Watering Down Environmental Regulation in China

This paper estimates the effect of environmental regulation on firm productivity using a spatial regression discontinuity design implicit in China’s water quality monitoring system. Because water quality readings are important for political evaluations, and the monitoring stations only capture emissions from their upstream regions, local government officials are incentivized to enforce tighter environmental standards on firms immediately upstream of a monitoring station, rather  than  those  immediately  downstream. Exploiting  this  discontinuity  in  regulation stringency  with  novel  firm-level  geocoded  emission  and  production  datasets,  we  find  that immediate  upstream  polluters  face  a  more  than  24%  reduction  in  Total  Factor  Productivity (TFP), and a more than 57% reduction in chemical oxygen demandemissions, as compared to their immediate downstream counterparts. We find that the discontinuity in TFP does not exist in  non-polluting  industries,  only  emerged  after  the  government  explicitly  linked  political promotion to water quality readings, and was predominantly driven by prefectural cities with career-driven  leaders.  Linking  the  TFP  estimate  with  the  emission  estimate, a  back  of  the envelope calculation indicates that China’s water  regulation  efforts  between 2000  and  2007 was associated with aneconomic costof more than 800billion Chinese yuan.