FIW Working Papers | 2024-07

China’s Manufacturing Pollution, Environmental Regulation and Trade

Real manufacturing output increased rapidly in China from 1998 to 2012 while sulfur dioxide (SO2) pollution emissions grew at a much lower rate. To study the reasons for this, I focus on the contributions of environmental policy, trade liberalization, and other factors linked to China’s development process. Using China’s entry into the World Trade Organization and the 11th Five-Year Plan as policy shocks, the difference-in-differences analyses show that these policies effectively reduced firm-level pollution intensity. The change in pollution is primarily driven by within-sector firm heterogeneities rather than industry structural change toward less polluting sectors. Finally, the counterfactual analysis based on a quantitative model reveals that environmental regulations play a major role in reducing pollution and the implicit pollution tax faced by firms grew substantially over the period. In addition, tariff cuts due to trade liberalization reduce variable costs of trade and allow firms to abate pollution more.