Does Chinese Environmental Policy Affect Income Inequality? Evidence from the Central Environmental Protection Inspection

• Published date: 01 May 2024
• Author: Xiaoyun Wei,Chuanmin Zhao
• Date: 01 May 2024
• DOI: http://doi.org/10.1111/cwe.12534

©2024 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 130–161, Vol. 32, No. 3, 2024

130

Does Chinese Environmental Policy Af‌f ect Income

Inequality? Evidence from the Central Environmental

Protection Inspection

Xiaoyun Wei, Chuanmin Zhao*

Abstract

This paper investigates the effect of environmental policy on income inequality.

It focuses on the central environmental protection inspection led by the central

government in China. Using a difference-in-differences approach, it finds evidence that

environmental regulation decreased the per capita income and enlarged the gap between

urban and rural income while showing an insignificant effect on employment. Although

the policy can reduce pollution levels and bring environmental benefits in aggregate,

the findings of this study suggest that the regulations appear to have reduced the

proportion of manufacturing industry and hindered general innovation and investment

from entrepreneurs, which resulted in greater inequality. Rural residents suffered

more from environmental regulation due to relatively high migration costs and their

disadvantaged human resources on the aspects of health, education level, and skills. The

local government’s execution incentive can also play a key role in the effectiveness of

environmental policy. Regions with lower GDP growth targets and younger government

leaders were affected significantly with regard to the income growth of local residents

and the urban–rural income gap.

Keywords: central environmental protection inspection, income inequality, promotion

incentive, top-down policy, urban–rural gap

JEL codes: D31, Q58, R11

I. Introduction

China, the largest developing country, has experienced rapid economic growth along

with increasing income inequality and heavy environmental pollution (Chen et al., 2018).

*Xiaoyun Wei, Post-doctoral Researcher, China Academy for Rural Development and School of Public

Affairs, Zhejiang University, China. Email: xiaoyun.wei@zju.edu.cn; Chuanmin Zhao (corresponding author),

Post-doctoral Researcher, China Investment Corporation, China. Email: chuanmin_zhao@126.com. The

authors are grateful for support from the National Natural Science Foundation of China (Nos. 72173085 and

71973094). Chuanmin Zhao is grateful for support from a China Postdoctoral Science Foundation funded

project (No. 2023M743896).

©2024 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Environmental Policy and Income Inequality 131

On the one hand, facing up to increasingly serious environmental problems, China has

recently witnessed a striking transition in the environmental governance system and

has developed many novel policy interventions (Chen et al., 2018; Jia and Chen, 2019).

On the other hand, concerns have been raised that increasingly strict environmental

regulation can hinder economic development to some extent. Wang and Lei (2020)

found that local governments were willing to sacrifice some economic growth under

pressure to protect the environment. Moreover, environmental regulation can affect

employment in different ways depending on the characteristics of workers and the

sectors they are in (Walker, 2011), which may increase income equality. In the context

of China, as Ravallion and Chen (2021) showed, the Gini coefficient has been above 0.40

since 2002, and the average income in urban areas is as much as 2.5 times greater than

that in rural areas.

The migration of labor from the agricultural sector to the manufacturing and service

sectors is the key to improving living conditions and increasing the income level of rural

residents. As migrant laborers in rural areas of China possess disadvantaged human

resources on the aspects of health, education level, and skills (Sheng et al., 2022),

over 80 percent of rural migrant laborers work in manufacturing and low-skill service

sectors.1 Environmental policies that restrict the development of manufacturing may

therefore affect the incomes of rural residents.

Considering the large income gap and the labor mobility barriers between rural and

urban areas in China, the central environmental protection inspection (CEPI) policy

might exacerbate the rural–urban income inequality. In this paper, we take advantage of

the CEPI in China as an exogenous shock and use the difference-in-differences (DID)

method to study comprehensively its effect on income growth as well as the urban–rural

income gap.

There are three advantages of studying China in this regard. First, as the largest

developing country, China experiences fast economic development along with large

rural–urban income inequality and serious environmental problems. Second, the

Chinese government has carried out dozens of environmental regulations in recent

years, aiming to transform extensive economic growth into sustainable development. As

the existing literature mainly concentrates on evaluating the effectiveness of policy in

developed countries, our research, based on China’s environmental policy assessment,

provides important evidence to assist developing countries to simultaneously develop

environmental governance and economic growth and control income inequality. Finally,

the top-down policy implementation and promotion system of local politicians in

1The data is from the dataset of China Family Panel Studies (CFPS) survey, which is available from the

website: https://www.isss.pku.edu.cn/cfps/.

Xiaoyun Wei, Chuanmin Zhao / 130–161, Vol. 32, No. 3, 2024

©2024 Institute of World Economics and Politics, Chinese Academy of Social Sciences

132

China provides clean, quasi-natural experiments to identify the effect of environmental

regulations and the role of government execution.

The specific effects of environmental regulations on particular firms intuitively

depend on the mechanisms involved. First, environmental regulation can cause high

regulatory costs or the exit of firms with high emission intensity and low productivity

(Chen, 2023). As regulatory costs are hard to pass on to customers due to high demand

elasticity, firms under the pressure of environmental regulation are likely to hire

fewer workers (Wang et al., 2021). Second, environmental regulation can reduce the

demand for labor by stimulating the process of capital deepening (Li et al., 2023).

Specifically, the reduction in demand for labor depends on ownership characteristics,

with domestically owned private firms suffering more from the regulations. Polluting

industries have also experienced greater job destruction due to environmental regulation

(Wang and Lei, 2020; Li et al., 2023).

The reduction in demand for labor and its heterogeneous effects on different

sectors and firms intuitively cause income inequality. The negative effect of

environmental regulation is characterized by output reduction rather than employment

shocks (Li et al., 2020), which indicates that unequal impacts are more concentrated

on wage income instead of labor participation. Qin et al. (2021) found that

environmental regulation can inhibit wage growth and widen the income gap between

skilled and unskilled labor. Moreover, the aggregate effect of environmental regulation

largely depends on the extent of the enforcement (Wang and Lei, 2020; Qin et al.,

2021).

Although the existing literature has provided rich evidence on how environmental

regulation affects firm performance, labor demand, and income inequality, the aggregate

effect of environmental regulations on the welfare of different groups of people still

needs to be clarified and it is worthwhile exploring the mechanisms behind it. In

addition, as an important factor of the implementation of environmental regulation,

the motivation of local politicians is crucial to evaluate the side effect on the economic

development while the relevant studies are scarce.

In the context of China’s CEPI policy, we adopted the DID method and used the

city-level dataset for the 2010–2019 period to emphasize the effect of environmental

regulation on local economic development and the urban–rural income gap. Known as a

major institutional arrangement and reform measure, the efficiency of CEPI policy has

been confirmed in the literature (Jia and Chen, 2019; Wang et al., 2021).

The empirical results indicate that the CEPI indeed has had a significant negative

effect on income growth, especially that of rural residents. But its effect on employment

was insignificant. Specifically, residents in large cities experienced an income reduction