Trade uncertainty, emission cap and firm pollution

Abstract

This study investigates the effects of reducing trade policy uncertainty (TPU) on firms’ production and pollution dynamics under different extents of environmental regulation stringency. We develop a trade model with heterogeneous firms subject to different regulatory pressures. Our calibration shows that reduced TPU boosts firm output by 6%, which persists even under stricter environmental regulations. Meanwhile, the emission cap control prominently reduces emissions and emission intensity. By constructing a firm-level TPU reduction shock following the U.S. granting of permanent normal trade relations to China, we empirically test our model’s predictions using Chinese data. Consistently, we find that while firms in both environmentally regulated and non-regulated zones increase output to similar extents, only those in Two-Control Zones with stringent sulfur dioxide (SO2) emission controls reduce their total emission intensity through decreased fossil fuel use, desulfurization, and increased investment in pollution abatement.