Productivity implications of inefficient environmental regulation: Evidence from China

Inefficient environmental regulations can lead to a misallocation of abatement efforts among firms, resulting in a loss of aggregate productivity. Beginning in 2006, the Chinese central government adopted a top-down approach to incentivize local officials to combat pollution through the “cadre evaluation system”, resulting in a significant emission reduction. This paper assesses the productivity implications stemming from the misallocation of abatement efforts due to this drastic regulation tightening. Utilizing data from Chinese manufacturing firms spanning the years 2000 to 2009, we document a significant increase in the dispersion of regulation intensity across firms. Through a structural accounting framework, we find that the misallocation of abatement efforts among firms (holding total emission constant) resulted in a 1.8% decrease in manufacturing total factor productivity (TFP) during the years 2006 to 2009, compared to the period before the regulation tightening.