Greening to grow: Evidence from environmental regulation and industrial firm productivity in China

Abstract:

We study the impact of a major air pollution regulation on industrial firm productivity in China and show that accounting for heterogeneity in regulatory exposure is crucial for understanding the economic effects of environmental regulation. Exploiting variation generated by the regulation’s geographic design and industry pollution intensity, we find that total factor productivity increased by about 5% for regulated firms in less pollution-intensive industries relative to unregulated firms. In more pollution-intensive industries, average productivity declined relative to regulated cleaner industries but remained stable relative to unregulated firms. We show that productivity gains were achieved through a combination of market selection, reallocation, and within-firm industrial upgrading, but the relative importance of these channels varies with pollution intensity. Firms in “cleaner” industries upgraded broadly and expanded, while firms in dirtier industries invested in capital upgrades and improved input efficiency without expansion. Creative destruction dynamics are concentrated among private firms rather than state-owned enterprises, highlighting the role of political institutions and incentives in shaping the productivity consequences of environmental regulation.