When pollution improves efficiency: air quality and labour investment in firms

Using Chinese listed firms outside heavily polluting industries from 2009 to 2020, we show that higher local air pollution raises measured labour investment efficiency. We identify this effect using city-level thermal inversions and atmospheric ventilation coefficients as instruments for pollution. We explain the pattern through government pressure reallocation. Local governments face simultaneous targets for growth, employment stability, and environmental improvement. When pollution increases environmental scrutiny on high-polluting industries, firms outside those industries, especially local state-owned enterprises and politically connected firms, become key carriers of growth and employment objectives. Consistent with this mechanism, pollution increases a local multi-objective pressure index, and the estimated effect is strongest where multi-objective pressure is high. Firm-level evidence shows that the adjustment is accompanied by higher employee welfare spending. The apparent improvement is not followed by higher productivity, profitability, or market value, and it sometimes predicts weaker performance. These findings show that pollution reallocates policy pressure and induces labour expansion by firms with capacity to absorb social and employment responsibilities. Our study reveals a hidden organizational cost of air pollution.