The aggregate effect of air pollution regulation on CO2 mitigation in China's manufacturing industry: an econometric analysis

We studied the aggregate effect of actual air pollution regulation on CO2 mitigation in China based on a theoretical framework of co-benefits and the empirical evidence. Under the lens of the factor demand theory in economics, different types of pollutants can be treated as different inputs in firms' production functions, and thus become complements or substitutes, which well characterize the impact on one type of emissions from regulating the other type of emissions. The spillover mechanisms can be decomposed into an output effect and a substitution effect. With industry-aggregate data of 18 manufacturing sectors from 1991 to 2010, we used the panel data models to estimate the complementarity or substitutability of two types of local air pollutants, i.e. SO2 and soot, for CO2, and the contributions of the output and the substitution effects in China. We empirically found that CO2 was a gross complement and a net substitute to SO2. This means that more stringent regulation on SO2 reduced the overall CO2 emissions, but it caused more CO2 emissions when the output effect was eliminated. In contrast, we detected the conflict between the control of CO2 and soot at the aggregate level by finding that CO2 was both a gross and a net substitute to soot. After 2006, due to the regulation improvement, CO2 became a net complement to SO2, indicating the enhancement of technical synergy between SO2 and CO2 abatement, while it remained a gross and a net substitute to soot. The contrasting results for SO2 and soot can be attributed to the different regulations on them. SO2 regulation provides a reference and model for regulating other air pollutants and for reaping the ancillary carbon benefits in China. As China has announced the launch of the nationwide carbon market which will cap its total CO2 emissions in 2017, based on our results, SO2 regulation will reduce the price of carbon permits due to the complementarity between SO2 and CO2. (C) 2016 Elsevier Ltd. All rights reserved.