Market-based environmental regulation and total factor productivity: Evidence from Chinese enterprises*

Taking China?s recent SO2 Emissions Trading Pilot as a quasi-natural experiment on changing regulatory stringency and using large panel data of Chinese industrial enterprises for 1998?2007, this study identifies the productivity effects of this market-based environmental regulation by employing a difference-in-difference-indifferences design. Our results suggest that the market-based environmental regulation has exerted significant productivity-enhancing effects across all types of industrial enterprises, with stronger effects associated with privately owned, more productive, and less pollution-intensive enterprises. We also identify a dynamic productivity-enhancing effect that tends to decay slowly over time. The SO2 Emissions Trading Pilot, as a marketbased environmental regulation, allows more flexible mechanisms for production adjustment and innovation than do conventional command-and-control regulations. Thus, our results provide evidence supporting the narrow but strong version of the Porter Hypothesis that strict but flexible environmental regulations are more likely to trigger positive productivity effects.