Political incentives in market-based environmental regulation: Evidence from China's carbon emissions trading scheme.

This paper used a multi-period DID model with panel data from 283 Chinese cities between 2006 and 2019 to investigate the emission reduction effects and mechanisms of China's carbon trading scheme. The research revealed that China's Carbon Emissions Trading Scheme not only stimulated businesses to reduce emissions as a market-based environmental regulation policy but also influenced local governments' governance objectives. As a result, the Hawthorne effect inevitably manifested during the experimental period of China's Carbon Emissions Trading Scheme. Further analysis indicated that China's CETS encouraged local authorities to take a more proactive stance towards the balance between environmental preservation and economic growth, aiming to achieve a mutually beneficial outcome. Based on the political stance of local governments, they are likely to simultaneously increase their focus on both economic growth and environmental protection. However, when faced with the conflict between economic advancement and environmental safeguarding, pilot regions prioritized ecological conservation in their practical steps, leading to a modest decline in economic growth. In other words, the government's high-profile announcements may not always manifest in actual deeds. In practice, local authorities tend to allocate more administrative resources to areas highly prioritized by the central government. Furthermore, the extended analysis reveals that China's CETS has resulted in a reduction in social welfare due to a shift in governance priorities influenced by political incentives. Therefore, fine-tuning the performance evaluation mechanism, preventing any bias towards the target preferences of local authorities, and guaranteeing the successful operation of the market mechanism are imperative to achieve truly low-cost and sustainable emissions reductions objectives for CETS.