2.1. Background
Despite several rounds of environmental regulations by China, the results were not viewed as satisfactory. Then, a new approach (the Environmental Protection Law) was adopted by the Chinese government on 24 April 2014, and it was passed in the 7th meeting of the Standing Committee of the General Assembly. The objective of the Law is to set up the “ecological protection red line” (the Red Line) to “protect and improve the environment, prevent pollution and other public hazards, safeguard public health, promote the construction of the ecological civilization, and promote sustainable economic and social development” (the details are provided in
http://www.law-lib.com/law/law_view.asp?id=6229 (accessed 13 April 2019)). The Law was implemented on different dates in different provinces, beginning in 2014. The major provision of the Law is to explicitly define ecological protection standards (red lines) in each province. Different from the previous silo approach of having separate legislation for land, forest, air, solid waste, and water pollution, the Environmental Protection Law represents a holistic approach to environment protection.
With mandates from central government, each province is asked to set environmental protection standards (red lines) on ecological, environmental, and resource sustainability considerations, and considers all aspects of protecting the environment. In July 2015, each province finalized the new standards, and the CPC Central Committee and State Council of China approved the standards in late 2017. In terms of execution of the Red Line, there are four phases: (1) setting the specific pollution standards (red lines), (2) completing the legislation and the implementation of the Red Line, (3) surveying the results and continuous improvement of the red lines, and (4) evaluating the effectiveness of the Red Line.
Table 1 presents the progress of each province as of 1 January 2018. Three provinces (Guangdong, Hubei, and Hainan) reached Phase 3 of the Red Line, 10 other provinces reached Phase 2, and the remaining provinces remain in Phase 1.
The Red Line policy has two major features which are different from other environmental regulations. First, different from the previous silo approach of previous environmental regulations in which having separate land, forest, air, solid waste, or water pollution legislations, the Red Line is considered as a holistic approach to environment protection. Therefore, all major pollution standards were set. Government officials are required to follow the standards. Hence, government officials do not look at one pollutant at a time. Instead, government officials are charged with a system-wide effort in tackling all types of pollution under their jurisdictions. Second, the Chinese government publicly announces the progress of each province toward specific phases of the Red Line, which de facto sets up a pseudo tournament for all provinces to show their results in the execution of the Red Line. Provincial leaders are implicitly asked to compete with their peers in the environmental performance under the standards in the Red Line. When one or several provinces advance in the specific phase of the Red Line, other provincial leaders are then pressed to catch up in the pollution performance along the Red Line standards.
2.2. Literature Review
Two strands of related literature are discussed below. Given the voluminous amount of studies, we only highlight some of them here. The first strand concerns the pollution haven hypothesis. This hypothesis puts forth that firms in developed countries move to LDCs in order to take advantage of their lower pollution standards. The finished products are then exported to the rest of the world. As LDCs continue to grow, they raise their environmental protection standards. Then, the costs of production in LDCs are raised. Subsequently, the firms from the developed countries are forced to move out of the LDCs due to high environmental standards. Accordingly, firm exports decrease in LDCs. Essentially, LDCs are pollution havens for firms from developed countries. Kearsley and Riddel [
3], Kolcava et al. [
4], Xu et al. [
5], Rana and Sharma [
6], and Martinez-Zarzoso et al. [
7] offer cross-country or single-country evidence to support the hypothesis.
In addition, heavily polluting firms in a country typically increase their foreign direct investments and production to circumvent the environmental regulations in their home countries, as reported in Hanna [
13]. Chinese target and non-target cities are compared in Hering and Poncet [
12] in terms of strict regulations on sulfur dioxide emissions (two control zone policy). The authors report that firm exports in target cities (with stricter pollution standards) decreased relative to non-target cities. Similarly, a decrease in foreign direct investments in the target cities in China was shown in Cai et al. [
14]. Using firms in heavily polluting industries, Shi and Wu [
15] found that stricter environmental regulations reduce both the probability that a firm will export and the volume of exports in China. Using counties in New York State in the USA and the passage of the Clean Air Act, List and McHone [
16] report that pollution-intensive manufacturing plants relocated from counties with stringent environmental regulations to less-stringent counties. After applying a PSM method to properly match polluted firms with non-polluted firms, List et al. [
17] and Milliment and List [
18] find that polluted firms respond to environmental regulations by moving to less-stringent locations. Thus, while they do not directly relate to LDC exports, these within-country studies offer support to the pollution haven hypothesis.
Some studies report opposing evidence regarding the pollution haven hypothesis. For instance, Birdsall and Wheeler [
19] document that foreign direct investments in Latin American countries do not concentrate on heavily polluting firms, and thus cast doubt on the pollution haven hypothesis. Liang [
20] examines air pollution in China and finds that foreign firms move into LDCs and crowd out inefficient local firms. Consequently, local air pollution is alleviated.
The second strand of the literature is related to the Porter hypothesis. The hypothesis was proposed by Porter [
8] to show that a properly designed environmental regulation can stimulate firm innovation and enhance the firm competitiveness. The increased cost of responding to the high standards of environmental regulation can be more than offset by an increase in production efficiency and profit. Consequently, firm exports increase. Specifically, Ramzy and Zaki [
9] study the impact of stringent environmental protection regulation on agricultural trade between countries in the European Union, Middle East, and North Africa, and report evidence to support the Porter hypothesis. Tsurumi et al. [
10] examine bilateral trade flow data and find support for the Porter hypothesis. Porter and van der Linde [
21] further suggest that the scope in previous studies of the pollution haven hypothesis was limited to the direct effect of pollution on production. The externality of firm innovation brought by environmental regulations is seldom incorporated. The authors argue that environmental regulations can promote firm exports. Several studies offer evidence to support the Porter hypothesis. For instance, environmental regulations are found by Berman and Bui to accelerate the technological improvement of the oil refining industry [
22]. Bi et al. find that the carbon tax in China promoted long-run economic growth [
23]. Similarly, the Porter hypothesis is found to be valid in Sweden by Weiss and Anisimova [
24]. They show that a flexible and dynamic command-and-control environmental regulation is particularly useful in promoting innovation—a key underlying element of the Porter hypothesis. Jin et al. [
25] report that in foreign direct investment settings, environmental regulations stimulate the environmental innovation of a local firm due to its parent’s superior cross-border environmental management capabilities. In contrast, Dou and Han [
26] examine Chinese firms during 2000–2015 and report that some firms simply moved to a province with lower environmental standards after their previous host provinces raised their environmental standards, suggesting that the Porter hypothesis may not be valid in China.
In sum, two conclusions can be drawn from the literature. First, the pollution haven hypothesis literature provides mixed findings. Second, there is plenty of evidence supporting the Porter hypothesis. However, some studies document that the Porter hypothesis may not be applicable in China. Overall, the evidence is mixed for the impact of environmental regulations on firm exports.
We argue that these studies examine one specific pollution indicator, such as air pollution (List and McHone [
15]). Hence, the investigation in the literature is silo. In addition, data prior to 2015 are used in studies reporting evidence supporting the pollution haven hypothesis (e.g., List and McHone [
15]) or do not support the Porter hypothesis (e.g., Dou and Han [
26]). The mixed evidence about the pollution haven and the Porter hypotheses suggest that it is worthwhile to re-examine the two competing hypotheses. In addition, the Chinese environmental regulations have been found to be ineffective (Zhu et al. [
11]). Thus, it is also interesting to study the impact of a holistic environmental regulation positioning the approach as pseudo-tournaments for government officials (i.e., the Red Line regulation) on firm exports using more recent data. It remains a research question if the Red Line is able to help in protecting the environment while promoting firm exports. The findings carry significant policy directive to other LDCs in adopting a holistic approach to tackle environmental issues. We propose the testable hypothesis as follows:
Hypothesis 1. The Red Line policy promotes firm exports.