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Policy Sciences

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01-06-2015

Foreign aid, economic globalization, and pollution

Authors: Sijeong Lim, Victor Menaldo, Aseem Prakash

Published in: Policy Sciences | Issue 2/2015

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Abstract

This paper explores how trade and foreign direct investment (FDI) condition the effect of foreign aid on environmental protection in aid-recipient countries. We suggest that (1) environmental protection should be viewed as a public good and (2) all else equal, resource flows from abroad (via aid, trade, and FDI) influence governments’ incentives to provide public goods. (3) Because these resources shape governments’ incentives differently, their interactive effects should be examined. We begin with the assumption that developing country governments seek some optimal level of environmental protection, a level conditioned by their factor-intensive growth phase. We hypothesize that at low levels of export receipts or FDI inflows from the developed world, foreign aid is associated with superior environmental protection. This is because foreign aid, as an environmentally neutral addition to revenue, allows recipient governments to partially relax the trade-off between economic growth and environmental protection. As levels of export receipts or FDI inflows from the developed world increase, however, the salutary effect of foreign aid will diminish and eventually be reversed. This is because foreign aid mitigates the recipient government’s dependence on traders and investors in the developed world, and concomitantly reduces their pro-environmental policy leverage. Our analysis of 88 aid recipients, for the period 1980–2005, lends support to our argument.

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While environmental groups have actively lobbied multilateral organizations such as the World Bank, and the Bank has instituted policies such as the Strategic Environmental Assessment and Environmental Impact Assessment (Gutner 2002; Nielson and Tierney 2003; Park 2005), such groups nonetheless tend to lack the leverage that would lead donors to prioritize environmental issues over other goals. A recent empirical study also suggests that aid is largely “environmentally neutral” (Hicks et al. 2008).

As the salience of FDI originating from developing countries such as China and India increases, the pro-environmental pressures of FDI on the host economy might diminish. However, in the time period of our study, 1980–2005, the bulk of FDI received by developing countries originated from the North. According to Aykut and Ratha (2004), by the end of 1990s, over two thirds of the total FDI inflows to the developing world originated from the high income countries.

http://health.india.com/news/indias-public-health-system-has-collapsed-jairam-ramesh/.

We believe that our characterization of foreign aid as a free addition to recipient government’s coffers holds even for earmarked aid or in-kind aid. There is a literature suggesting that aid earmarked for the provision of specific public goods such as schools and hospitals is largely fungible, and can produce fiscal displacement. Feyzioglu et al. (1998), for instance, find that developing-country governments receiving loans for agriculture, education, and energy can reduce public investments in these sectors. Farag et al. (2009) find that an increase in donor funding for health is associated with a proportionate decrease in government health spending. Foreign aid, even when it is earmarked for a specific purpose, still enables governments to divert resources elsewhere, according to their own priorities (Waddington 2004).

We also evaluated other dependent variables such as biochemical Oxygen demand (BOD), as a proxy for water pollution, and NO₂ (Nitrous Oxide). Data for both of these pollutants is available for a smaller number of countries, and for much limited time period (from mid and late 1990s for most countries). Hence, we did not include these analyses in our study. While the data on CO2 intensity is widely available, we do not use the CO₂ indicator because it is not a regulated pollutant in developing countries during most of the period covered in our study, and therefore is not appropriate as a proxy for the government’s commitment to environmental protection.

Fisher type Augmented Dickey-Fuller (ADF) panel unit root tests conducted with several different lag length selections (1–5 years) reject the null hypothesis of a unit root.

In using the OECD foreign aid dataset, we treat all reported missing values as truly missing (and thus exclude them from the analysis).

Exports to donor countries were calculated using bilateral trade data from the Correlates of War Project (COW 2008). We treat all reported missing values as truly missing (and thus exclude them from the analysis), and accept all reported zeros as true zeros. Donor countries refer to the members of the Development Assistance Committee (DAC) in the OECD. Greece, Portugal, South Korea, and Spain are excluded due to their very recent membership into the DAC.

FDI flow data is from the World Bank Development Indicators (WBDI); FDI stock data is from the United Nations Conference on Trade and Development (UNCTAD). Both FDI indicators are expressed as a percentage of GDP, and the correlation between the two is 0.41. We treat all reported missing values as truly missing (and thus exclude them from the analysis), and accept all reported zeros as true zeros.

Outward FDI from China has become an important phenomenon only in the recent years. Chinese FDI stock by the end of 2006 only accounted for 0.85 % of the world’s total FDI (Yang 2008).

Total trade data are from the WBDI.

The data are from Haber and Menaldo (2011).

The data are from the WBDI. The industry value added indicator comprises value added in the mining, manufacturing, construction, and energy (electricity, water, and gas) sectors.

The data are from Polity IV (2010).

The data are from the WBDI.

We test for remaining serial correlation across our LDV models, and do not find any remaining serial correlation. Although our main models are partial adjustment models, we also estimate a more general Autoregressive Distributed Lag (ADL) specification as a robustness check.

\(LRM_{Aid} + LRM_{Interacton.term} \times \, Globalization \, Flows.\)

Exports and FDI tend to be highly correlated. By including both in our model, we are estimating only their unique (non-overlapping) effects on pollution intensities. It makes little sense to drop either of them because that would lead to an under-specified model. Nevertheless, because of this collinearity, the results we present should be viewed as conservative estimates.

In different geographic regions and time periods, we find cases where developing countries receiving high levels of globalization flows from the North (i.e., levels close to or above the cut points we estimate) also receive increasing amounts of foreign aid. Among the cases are Singapore (during the early 1980s), Congo, Angola, and Cambodia (all during the mid 1990s), and the Czech Republic in the early 2000s.

The data are from WBDI. Total natural resources rents are the sum of oil rents, natural gas rents, coal rents (hard and soft), mineral rents, and forest rents.

The negative coefficient estimate of natural resource rent may be attributable to the fact that SO₂ is an industrial pollutant. Its major emission sources include power plants, locomotives, ships, and other industrial processes. Resource extraction processes in resource rich developing countries generate trivial amounts of SO₂, and therefore involve fewer SO₂ emissions compared to manufacturing intensive production in countries at the same level of income. And although refineries produce sizable quantities of SO₂, the world’s largest refineries are located in the US and South Korea, not in the oil exporting countries of the developing world.

Environmental aid is the segment of the ODA dedicated (committed) to environmental protection based on the classification of OECD’s Creditor Reporting System (CRS).

Unlike other models where the coefficient estimates for the lower order aid term were negative, this term is not statistically significant in Model 7. That is, aid does not reduce pollution even when FDI levels are low. Why so? This might be the result of controlling for environmental aid, but might also be attributable to the fact that Model 7 only covers the period between 1996–2005 due to the limited availability of disaggregated aid data. While Model 7 controls for Export to Donors, the average export from the South to the North in mid 1990s and 2000s is already much greater than that in the 1980s. Thus when only the later period is included in the analysis, even the observations with low FDI levels might be considerably globalized in terms of exports. If so, the lower order aid term can no longer capture the marginal effect of aid at little or no globalization flows.

This technique also addresses the possibility that, in our previous models, Nickell bias is distorting our results due to the correlation between the lagged dependent variable and country fixed effects.

As we have a relatively long time dimension (the maximum is 26 years), to prevent instrument proliferation we use instruments at these lag depths rather than using all available lags (Roodman 2009b).

In our earlier models, the Polity 2 Score was included as a control variable. The coefficient estimates of this variable (which capture the average marginal effect of regime type on pollution intensity) were insignificant.

Rather than introducing three-way-interaction terms, we conduct split sample analyses to allow the effects of independent and control variables to vary by regime type as well.

\({\text{SO}}_{2} {\text{Intensity}}_{it} = \phi_{1} {\text{SO}}_{2} {\text{Intensity}}_{i,t - 1} + \gamma_{1} {\text{Aid}}_{it} + \gamma_{2} {\text{Aid}}_{i,t - 1} + \gamma_{3} {\text{Globalization Flow}}_{it} \, + \, \gamma_{4} {\text{Globalization Flow}}_{i,t - 1} + \gamma_{5} {\text{Aid}} \times {\text{Globalization Flow}}_{it} + \gamma_{6} {\text{Aid}} \times {\text{Globalization Flo}}w_{i,t - 1} + \, x_{it} \beta_{1} + {\text{x}}_{i,t - 1} \beta_{2} + \alpha_{i} + \tau_{t} + \varepsilon_{it}.\)

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Title: Foreign aid, economic globalization, and pollution
Authors: Sijeong Lim
Victor Menaldo
Aseem Prakash
Publication date: 01-06-2015
Publisher: Springer US
Published in: Policy Sciences / Issue 2/2015
Print ISSN: 0032-2687
Electronic ISSN: 1573-0891
DOI: https://doi.org/10.1007/s11077-014-9205-6

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