Guojun He, Shaoda Wang, Bing Zhang; Quarterly Journal of Economics

Key Takeaways:

  1. After growing social unrest to improve China’s worsening pollution, the central government began aggressive reforms starting in 2003. Included in this era of reforms was a target-based system to improve water quality. The central government installed several hundred state-controlled water monitoring stations along the major national river trunks and used the water quality readings to help determine the promotion of local government officials.
  2. Water monitoring stations can only capture emissions from upstream, giving local officials the incentive to enforce tighter regulations on polluters immediately upstream of stations, while shirking on their responsibility to reduce pollution coming from their downstream counterparts. The researchers used this spatial disparity to quantify the effects of environmental regulation on the country’s entire manufacturing sector.
  3. The study found that local officials more heavily enforced regulations on polluting firms that were monitored, with firms located immediately upstream of a station being 24 percent less productive and emitting significantly less pollution than their downstream counterparts. The productivity loss was mainly driven by upstream polluters investing more in abatement equipment to meet tighter regulations. The upstream-downstream gap in productivity existed only in polluting industries and did not emerge until the central government started to link water quality readings to political promotions.
  4. These estimates suggest that environmental regulation led to significant economic costs for China. A 10 percent reduction in pollution led to a 3 percent drop in productivity for China’s polluting industries. Taken together, China’s efforts in reducing water pollution led to a total loss in industrial output of more than 800 billion Chinese yuan over the eight years studied.
  5. Further, the study found that the higher the political incentive to local officials and the more difficult it was for them to manipulate the monitor readings directly, the more significant the gap in productivity between upstream and downstream firms.
  6. The study provides a timely assessment of the central government’s efforts in leveraging high-powered political incentives to fight pollution. It demonstrates a clear misalignment between the national policy goal and local bureaucratic incentives as local leaders prioritized “water quality readings” over “actual water quality,” as the well-intentioned policy had aimed.