Environmental regulation, hidden economy, and China's outward foreign direct investment

The need to balance economic growth and its environmental impact continues to be a serious issue in China. As environmental regulation in China increases in importance, it is critical to understand how it impacts economic growth drivers such as outward foreign direct investment (OFDI) to formulate effective policies. One consideration should be the hidden economy, which can weaken the effects of environmental regulation on OFDI. This study investigates the scale of the hidden economy in 30 provinces and province-level municipalities in China in the period 2004 to 2015. The study uses the multiple indicators and multiple causes (MIMIC) model and the systematic generalized method of moments (GMM) test to analyze the impact of environmental regulation and the hidden economy on China's OFDI. The results show that stronger environmental regulation promotes OFDI. However, the hidden economy inhibits China's OFDI, as the positive effects of environmental regulation that drive OFDI are distorted. From a regional perspective, stronger environmental regulation promotes OFDI as well, while the hidden economy inhibits it. The interaction between environmental regulation and the hidden economy also inhibits it significantly.