Trade Growth, Production Fragmentation, and China's Environment

Trade growth for a relatively poor country is thought to shift the composition of industrial output towards dirtier products, aggravating environmental damage. China's rapidly growing trade and serious environmental degradation appear to be no exception. However, much of China's trade growth is attributable to the international fragmentation of production. This kind of trade could be cleaner, if fragmented production occurs in cleaner goods, or if China specializes in cleaner stages of production within these goods. Using Chinese official environmental data on air and water pollution, and official trade data, we present evidence that (1) China's industrial output has become cleaner over time, (2) China's exports have shifted toward relatively cleaner, highly fragmented sectors, and (3) the pollution intensity of Chinese exports has fallen dramatically between 1995 and 2004. We then explore the role of fragmentation and FDI in this trend toward cleaner trade. Beginning with a standard model of the pollution intensity of trade, we develop a model that explicitly introduces production fragmentation into the export sector. We then estimate this model using pooled data on four pollutants over ten years. Econometric results support the view that increased FDI and production fragmentation have contributed positively to the decline in the pollution intensity of China's trade, as has accession to the WTO and lower tariff rates.