Unintended Environmental Consequences of Government Subsidies: Evidence from Chinese Industrial Firms

Government subsidies can alleviate firms’ financing constraints and facilitate production expansion, but they may also increase pollution emissions. Their environmental consequences depend on the relative effects of production expansion and improvements in environmental efficiency. By matching data from the China Environmental Statistics Database and the China Industrial Enterprise Database, this study examines the relationship between government subsidies and firm-level pollution emissions using firm fixed effects and multidimensional interacted fixed effects. The results reveal a significant positive association between government subsidies and firms’ chemical oxygen demand (COD) emissions. This finding remains robust to alternative pollution measures, entropy balancing, double machine learning, and instrumental variable estimation. An examination of firms’ responses shows that government subsidies are associated with higher industrial output, greater resource consumption, and increased wastewater discharge. At the same time, subsidies are associated with lower industrial water use and wastewater discharge per unit of output, as well as higher COD removal rates, suggesting that production expansion and improvements in environmental efficiency may occur simultaneously. Further analysis reveals a significant convex nonlinear relationship between government subsidies and pollution emissions. Firms’ information technology infrastructure weakens the positive relationship, whereas a larger existing capital stock strengthens it. These findings suggest that improvements in resource-use efficiency and pollution abatement may be insufficient to offset the additional emissions associated with production expansion. They highlight a potential trade-off between promoting firm production and controlling pollution through fiscal support, providing firm-level evidence to inform assessments of the environmental consequences of general government subsidies and the design of subsidy policies.