Internalizing externalities through ecological compensation: Evidence from trans-boundary water pollution in China

Abstract

This study examines the effects of China's cross-provincial ecological compensation scheme (CpECS) on trans-boundary water pollution. Using a staggered difference-in-differences method, we find that the CpECS significantly reduces water pollution in terms of ammonia nitrogen (NH₃-N) concentrations by 33.4 %. By linking water quality with point-source and nonpoint-source pollution control practices, we find that these improvements result from reductions in industrial wastewater discharge and pig production, and improvement in municipal sewage treatment capacity. However, the scheme does not yield a significant reduction in chemical oxygen demand (COD) concentrations, likely due to a lack of incentives to exceed contractual targets in policy areas once those targets are met.