An anatomy of China’s eco-efficiency gains: the role of FDI^*

This paper quantifies the role of FDI in the remarkable fivefold gains in eco-efficiency in China’s manufacturing during the period 1995–2006. We refine the conventional index decomposition method and apply it to China’s SO₂ emission. We find that (i) foreign-invested enterprises (FIEs) have shifted production toward cleaner industries; (ii) the better abatement technique of FIEs explains 23% of the eco-efficiency gains; and (iii) another 69% of the eco-efficiency gains come from by progress in domestic firms’ abatement technique, which is associated with forward environmental spillovers from FIEs. Findings (ii) and (iii) lend support to the so-called Pollution Halo Hypothesis.