Firm Presence, Pollution, and Agglomeration: Evidence from a Randomized Environmental Place-Based Policy

Firm location decisions are a key managerial choice, usually optimized over factors like proximity to customers or suppliers. These decisions may also impose externalities on the environment, and on other firms due to competitive or agglomerative forces. The inherent endogeneity of location decisions makes estimating the impact of firm presence difficult. In this paper, we study an environmental place-based policy that randomly moved over 20,000 small firms in New Delhi to industrial areas outside the city over several years. We find that a reduction in firm presence improves air quality, reducing industrial pollution by 8% for the average neighborhood. However, industrial relocation is costly for firms, significantly increasing the probability of firm exit. We combine the exogenous assignment of firms to industrial plots with a model of firms playing a game of incomplete information to estimate the effect of neighborhood composition on firm survival through Marshallian agglomeration forces. We find that proximity to neighboring firms with input-output linkages increases the likelihood of firm survival, and taking these into account while determining firm placement in industrial areas would have halved the costs imposed on firms by the policy. These results provide causal evidence on the trade-offs between firm presence and environmental quality, and show that firm spillovers can be a useful force to minimize the costs on regulated firms.