Trade Uncertainty and Firm Pollution: The Role of Emission Caps

Abstract

How does a reduction in trade policy uncertainty affect firms' pollution behavior? Guided by a simple model, we show that the answer to this question depends on whether an emission cap exists. Reduced uncertainty leads to lower emissions per unit of output (emission intensity) when an emission cap exists and has no effect on emission intensity when one does not. We exploit spatial variations in reductions in export policy uncertainty caused by the U.S. conferral of PNTR to Chinese exporters and variations in the stringency of local SO2 emission controls in China to test the hypotheses. We find that the reduced uncertainty increases firm output by comparable magnitudes across the regions with different degrees of emission control, but they reduce firm SO2 emission intensity and firm total SO2 emissions only in regions with stringent emission control. The decline in SO2 emissions is caused by reduced use of fossil fuel and more abatement equipment. We also find that the reduction in uncertainty and emission control jointly improve firms' productivity, consistent with the Porter hypothesis.