The Costs of "Blue Sky": Environmental Regulation, Technology Upgrading, and Labor Demand in China

To cope with the stricter environmental regulation, manufacturing firms need to carry out pollution reduction activities and change their optimal production decisions, which may affect their labor demand. Using a ten-year firm-level panel dataset (1998–2007), we use an estimation technique pairing propensity score matching (PSM) with a difference-in-differences (DID) estimator to examine the impacts of a national air pollution control policy on employment in China. We find that China's Key Cities for Air Pollution Control (KCAPC) policy effectively lowered sulfur dioxide (SO2) emissions by approximately 26%. The new environmental regulation significantly reduced manufacturing labor demand by approximately 3%. Most importantly, firms reduce pollution emission mainly by upgrading production technology so the decline in labor is partly due to the increase in labor productivity brought about by technological progress. As a result of pollution reduction, low-skilled employees and workers in domestic manufacturing firms are more affected by environmental regulation in China.