Relocate or Innovate? The Impact of Environmental Regulation Stringency on Pollution-Intensive Firms in China

Abstract

This paper assesses the impact of environmental regulation stringency on the relocation of pollution-intensive firms in China. Pollution haven hypothesis (Porter theory) suggests that firms would (not) choose to relocate (but to innovate). We proxy the regulation stringency with multidimensional institutional capacity and construct an index by using the entropy method and find that stringency reduces the number and growth rate of pollution-intensive firms in highly regulated regions, especially these in heavy industries. An important channel for stringent regulations to hold back firm creation is the increased financing cost. Stringent regulations are not found to promote technology innovation presumably because relocation is less costly. Overall, the results support pollution haven hypothesis.

Keywords: China, environmental regulation, financial cost, pollution-intensive firms, regulation stringency

JEL Classification: G30; K32; Q50; Q58