The effects of emission trading system on corporate innovation and productivity-empirical evidence from China’s SO2 emission trading system

Emission trading system is a significant market-based environmental regulation tool worldwide. This study fills existing knowledge gap on whether ETSs have “weak” and “strong” version of Porter hypothesis effects in China, by examining the effects of the Chinese SO2 emission trading on corporate innovation and productivity. Using the micro-data of domestic-listed manufacturing companies from 2004 to 2015, this study regarded China’s SO2 emission trading system as a quasi-natural experiment by applying a difference-in-difference framework to eliminate endogenous problems. It was found that the SO2 emission trading system significantly promoted corporate innovation but did not have a significant effect on corporate productivity. The cause analysis showed that suboptimal institutional context and lack of corporate dynamic response led to the failure of strong Porter hypothesis effect. In addition, small- and medium-sized enterprises and non-state-owned enterprises gained greater innovation compensation effects of the emission trading system. This research believed that, the design, institutional context, and market incentives of emission trading systems need to be improved from the top down, to achieve the dual goal of environmental sustainability and economic growth.