How market-based and command-and-control policies create divergent local and spillover effects on low-carbon innovation

This study empirically examined the differential effects of China’s two major types of environmental pilot policies—the command-and-control policy (e.g., the Low-Carbon-City pilot, or LCC) and the market-based policy (e.g., the Carbon-Emission-Trading pilot, or CET)—on low-carbon innovation, with a focus on their distinct local and spatial spillover outcomes. Employing a spatial Durbin difference-in-differences (SDM-DID) model on city-level panel data (2008–2022), we identify a stark contrast in the effects of the two policy types on urban low-carbon innovation. The LCC policy generates weak direct effects within pilot cities but induces strong positive spatial spillovers, significantly promoting low-carbon innovation in neighboring cities. Conversely, the CET policy robustly stimulates innovation within pilot areas but exhibits virtually no significant spillovers and may even suppress exploitative innovation in surrounding regions. Mechanism analyses indicate that both types of policies enhance innovation by elevating governmental environmental attention and boosting R&D investment, albeit with divergent spatial ramifications. Heterogeneity analyses further reveal that the LCC approach fosters both exploratory and exploitative innovation across regions, while the CET’s impact remains concentrated locally. Our findings underscore the strategic complementarity between the two policy types and highlight the critical importance of accounting for spatial interdependence and the pattern of opposing types of innovation that the policies tend to stimulate, when designing environmental regulations.