Financial incentives and endogenous enforcement in China's pollution levy system

Using data from 3000 Chinese factories, we estimate an econometric model of endogenous enforcement in which factories' levy rates and emissions are jointly determined by the interaction of local and national enforcement factors, abatement costs and regulator-manager negotiations that are sensitive to plant characteristics. Our results demonstrate the significant deterrent impact of a system that combines progressive financial penalties and self-reporting with few options for contesting regulatory decisions, despite the prevalence of state enterprises and developing-country conditions in China. Despite central pressure for uniformity in enforcement, we find great regional diversity that reflects local conditions. We also find that pollution control through financial incentives has a much greater impact on production processes than on end-of-pipe abatement.