Strict environmental policy: An incentive for FDI

Empirical evidence has so far failed to confirm that lenient environmental regulation attracts investment from polluting firms. We show that a firm may want to relocate to a country with stricter environmental regulation, when the move raises its rival's cost by sufficiently more than its own. We model a Cournot duopoly with a foreign and an incumbent domestic firm. When the foreign firm moves to the home country, the domestic government will respond by increasing the environmental tax rate. This may hurt the domestic firm more than the foreign firm. The home (foreign) country's welfare is (usually) lower with FDI