, 2019; Oates, 1972). 

Damgaard, Elkjaer, and Johannesen (2019) have shown that countries with low corporate taxes 

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attract high FDI. Any additional taxes may deter new foreign firms from Africa and existing ones 

may relocate. This makes carbon tax a sensitive topic in the region. We show in this paper that, 

although carbon tax harms FDI; the revenue can be recycled to cut down other forms of taxes to 

reduce the burden on the taxpayers. 

1.3 Research Objectives 

The objectives of the study are to: 

i. Examine the role of financial sector development on the relationship between FDI and 

environmental risk 

ii. Assess the impact of financial depth, access and efficiency on the FDI-environment 

nexus. 

iii. Examine the effect of tax policies on the relationship between FDI and environmental 

risk. 

iv. Investigate the impact of carbon tax introduction on FDI in Africa. 

1.4 Research Hypothesis 

Subsequently, the study specifies the following null hypothesis: 

i. Financial sector development has no impact on the relationship between FDI and 

environmental risk. 

ii. Financial depth, access and efficiency have no impact on the FDI-environmental risk 

nexus. 

iii. Tax policies are irrelevant in accounting for the effect of FDI on environmental risk. 

iv. Carbon tax has no effect on FDI to Africa. 

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1.5 Significance of the Study 

Extant studies have investigated the individual effect of FDI, financial development and tax 

policies on environmental quality. The interrelationships between these variables have been 

marginalized in the existing literature. This thesis lays theoretical and empirical foundations for 

the need to study these variables together. Our study opens the frontiers to the climate change 

discussions by offering a broader view of interrelated factors that have long been sidestepped in 

the existing studies. 

Again, the current study introduces the ‘Toxic Taxes, Dirty FDI Model’ conceptual framework 

(Figure 5.2) into the FDI-environmental risk debate. The framework is grounded on the tax haven 

and pollution haven hypothesis illustrate clearly how a lenient tax regime may attract more FDI 

inflows and the channels through which FDI influences the quality of the environment. The 

introduction of this model forms the basis of new thinking that can influence future studies. 

There is a policy specificity crisis in the current studies. This is because a large segment of the 

existing studies has proposed improvement in institutional quality as a panacea to curbing the 

negative effect of FDI on the environment. The definition of institutional policy in the existing 

studies covers administrative governance, rule of law, fiscal and monetary discipline, voice and 

accountability, among others. Placing all these variables into one basket and prescribing 

institutional quality as a solution to the FDI – environmental quality debacle leaves policymakers 

in a dilemma, as to which aspect of the institution influence the nexus. This study which forms 

part of the broad institutional literature settles the confusion by offering specific policy 

interventions in containing the harmful effect of FDI on the quality of the environment.  

Additionally, the significance of the study lies in the value it contributes to the literature on the 

carbon tax. Because to the best of the authors' knowledge, it is the first study to examine the 

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implications of carbon tax on FDI, more especially in the African context. The recommendations 

from this exercise will serve as a guide to policymakers in determining the appropriate carbon tax 

that could maximize inward FDI and at the same time mitigate the negative effects of FDI on the 

environment. Again, the non-availability of carbon tax data in Africa is a hindrance to researchers 

who desire to explore this area. The strategy adopted in this study by the authors in constructing 

carbon tax data in Africa can guide future studies. 

The financial sector development aspect of the thesis also provides guidelines to investors as to 

the direction of funding. This is helpful to investors and the policymakers in identifying funding 

concentration and the need to create an enabling environment in green energy sectors to be 

financially attractive to investors. 

Also, the relevance of the study lies in its timeliness due to the urgency of climate change. As 

national and international leaders solicit for new ideas to contain climate change and mitigate its 

negative effect on lives and properties, the timing of this study could not have been better than 

now. To facilitate climate adaptations and mitigations, the authors have carefully explored the 

channels through which FDI influences the environment and propose measures to improve the 

effect of FDI on the environment.  

1.6 Scope and Limitations of the Study 

The study explores the role of financial sector development and tax policies in the relationship 

between FDI and environmental risk in Africa. Data availability of the tax policy variables is a key 

issue within this study. The data problem makes it difficult to find a standard environmental tax 

variable which is uniform across Africa. The authors resort to the corporate tax rate and assume 

that any specific environmental tax may mimic the nature of corporate tax existing in the resident 

country. The authors acknowledge that although the corporate tax rate is not originally designed 

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to regulate the effect of FDI on the environment, it can be the closest proxy given the current 

circumstance. Since corporate tax is used to attract inward FDI, it can also be used to direct FDI 

into sectors that either worsen or improve environmental quality. 

Further, another challenge for this study is the non-availability of data on carbon taxes in Africa. 

South Africa is the only country in Africa that has implemented a carbon tax as of the end of 2021. 

This makes it difficult to conduct a study in this area. However, the authors overcome this 

challenge by constructing three different carbon taxes based on sound financial and economic 

assumptions. 

1.7 Structure of the Thesis 

Chapter One covers a general introduction to the research and identifies the problem the study 

seeks to address. 

In Chapter Two, we discuss the broad literature that covers all the four empirical chapters of the 

thesis. The chapter offers a detailed review of both the theoretical and empirical literature and 

attempt to situate the thesis in the context of the available studies. The chapter also defines and 

explains key variables and their measurements. 

Chapter Three contains the first empirical chapter of the study. It addresses the objective one of 

the theses and is entitled “Foreign Direct Investment and Environmental Risk: the role of Financial 

Sector Development”. In this chapter, the authors examine the role of financial sector development 

in the relationship between FDI and environmental risk by adopting Sahey et. al. (2015) broad 

based measurement of financial sector development into the international capital and climate 

change debate. We apply the system GMM techniques to accommodate the dynamic nature of the 

dataset and make provisions for endogeneity and heteroskedasticity in the series. 

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Chapter Four addresses objective two of the thesis and is titled “Environmental Risk and Foreign 

Direct Investment: the role of financial deepening, access and efficiency”. In this chapter, we 

employ a dynamic panel of 45 economies from 1982 to 2018 and decomposed the financial sector 

development indicator into its three key determinents (depth, access, and efficiency) to investigate 

whether they can help to overturn the negative impact of FDI on the environment. 

Chapter Five contains the empirical chapter that addresses objective three of the thesis. In this 

chapter, we use various empirical models to examine the moderating efficacy of tax policy in the 

relationship between FDI and environmental risk. We explore whether countries with ‘weak’ or 

better still low tax rates attract ‘dirty’ FDI to deteriorate their environment. 

Chapter Six is the empirical chapter four and addresses objective four of the thesis. In this chapter, 

we open up the frontiers to the discussions on the implications of carbon tax introduction on the 

free movement of international capital. This chapter expands the discussion on the carbon tax to 

question the snail-paced of its implementation in Africa. A carbon tax can deter dirty industries 

from polluting the environment and at the same time generate revenue to augment public funds. 

Despite these benefits, only South Africa has introduced a carbon tax across Africa. The lack of 

enthusiasm among African countries to implement carbon tax necessitated this research, perhaps, 

the effect of carbon tax transcends beyond emission reduction.  

Finally, in Chapter Seven, we summarize the findings of this work, conclude based on the findings 

and provide recommendations for policy and future research. 

1.8 Chapter Summary 

This chapter presented an introduction to the thesis. In doing so, it provided a background to the 

thesis, identified the problem, stated the research questions and objectives, and explained the 

significance of the thesis. It also presented the scope and structure of the thesis. 

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CHAPTER TWO 

 
LITERATURE REVIEW 

 

 

 

 

 

 

 

 

 

 

 

 

 

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CHAPTER TWO 

LITERATURE REVIEW 

2.1 Chapter Introduction 

The relationship between FDI and environmental risk is well known in both the theoretical and 

empirical literature. In this chapter, the authors discuss the conceptual framework for the study 

and review topical highlights in the literature. The chapter also establishes the role of financial 

sector development and tax policies in accounting for the impact of FDI on environmental risk. 

The theoretical review focuses on the definition of key concepts and theories relating to 

environmental risk, FDI, financial sector development, and tax policies. 

In addition, four major strands of the empirical literature are discussed. First, we examine the 

relationship between economic growth and environmental risk. Second the effect of FDI on 

environmental risk. Third, the study investigates the effect of financial sector development on 

environmental risk. We look at the role of financial sector development in the FDI-environmental 

risk nexus. Finally, the chapter reviews the literature on carbon tax and the role of tax policies on 

the effect of FDI on environmental risk  

 

2.2 Environmental Risk and Economic Activities 

Ustohalova (2011, p. 603) defines environmental risk as “the probability and consequence of an 

unwanted environmental accident”. Ustohalova (2011) further elucidates that the likelihood of 

environmental risk occurrence is due to deficiencies in waste management, waste transport, and 

waste treatment and disposal, which cause serious threats to human health. Additionally, Xu and 

Liu (2009) explain environmental risk as the risk that an organization’s (human) activities may 

emit toxic gasses or deplete resources in such a way that it brings actual or potential negative 

effects on the ecological system. According to Ustohalova (2011), the impact of environmental 

risk can be assessed at two levels: the global and local impacts. The global impact of environmental 

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risk is where carbon dioxide, methane, and other harmful gases are released into the ecosystem 

and their effects go beyond the borders of the emitting country. These dangerous gases contribute 

to the increasing threat of climate change. The local impact of environmental risk on the other 

hand contributes to the contamination of the immediate environment. This often occurs through 

the release of harmful chemicals into the soil which affects groundwater, carbon monoxide from 

cars, and reactive waste substances, among others. The local impact of environmental risk usually 

comes with immediate health and environmental complications. The existence of environmental 

risk in business operations has led to categorizing industries into destructive and non-destructive 

sectors. An industry is described as destructive if its operations lead to “over-consumption of 

natural resources - forests, fisheries, wetlands, rivers, etc., and causes pollution of air, water, and 

land” (Bazerman & Hoffman, 2000). 

Largely, the environmental risk does not occur in a vacuum. Environmental risk occurs as a result 

of human activities, making it anthropogenic. The anthropogenic nature of environmental risk 

offers clues to the causes, drivers, as well as solutions to environmental risk. One human activity 

identified as a major driver of environmental risk is economic growth (Stern, 2002; Dasgupta, et. 

al., 2002; World Commission on Environment and Development, 1987).  

 

Environmental risk is the by-product of economic growth. The environmental impact of economic 

growth (activities) as popularized by Grossman and Krueger (1991) in their Environmental 

Kuznets Curve (EKC) hypothesis suggest that economic growth reduces the quality of the 

environment. This is because economic growth requires expansion in economic activities which 

in turn place a huge demand on the factors of production. Classical economics have identified land, 

capital, and labour as the basic inputs of production. Land (environment) provides the physical 

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capital and the natural resources required for production activities. A critical attribute of land is 

that it is fixed in supply (Kaika & Zervas, 2013). The fixed nature of the land and in this case the 

environment places constraints on the absorptive capacity of the waste resulting from production. 

The over-accumulation of production waste trapped within the environment is what has been 

identified as the main cause of climate change. The likelihood that these economic activities may 

lead to more carbon emissions has been well articulated (Meadows et al., 1992).  

2.3 The Pollution-Income-Relationship (PIR) and EKC 

The relationship between pollution and income has been a thorny subject for both research and 

policy to settle. But it all began with the seminal work of Kuznets (1955) who postulated a 

quadratic relationship between economic development and income inequality. Kuznets (1955) 

believes that income inequality rises at the initial stage of economic development and then falls at 

a higher level of economic development leading to an inverted U-shape in what has been termed 

the Kuznets Curve. Later in 1993, Panayotou expounded on this frontier and tested the Kuznets 

Curve assumption within the scope of environmental degradation. Panayotou (1993) found that at 

the beginning stage of economic development, pollution rises and declines when economic 

development has exceeded a certain threshold.  

 

Hence, developing countries will emit more pollution than developed nations. Panayotou (1993) 

further suggest that, unlike developing economies, developed countries can acquire advanced 

technologies and improved production processes that help reduce pollution. Consequently, 

Panayotou (1993) proposed an inverted U-shape between economic development and 

environmental quality. This is what is popularly known as the Environmental Kuznet Curve 

(EKC). It should be mentioned that the EKC was not proposed by Kuznets (1955) but it is so-

called because Grossman and Krueger (1991) and Panayotou (1993) built the EKC theory within 

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the original assumptions of the Kuznet income-growth theory. Chronologically, Grossman and 

Krueger (1991) had earlier established the inverted U-shaped relationship between per capita 

income and pollution concentrations using samples from North American countries. Grossman 

and Krueger (1991) use comparable measures of three air pollutants in a cross-section of urban 

areas located in 42 countries to study the relationship between air quality and economic growth. 

The results from their empirical estimation models show different concentration levels at different 

levels of economic growth.  

Specifically, two out of the three pollutants – sulfur dioxide and smoke recorded high emission 

concentrations at lower per capita GDP but the level of concentrations reduced as the level of per 

capita GDP increased. The inverted U-shaped of the EKC makes more sense when analyzed in the 

light of Maslow’s theory of the pyramid of needs (Maslow 1943). At the early stage of a country’s 

economic development, there is little motivation to protect the environment. Resources are rather 

channelled into achieving the basic needs of the nation which can be likened to the bottom of the 

Maslow’s needs pyramid; hence, economic development is pursued at the expense of 

environmental sustainability. The concern for the environment is almost an afterthought to 

development. It is the reason why rich nations are more likely to show concern for the environment 

than poor nations (Grossman & Krueger, 1991). 

 

Recent studies like Bandyopadhyay and Rej (2021), Destek (2020), Hasanov et. al. (2019), Isik, 

Ongan, and Özdemir (2019) report empirical results which are consistent with the EKC theory. 

Zakaria and Bibi (2019) confirm the EKC in the South Asia panel study for the period 1984-2015 

by positing that a 1% increase in economic growth worsens the environment by 1.709%; however, 

a further increase in economic growth improves the environment by 0.104%. 

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Nevertheless, other studies have contended the claims put forward by the EKC. For example, Stern 

(2004) posits that countries do not necessarily follow the EKC trajectory of economic development 

and that some developing countries show more concern for the environment than developed 

countries. In the words of Stern (2004, p.1419) “if the EKC hypothesis were true, then rather than 

being a threat to the environment, economic growth would be the means to eventual environmental 

improvement”. This point is further supported by the current data from the World Bank’s World 

Development Indicators which suggest that developed nations continue to emit more pollution 

than developing countries (World Bank, 2020). The inverted ‘U’ shape in the EKC is not supported 

by the current emission data in the global regions. This cast doubt on the perceived turning point 

at which economic growth enhances environmental quality.  

 

However, there is a thin line between Stern’s ideologies and the EKC. The main point of departure 

is that Stern believes that environmental quality can be integrated at every stage of economic 

development rather than pushing it to the end of economic development. Postponing 

environmental considerations into the future may come with a very high cost of repairing the 

environmental damage caused by economic development. It is on this basis that the concept of 

sustainable development and the circular economy is founded. The concept of economic 

sustainability or sustainable development as introduced by the Brundtland Commission Report 

“Our Common Future” believes that current economic growth should not endanger the ability of 

future generations to meet their own needs (World Commission on Environment and 

Development, 1987).  

On the other hand, the concept of circular economy advances the idea of a cyclical system of 

production where economic resources are shared, recycled, and reintroduced into the economy 

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(Kneese, 1988). The circular economy minimizes pollution and waste, recycling production 

factors, and regeneration of the environment.  

 

Additionally, other empirical studies doubt the EKC claims and have since advocated for 

sustainable development. For instance, Demissew-Beyene and Kotosz (2020) study the economic 

growth path of 12 eastern African countries and argue that developing countries depart completely 

from the EKC. Demissew-Beyene and Kotosz (2020) stress that countries can grow and achieve 

environmental sustainability together. Gill, Viswanathan, and Hassan (2018) also think that the 

EKC exists in the empirical literature due to weak econometric models used in arriving at the 

various results and conclusions. Additionally, the EKC studies are biased by choice of countries, 

data quality, and mismatched time scales (Busa, 2013). Hasanov, Hunt, and Mikayilov (2021) 

added that the EKC could have been possible in the prior studies due to weak specifications, 

inappropriate indicators/variables, and lack of data. 

Most importantly, it is not within the ambit of this study to point out which side of the economic 

growth and environmental sustainability argument is right or wrong. It is the authors’ firm belief 

that the two extremes of the Pollution-Income-Relationship theories may be valid depending on 

the assumptions and constrained imposed on them. This study draws the strength from these 

theories to examine the role of financial sector development in the relationship between FDI and 

environmental risk.   

2.4 Capital needs, FDI and Economic Activities in Africa 

Financing economic activities to promote development has not been easy in the African region. 

Poor domestic revenue mobilization coupled with low private savings makes it difficult to mobilize 

the needed capital resources to finance economic activities. In Figure 2.1, the authors use data from 

the OECD to illustrate the main financing sources for Africa. In Figure 2.1, it is observed that 

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public revenue consist of taxes, fines, loans, grants, and others contributes about 41% to the total 

financing to Africa (OECD, 2021). Africa’s public revenue is highly driven by loans due to low 

domestic revenue mobilization.  

The IMF (2020b) reports that the average domestic revenue mobilization as a percentage of GDP 

has been 14.8% between 1990 and 2019. The bank further estimates that the post-pandemic could 

trigger a sharp decrease in the domestic revenue mobilization in the region. Hence, other sources 

of finance like foreign capital inflows are needed to fill the eminent capital gap. Moreover, foreign 

capital contributes at least 19% to the capital needs of Africa. One significant component of foreign 

capital is FDI contributing an average of 24% (see Figure 2.1). Like any other capital source, FDI 

plays a critical role in the economic development of Africa. In the World Bank (2020) World 

Development Indicators dataset, foreign direct investment is defined as the direct investment 

equity flows in the receiving country. It comprises ordinary share capital, reinvestment of earnings, 

and other capital. The World Bank (2020) expatiate that FDI is a typical cross-border investment 

associated with a resident in one economy having control or a significant degree of influence on 

the management of an enterprise that is resident in another economy. For an investment to 

constitute FDI, the ownership of the equity stake qualifying for voting should be 10 per cent or 

more. 

The relevance and uniqueness of FDI to the economic fortunes of a country are summed up by 

Ajayi (2006):  

 

“The benefits of FDI include serving as a source of capital, employment generation, facilitating 

access to foreign markets, and generating both technological and efficiency spillover to local 

firms. It is expected that by providing access to foreign markets, transferring technology and 

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generally building capacity in the host country firms, FDI will inevitably improve the integration 

of the host country into the global economy and foster growth”.  

 

The effect of FDI on the host nations’ economies has been variously researched. The findings point 

out that FDI affects the economy of the receiving nation positively (Alfaro et al., 2004; Durham, 

2004; Li & Liu, 2005; Borensztein et. al., 1998). And even in cases where the FDI does not bring 

actual cash inflows, it improves the receiving nations’ technical know-how through improved 

managerial skills, advanced technology transfer, and enhanced production processes (Li & Liu, 

2005).  

Borensztein et. al. (1998) investigates the effect of FDI on economic growth in a cross-country 

study of 69 developing countries over two decades. Their regression results show that “FDI is an 

important vehicle for the transfer of technology, contributing relatively more to growth than 

domestic investment”. Recently, Asafo-Agyei and Kodongo (2022) built a panel of 25 countries 

in Sub-Saharan Africa over 23 years and used the Borensztein et. al. (1998) approach to retest the 

effect of FDI on economic growth. Their threshold regression which controls for nonlinearity 

affirmed the findings of Borensztein et. al. (1998), that FDI has an appreciable impact on economic 

growth.  

Again, in a separate study Opoku, Ibrahim, and Sare (2019) examine the role of FDI in the 

economic development of Africa using the system generalized method of the moment (GMM). 

They found that FDI affects African growth through the various productive sectors of the economy. 

They further report that the agricultural sector is the main channel through which FDI influences 

economic growth in Africa. The sectorial channel is part of what Asafo-Agyei and Kodongo (2022) 

termed the FDI absorptive capacity of the economy. The existence of the absorptive capacity can 

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ensure that FDI minimizes income inequalities. A study by Kaulihowa and Adjasi (2018) on the 

relationship between FDI and income inequality reveals that with the existence of the required 

absorptive capacity the dividends from FDI can increase the equality in the distribution of income 

among African countries. 

 

Notwithstanding, other studies believe that FDI is overhyped and does not have a direct effect on 

economic growth. Such studies advance that in the absence of key factors like human development, 

institutions, financial sector development, and natural resources, FDI may not benefit the domicile 

countries as reported in the literature. For example, extant empirical studies have argued that for 

FDI to be growth-enhancing, the host nation should have access to key factors such as the quality 

of institutions or governance (Agbloyor, 2019; Busse & Groizard, 2008), the level of human 

development (Shahrivar & Jajri, 2012; De-Mello, 1997) and the level of financial sector 

development (Osei & Kim, 2020; Agbloyor et. al., 2013; Alfaro et. al., 2004). 

 

 

Figure 2.1: Africa’s financing options  

 
Source: Authors’ construct, Data from OECD (2020). 

Foreign 

inflows, 

19%

Public 

revenue, 

41%

Private 

savings, 

40%
Africa Financing

Portfolio, 

15%

Remittances

, 35%
FDI, 24%

Net ODA, 

26%

Foreign inflows

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2.5 FDI and Environmental Risk 

Empirical evidence shows that economic activities among other factors are underpinned by the 

availability of capital resources (McKinnon, 2010; Borensztein, De Gregorio, & Lee, 1998; Khan 

& Reinhart, 1990). This is the reason the empirical literature is tilting towards investigating the 

effect of capital resources on environmental risk (Frutos-Bencze, & Kulvanich, 2017; Zheng & 

Sheng, 2017; Zhu, et. al., 2016; Jorgenson, et. al., 2007). Undoubtedly, Africa lacks all the capital 

needed to finance its economic growth (Sachs et al, 2004; Burnside & Dollar, 2000). The capital 

constraints in Africa translate into fewer economic activities which subsequently account for the 

low carbon dioxide emissions (World Bank, 2020; Panayotou, 1993). This implies that Africa’s 

lack of capital is the main reason for low carbon dioxide emissions. Therefore, all other things 

being equal if the capital constraints are removed, Africa like any other global region will increase 

its carbon dioxide emissions.  

One capital source often linked to carbon dioxide emissions is FDI. The environmental effect of 

FDI is of particular interest for several reasons. As advanced countries get richer, they tighten 

environmental laws, making it expensive for carbon-intensive firms to continue operations. These 

firms relocate, mostly into developing and emerging economies with less stringent environmental 

laws. It is the more reason why extant studies report that FDI worsens environmental risk. For 

example, Singhania and Saini (2021) study the relationship between FDI and environmental 

sustainability using a sample of 21 countries between 1990 and 2016. The results from their 

dynamic system GMM indicate that FDI has a significant positive effect on environmental risk. 

Singhania and Saini (2021) believe that FDI takes advantage of the lack of a mandatory 

statements of environmental disclosures to degrade the environment. They contend that the 

absence of strict laws to regulate the environmental reporting of FDI contributes to its negative 

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effect on the environment. Additionally, the effectiveness of environmental laws influences FDI 

relocation decisions. Multinational companies are more likely to move out from jurisdictions with 

strict environmental laws.  

Zhang and Fu (2008) confirm this position when they investigated the stringency of environmental 

regulations and their effect on the choice of location for FDI among 30 provinces in China. They 

conclude that FDI prefers to locate in regions with relatively weak environmental regulations. 

Shahbaz et. al. (2018) on the other hand estimated the effect of FDI on carbon dioxide emissions 

in France using a 62-year time series. They find that FDI negatively influences the quality of the 

environment in France. In Africa, Bokpin (2017) built a panel of 24 countries to explore the impact 

of FDI on environmental sustainability. The empirical results show that FDI significantly increases 

environmental risk in Africa.  

Also, Halliru et. al. (2021) study the environmental effect of FDI in Westen Africa and find results 

consistent with Singhania and Saini (2021), Shahbaz et. al. (2018), and Bokpin (2017). Studies 

such as Frutos-Bencze, and Kulvanich (2017), Zheng and Sheng (2017), Omri, et. al. (2014), Sbia, 

et. al. (2014), and Jorgenson et. al. (2007) has all found an adverse effect of FDI on the quality of 

the environment. All the studies that report that FDI toxifies the environment lean on the pollution-

haven hypothesis. This suggests that, when multinational companies (MNCs) are considering 

setting up international branches, they locate countries with the cheapest resources in terms of 

land, material, and labour (Levinson & Taylor, 2008). According to the theory, this practice 

accounts for the reasons why developing countries with cheap resources attract carbon-intensive 

MNCs. Firms by nature are profit-oriented and would explore every opportunity to reduce cost; 

hence, MNCs will easily locate countries with lax environmental standards when the need arises. 

Environmental standards affect firms’ margins, influence investment location decisions, and 

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contribute to a country’s competitive advantages which are key factors in determining FDI inflows. 

There are also snowballing games countries play which worsen the environmental effect of FDI. 

In the snowballing game countries deliberately set environmental standards below their 

counterparts or the internally required levels to attract FDI (Millimet & Roy, 2016). The 

environmental cost consideration of FDI is what makes a section of the literature believe in the 

existence of the pollution-haven hypothesis.  

 

Conversely, other scholars disagree with the claims put forward by the proponents of the pollution-

haven hypothesis by citing several weaknesses like inappropriate measurements and weak 

empirical support (Kim, & Adilov, 2012; Hoffmann, et. al., 2005). Demena and Afesorgbor (2020) 

conduct an extensive literature review of studies that have investigated the effect of FDI on carbon 

dioxide emissions. They cited issues such as differences in data samples (mixing developed with 

developing countries), econometric techniques, diversities in environmental indicators, and a host 

of varying control variables as the main factors accounting for the inconsistencies in the literature.  

 

The use of varying levels of development and emissions heightens the heterogeneity problems in 

the myriad of studies available, that is why the meta-analysis by Demena and Afesorgbor (2020) 

produce 1006 elasticities in the results. They further report that the underlying effect of FDI on 

environmental emissions is close to zero; however, after accounting for heterogeneity in the 

studies, they find that FDI significantly reduces environmental emissions. Following this, the 

Pollution-halo hypothesis has been suggested as an alternative theory. The Pollution-halo 

hypothesis suggests that FDI rather enhances the quality of the environment (Hines & Rice, 1994).  

Kim and Adilov (2012) argue that most FDI comes from developed countries with strict 

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environmental regulations, hence, they can transfer superior environmental technologies to the 

host nation. The dissemination of superior environmentally friendly technologies helps train the 

local workers in good environmental practices.  

Again, MNCs are believed to transfer improved production processes which influence local firms’ 

production process decisions (Wang, Dong, and Liu (2019). Some of these improved production 

processes are cheaper and more efficient than what is available locally. Locals end up copying 

from MNCs to neutralize competition advantages. Eventually, MNCs lead the way in promoting 

environmental sustainability in the host nation. Based on the pollution-halo hypothesis, Nepal, et. 

al. (2021) points out that, the adoption of energy-efficient techniques through FDI is important in 

cutting down carbon dioxide emissions. They employ a multivariate framework to investigate the 

role of FDI in energy use and carbon dioxide emissions in India over 39 years. Their ARDL model 

and VECM Granger causality tests reveal a strong long-run relationship between FDI, energy use, 

and carbon dioxide emission. They conclude that a 1% increase in FDI reduces energy use by 

0.013% and since the energy-use granger cause output, carbon dioxide in effect will decrease.  

 

Again, Shao (2017) use an extended cross-section of 188 countries between 1990 and 2013 to 

study the effect of FDI on carbon intensity. The results for the system GMM estimation process 

reveal that FDI hurts carbon intensity. Shao (2017) further divided the sample into three different 

income groupings (high-income, middle-income, and low-income countries) to retest his 

objectives. In all three scenarios, the findings suggest that FDI is effective in reducing carbon 

intensity.  

Wang, Dong, and Liu (2019) study the effect of Beijing's direct investment in promoting integrated 

development and tackling regional environmental problems since 2014. Their results show that 

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Beijing's direct investment is conducive to reducing industrial pollution emissions in the host 

administrative units, a pollution halo effect, and a win-win situation for both Beijing and its 

neighbours. More also, there are green FDIs that seek to contribute to a cleaner environment. For 

that reason, generalizing all FDIs as bad by the pollution-haven hypothesis could be an error in the 

literature. In Africa, Duodu et. al. (2021) tested the FDI pollution-halo effect among 23 sub-

Saharan African counties using the GMM estimation approach. The results show that FDI 

enhances the quality of the environment in Africa, especially in the long run. Similar findings 

relating to Africa have been reported by