The impact of environmental regulation on firms’ markups: evidence from China

A comprehensive evaluation of the costs and benefits of environmental regulations provides empirical evidence for policymakers to formulate and introduce environmental policies. Firms’ profitability and competitiveness manifest their market power and provide the micro foundation for economic development and social stability. Therefore, this paper focus on investigating the impact of air pollution environmental regulation on manufacturing firms’ market power, measured by markups, with a difference-in-differences (DID) method. Using air pollution control policy, requiring China’s Key Cities for Air Pollution Control (KCAPC) to meet air quality standards within a specified time limit as a natural experiment, our DID estimations show that air pollution regulation significantly leads to an increase in firms’ markup rate by 0.002 in key cities that did not meet air quality standards. Heterogeneous effects show that this impact is larger for polluting firms, private-owned and foreign-owned firms, and firms located in western and central cities and cities with high marketization. Productivity and market share may be two main influencing channels to explain the positive impact of air pollution environmental regulation on firms’ markups. Our findings suggest that strengthening environmental regulation is conducive to improving the competitiveness and market power of manufacturing firms, lending support to the enforcement of environmental regulations.