Induced Innovation from Environmental Regulation: Evidence from China

Abstract: We take a heterogeneous difference-in-differences approach to estimate the effect of an environmental regulation on jobs and firm performance in China. We study both directly regulated "dirty" firms and indirectly regulated "clean" firms, which allows us to estimate net effects and address spillovers to clean firms in regulated regions. The regulation increases jobs by 5% for dirty firms and 8% for clean firms. Total factor productivity (TFP) increases by 4.4% and 10% for dirty and clean firms, respectively. We provide evidence that the most plausible explanation is adoption of pollution-reducing technology—a form of induced innovation. Differential effects for state-owned enterprises (SOEs) relative to private- and foreign-owned firms are consistent with weak enforcement for SOEs only. We also explore the distributional consequences of the regulation and find that the effects on TFP are positive for firms in wealthier and more-populated regions as opposed to poor and less-populated regions, but the positive effects on jobs are similar despite regional wealth and population.