Using Political Incentives to Fight Pollution is Costly and Inefficient

Facing political pressures to improve water quality, local officials enforced tighter water quality regulations on polluters the central government could track and not those from firms not tracked.

Many of China’s environmental regulations set targets for local governments that are used to evaluate the possibility of promotion for local officials. A UChicago study shows that this well-intentioned centralized system of regulating may be ineffective in reaching national goals. The study looked at water quality regulations and found that local officials more heavily enforced regulations on polluting firms that were monitored and tracked by the central government, while not enforcing regulations on firms not tracked. This caused tracked firms to be significantly less productive and firms not tracked to continue to pollute.

The water regulations took effect in 2003, when the central government installed several hundred state-controlled water monitoring stations, set targets for the stations to meet, and used the water quality readings to help determine the promotion of local government officials. Because water monitoring stations can only capture emissions from upstream, local officials had the incentive to enforce tighter regulations on polluters immediately upstream of stations, while shirking on their responsibility to reduce pollution coming from their downstream counterparts.

Shaoda Wang, an assistant professor at the Harris School of Public Policy, and Guojun He, research director at EPIC-China, and their colleagues found that local officials more heavily enforced regulations on polluting firms that were monitored, with firms located immediately upstream of a station being 24 percent less productive and emitting 57 percent less pollution than their downstream counterparts. The productivity loss was mainly driven by upstream polluters investing more in abatement equipment to meet tighter regulations. The gap in productivity between upstream and downstream firms did not occur until 2003 when the new targets were announced. In addition, the regulation was concentrated within only a few kilometers upstream of each monitoring station, while farther upstream firms were essentially unaffected since their emissions dilute quickly over space and have little influence on water quality readings.

The unequal deployment of the regulations led to significant economic losses in China. A 10 percent reduction in pollution led to a 3 percent drop in productivity for China’s polluting industries. Taken together, China’s efforts to reduce water pollution led to a total loss in industrial output of more than 800 billion Chinese yuan over the eight years studied (2000-2007).

“By heavily regulating some firms and not regulating others, local leaders have made the needed water quality regulations more expensive to implement, given that firms typically have increasing marginal cost of abatement. It also creates immense spatial inequalities in regulatory burden and pollution exposure, which could have been avoided in the presence of a more `complete contract’ between the central and local governments.”

Shaoda Wang, Assistant Professor, Harris School of Public Policy

Further, the study found that the higher the political incentive to local officials and the more difficult it was for them to manipulate the monitor readings directly, the more significant the gap in productivity between upstream and downstream firms. This further indicates a clear misalignment between the national policy goals and local bureaucratic incentives as local leaders prioritized water quality readings over actual water quality.