Unintended Environmental Consequences of Capital Goods Imports: Evidence From China

ABSTRACT This paper examines the environmental consequences of capital goods imports, employing China's subsidy policy as a natural experiment. The policy, which provides reimbursement to firms for the cost of imported capital, has an unintended impact on the environmental outcomes of firms. We employ the difference‐in‐differences methodology to distinguish between firms highly expose to the policy as the treatment group and less exposed ones as the control group. The results indicate that the subsidy policy significantly reduces firms' total chemical oxygen demand emissions by 21.2% and their emission intensity by 21.8%, revealing notable unanticipated environmental benefits of the policy. The reduction in emissions is primarily attributable to improvements in the production process rather than post‐production abatement. State‐owned firms and firms with a higher proportion of skilled workers exhibit more pronounced reductions. Additionally, our findings suggest that the import of capital goods fosters green innovation, a crucial mechanism through which the subsidy policy exerts an influence on emission reductions. This study offers insights into the environmental consequences of trade policies and the combined effects of production and innovation strategies in response to non‐environmental incentives.