Principal Moral Hazard, Environmental Regulatory Biases, and Strategic Interaction among Chinese Local Governments

Abstract

Principal moral hazard is one of the major concerns that generates undesired and inefficient governance outcomes. Although the principal moral hazard theory is very well-established, little empirical evidence has been provided on how principal moral hazard is operating in practice and what consequences it brings about. In analyzing environmental enforcement activities of the Chinese central government, this dissertation provides the first systematic examination on principal moral hazard using observational data. The specific findings and contributions of this study are as follows. First, it empirically demonstrates the detrimental effects of principal moral hazard. Chapter 2 shows that under-enforcement by the central government stimulates local governments to give up the race-to-the-top competition, while over-enforcement tends to deter the local actors from participating in the game of race to the bottom (yet has no significant effect on the race-to-the-top activities). The results indicate the importance of setting the right incentives on the efficiency of regulatory competition and reveal the consequences of principal moral hazard. Second, in order to prevent the principal moral hazard from happening, we should better understand the factors that lead to regulatory biases. Chapter 3 shows that political connections between local officials and provincial leaders reduce the probability of overenforcement or increase the probability of underenforcement that cities experience. Put differently, a locality with politically connected officials likely has greater advantages relative to its peers regarding environmental inspection and enforcement activities conducted by the central environmental regulatory agency. Although the specific factors that associated with the biased regulation may vary depending on the research contexts, they all pointed to the potential problems with politically-oriented enforcement. Also, the last empirical chapter examines whether and how environmental regulatory biases can be corrected. Despite Miller and Whitford (2016) proposes that keeping bureaucratic independent and “above politics” is a potential solution to the principal moral hazard, it should be very costly and unrealistic for an authoritarian country like China. Therefore, Chapter 4 explores whether information disclosure and public awareness could affect regulatory behaviors and biases, which could be achieved relatively easily. The results show that increased public awareness on air issues stimulates the central government to increase air enforcement intensity and remedy prior slack enforcement of air quality standards. At the same time, the under-enforcement of air pollution standards is reduced while the probability of over-enforcement is increased. Although it is possible this over-enforcement is appropriate to encourage better environmental performance, the biases in the regulatory process may undermine environmental performance as over-enforcement reduces the benefits of compliance, offsetting the positive effects of the enforcement. In conclusion, the empirical evidence gives strong support to the theoretical argument and prediction of the principal moral hazard theory. However, several remaining issues require further exploration in order to better understand the phenomenon of principal moral hazard and prevent it from happening. At the end of the concluding chapter, from a practical perspective, I discuss why improving professionalism is essential for improving environmental governance in China and conducting unbiased enforcement should be the first step.