Association for Public Policy Analysis & Management

Product quality is crucial to both producers and consumers, while it is often overlooked under the study of environmental regulation. This paper explores how wastewater pollution regulation influences product quality by using manufacturing data and Customs Data from China (2001 - 2008). By using annual data from 2001 to 2008 from two administration data sets: the Chinese Annual Survey of Industrial Firms and Chinese Customs Trade Statistics, I apply a difference-in-differences strategy that compares the change in firms' product quality following the policy.

After controlling firms' anticipation effects of the second treatment group, the effects of the natural disaster on first treatment group in 2007, and the effects of recession in 2008, the empirical analysis can be summarized by five main findings. First, product quality increased by 4.5% after enforcing the regulation. The effects are mostly contributed by private firms, which experienced an increase in product quality of 5.9%, while the effects on state-owned firms and foreign firms are not statistically significant. Second, comparing the two different levels of regulations in the first treatment group, an inverted U-shaped relationship exists between product quality and environmental regulation. Third, the results of the heterogeneity analyses show that product quality increased more in the medium-sized firms than small-sized firms, and more in old firms that have been established for five years before the end of the calendar year than in young firms. Also, firms tend to export high-quality products to wealthy countries and countries geographically closer to China. Fourth, when analyzing the channel of the causal effects, I find that firms invested a large amount of money on purchasing more advanced machinery and equipment to alleviate the pressure of the regulation, rather than importing high-quality intermediate inputs. Finally, firms exited from the market due to financial constraints. Furthermore, since firms improve product quality may lead to a shortage of funds, firms with higher product quality improvements were more likely to exit the market.

This paper makes several major contributions. First, to the best of my knowledge, this is the first paper to analyze the impact of environmental regulation on product quality. I also discovered an inverted U-shaped relationship between product quality and environmental regulation. Second, I contribute to the literature on the effects of industrial wastewater pollution regulations in developing countries. Despite the unimaginable environmental hazard posed by wastewater pollution, the existing literature has paid limited attention to its effects, especially the effects faced by developing countries. Third, this paper also contributes to the rapidly growing body of literature on the “Porter Hypothesis."