Compliance, Efficiency and Instrument Choice: Evidence from air pollution control in China

This research evaluates China's main air pollution control policy. In 2005, China decided on a 10% SO2 emissions reduction goal as part of the 11th Five-Year Plan (2006-2010). I study the effect of this policy on pollution outcomes, using both the offcial, misreporting-prone indicator and independent NASA SO2 satellite data in a differences-in-differences strategy that exploits variation in target stringency at the province level. I find that results from the offcial and the satellite data differ initially when the Chinese government lacked the ability to effectively monitor SO2 pollution. Ultimately, however, the policy worked and reduced air pollution by 11%. The regulated provincial governments react through rhetorical compliance, measured by a unique dataset of quantified political statements, and by shutting down small, ineffcient thermal units. Rhetorical compliance increases, especially before the government gained the ability to monitor SO2 in 2008. Real compliance sets in through the shutdown of small, ineffcient thermal units. Next, I compute detailed marginal abatement cost curves for SO2 for each province in China, thus illustrating the large heterogeneity in abatement cost across provinces. I use those curves to construct the counterfactual cost-effcient allocation of SO2 reduction targets across provinces. Using this benchmark, I find that the cost-effcient allocation would increase effciency by 49% at the margin, by lowering marginal abatement cost from 658e/tSO2 to 338e/tSO2. This finding is robust to inclusion of a back-of-the-envelope measure for the marginal benefits of abatement. I conclude that a market-based allocation of SO2 reduction targets would have doubled the effciency of China's main air pollution control policy. Contrary to the US experience, I find that a mandate on scrubbers would reap most of those effciency gains.