Many of China’s environmental regulations set targets for local governments that are , used to evaluate the possibility of promotion for local officials. A new study shows that this well-intentioned centralized system of regulating may be ineffective in reaching national goals. The study looked at water quality regulations and found that local officials more heavily enforced regulations on polluting firms that were monitored and tracked by the central government, while not enforcing regulations on firms not tracked. This caused tracked firms to be significantly less productive and firms not tracked to continue to pollute.

“While the policies are well intentioned, leveraging high-powered incentives creates a mismatch in goals that ultimately causes the system to be inefficient,” says study co-author Guojun He, research director at the Energy Policy Institute at the University of Chicago in China (EPIC China) and a professor at the Hong Kong University of Science and Technology. “While local government leaders should be motivated by the altruistic goal of reducing pollution for the good of the people, their goal is instead to get promoted. They work to do so by narrowly regulating firms based only on what the central government can track.”

The water regulations took effect in 2003, when the central government installed several hundred state-controlled water monitoring stations, set targets for the stations to meet, and used the water quality readings to help determine the promotion of local government officials. Because water monitoring stations can only capture emissions from upstream, local officials had 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.

Guojun He and his co-authors 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 57 percent 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 gap in productivity between upstream and downstream firms did not occur until 2003 when the new targets were announced. In addition, the regulation was concentrated within only a few kilometers upstream of each monitoring station, while farther upstream firms were essentially unaffected since their emissions dilute quickly over space and have little influence on water quality readings.

The unequal deployment of the regulations led to significant economic losses in 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 to reduce water pollution led to a total loss in industrial output of more than 800 billion Chinese yuan over the eight years studied (2000-2007).

“By heavily regulating some firms and not regulating others, local leaders have made the needed water quality regulations more expensive to implement, given that firms typically have increasing marginal cost of abatement,” says study co-author Shaoda Wang, a postdoctoral scholar at EPIC and incoming assistant professor at the University of Chicago. “It also creates immense spatial inequalities in regulatory burden and pollution exposure, which could have been avoided in the presence of a more `complete contract’ between the central and local governments.”

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. This further indicates a clear misalignment between the national policy goals and local bureaucratic incentives as local leaders prioritized water quality readings over actual water quality.