Globalization and the environmental impact of sectoral FDI

•We analyze the environmental impact of capital inflows, such as the halo effect of FDI.•The effect of FDI depends on the industry and the country’s level of development.•FDI in manufacturing and nonfinancial services has a negative effect on pollution.•FDI in poor countries has a harmful effect on the environment.•FDI to developed countries has a beneficial effect, supporting the halo hypothesis. We analyze the environmental impact of capital inflows and investigate the halo effect (FDI improves the environment). We control for the type of FDI inflows, the EKC (Environmental Kuznets Curve) effect and the country income level, and find (i) a differential industry effect: FDI flows into manufacturing increase pollution (negative halo effect), while those flowing into services support the halo effect hypothesis; (ii) an income inequality effect: FDI flowing into low- and middle-income countries degrades the environment, while flows to high-income countries benefit the environment and support a halo effect; (iii) support for the EKC effect if capital flows into agriculture and services in poorer countries and into mining and manufacturing in wealthier economies. We show that studies relying only on firm-level or aggregate data miss the sectoral spillovers, and thus may lead to misleading conclusions.