Foreign Direct Investment, Technology Transfer and Pollution Abatement in a Small Open Economy

The chapter deals with the contentious issue related to environmental impact of foreign direct investment (FDI) in the presence and in the absence of technology transfer and attempts to search for the best way to abate pollution among alternative policy issues. A three-sector general equilibrium model which is a simple extension of the model of Beladi and Marjit (1992) has been considered where the domestic manufacturing sector pollutes the environment. It is assumed that FDI in terms of foreign capital flows to a foreign enclave that uses sector-specific foreign capital. Technology transfer takes place through FDI and it has spill-over effects on the rest of the economy. It is assumed that the foreign enclave transfers environmentally sound technology (EST) to the domestic manufacturing sector and for this purpose we have assumed Hicks-neutral-type technical progress function for the manufacturing sector. The chapter examines the impact of FDI both in the presence and in the absence of EST. It shows that FDI in the absence and presence of transfer of EST to the domestic manufacturing sector, contrary to the popular belief, increases the level of pollution in the economy under some reasonable assumptions. A better measure of pollution abatement would have been tax for controlling pollution.