Environmental regulation and firms' emission reduction – The policy of eliminating backward production capacity as a quasi-natural experiment

This study examines the effects of environmental regulations on firms' emission reductions. Using the Eliminating Backward Production Capacity policy in China as a quasi-natural experiment, our matching difference-in-differences estimation shows that the policy significantly reduces the sulfur dioxide (SO2) intensity of regulated firms by 5%. The results remain robust across different specifications and alternative outcome variables. The mechanism test results show that the reduction in SO2 intensity results from a smaller reduction in total output than in total SO2 emissions or energy consumption. This effect is particularly pronounced in regions with stronger motivation to reduce emissions, less fiscal pressure, and higher levels of air pollution, as well as in the central and western regions. Furthermore, this study finds a pollution leakage from regulated firms to other local firms. The larger the size of other local firms, the more pronounced the increase in their output. Overall, we find a 50% rebound in pollution due to leakage. However, as the policy also increases total output by 187%, our results indicate that the policy is effective in substituting backward with advanced production capacity. Our findings provide empirical evidence regarding the use of command-and-control policies to adjust the technological structure of production for technological upgrading and environmental improvement. This provides a valuable reference for developing countries to consider similar policies.