Effect of carbon market on air pollution: Firm-level evidence in China

Ancillary impacts of climate policies on issues other than climate consequences are important for the cost-benefit analysis of optimal policy design, policy-making process, and climate communications. A common perception, relying on scenarios and simulations, suggests substantial co-benefits of air quality and human health improvements from climate mitigation measures. Based on a quasi-experimental design for causal inference, however, we show at the firm level the existence of adverse side-effects of a regional carbon emissions trading program in China on local air pollution. An average firm in the emissions trading program emitted more local air pollutants compared to its counterpart outside of the program. The adverse side-effects were particularly significant in the power sector, where pollution control was more progressive. After ruling out possibilities of data manipulation or intended coordination in policy implementation, we reveal that conflict in firms’ dual compliance to climate and environmental policies may explain the unintended consequence: when facing a price of carbon from emissions trading, firms have lower incentives in pollution control, which is energy intensive. Our findings suggest that the direction of spillovers from climate policies are context-specific, depending on the stringency and instrument choice of existing environmental policies. Improved policy enforcement and information provision of mitigation measures can help avoid unintended policy impacts.