Domestic Pollution Havens: Linking Interregional Capital Flight and Water Pollution Regulation in China

This paper investigates whether stricter water pollution regulation induces capital flight toward relatively less-regulated regions in China. Exploiting a unique firm dataset, we construct an interregional investment network at the city pair level and examine the impact of a typical water pollution regulation as a natural experiment on interregional investment. We find that water pollution regulation does not significantly affect interregional investment flows. However, when considering geographical distance, there is substantial economic significance observed for close-range capital flight. These results suggest that the investment transfer of polluting industries is more likely to occur in local areas due to relatively small frictions in capital flow between geographically adjacent regions. Additionally, our findings indicate that strict water pollution regulation has a greater impact on private firms and foreign firms. Our study sheds light on a critical but always overlooked role of capital flow friction in pollution havens hypothesis and provides new evidence on the domestic pollution havens with geographical restrictions.