Can Korea provide a pollution haven for China? A theoretical approach to identify the pollution haven hypothesis

Environmental regulations vary across countries. The pollution haven hypothesis (PHH) predicts the spatial distribution of industries to be dependent on the differences in regulations with ‘dirtier’ firms locating to countries with less stringent regulations. However,the post NAFTA (North America Free Trade Agreement) experience seems to fly in the face of the hypothesis. Given a likely free trade agreement between China and Korea in the near future,it is important to understand the likely implication of such an agreement. Should we expect outcomes in line with the hypothesis or more in line with the NAFTA experience? We propose a model which bridges the gap between previous models and empirical findings by explaining the spatial distribution of firms based on the directly observable and tangible factors such as trade costs,regulation compliance costs and potential market size rather than on the existence of transboundary pollution. The existence of a spatial equilibrium is highlighted as a key factor in identifying the PHH. This discerns the China-Korea case from the NAFTA experience.