Going green in China: Firms' responses to stricter environmental regulations

Abstract

This paper finds that major 2006 Chinese environmental reforms creating mandatory emission reduction targets led firms to significantly reduce emissions, especially for firms in more polluting industries. A decomposition of the overall effect shows that firms relied primarily on technology upgrading (75.3%) rather than output cuts (24.7%) in meeting the regulatory changes. The driving forces for this “technique effect” are more water recycling and abatement device adoption. While polluting firms did not increase their green innovation, local equipment manufacturers—likely suppliers—did significantly increase green water patent applications, indicating an expanded environmental service market effect. Tests on firms' economic responses provide more evidence for an “internal” variant of the pollution haven hypothesis because firms' profit, capital, employment, market shares, and entry were all negatively affected by the more stringent regulation.