Firm productivity, pollution, and output: theory and empirical evidence from China

Using a theoretical model, this paper argues that as firm productivity increases, there is a decrease in firm-level pollution intensity. However, as productivity increases, firms tend to increase their aggregate output, which requires the use of additional resources that increase pollution. Hence, an increase in productivity results in two opposing effects where increased productivity may in fact increase pollution created by a firm. We describe the joint effect of these two mechanisms on pollution emissions as the “productivity dilemma” of pollution emission. Based on firm-level data from China, we also empirically test this productivity dilemma hypothesis. Our empirical results suggest that, in general, firm productivity has a positive and statistically significant impact on pollution emission in China. However, the impact of productivity on pollution becomes negative when we control for increases in firm output. The empirical evidence also confirms the positive influence of productivity on output, which suggests that the main determinant of pollution is the firm’s output. The empirical results provide evidence of the existence of, what we describe as, the productivity dilemma of pollution emission.