Over the past 40 years of reform and opening-up, China relies on economic reform and opening-up, resource investment, and demographic dividends to create a "miracle of China′s economic growth", but at the same time, the problems of environmental pollution and ecological damage brought about by China′s early extensive economic growth mode with high investment, high consumption and high pollution have become increasingly prominent. Factor-driven development at the cost of resource consumption and environmental pollution is unsustainable. China urgently needs to change the traditional economic growth mode and develop a new driver of economic growth. In order to break through the bottleneck of economic development and shape new advantages of economic development, the report of the 18th National Congress of the Communist Party of China clearly proposed the implementation of innovation-driven development strategy, highlighting the important role of innovation in economic development. At present, the Chinese economy is in a critical period of transition from high-speed growth to high-quality development. 〖JP2〗To accelerate the transformation of the economic development mode and promote the industrial upgrade, we must closely focus on the innovation-driven development strategy and rely on scientific and technological innovation to accelerate economic development. From this perspective, innovation-driven industrial upgrade is not only a major theoretical and practical issue, but also an important way to take into account environmental protection and sustainable, high-quality economic development. Industrial upgrade is the key tool for coordinating the economic development and environmental protection. On the one hand, industrial structure is directly related to how the economic system uses resources and discharges wastes, which is a converter of natural resource inputs, as well as a control system for the types and quantities of pollutants. On the other hand, environmental regulation will increase the cost of enterprises, and these enterprises have to adjust their production behavior, which leads to industrial upgrade. Therefore, it is essential to combine the research on industrial upgrade with environmental protection.
    Most of the existing studies that estimate the effects of environmental regulation on social and economic output. Firstly, they identify the effects of environmental regulation on environmental quality (Auffhammer & Kellogg, 2011) and health (Tanaka, 2015). Secondly, they test the pollution haven hypothesis (Cai et al. 2016; Wu et al., 2017), namely, FDI flows into regions with lax environmental regulation. Thirdly, they investigate how environmental regulation affect innovation and industrial competitiveness so as to test the Porter hypothesis (Albrizio et al.2017). In recent years, however, few papers (Shi and Zhao,2017) show that environmental regulation is conducive to industrial upgrade. The Two Control Zone (Acid Rain Control Zone and SO2 Pollution Control Zone, TCZ) policy that China began to implement in 1998 eased the trend of increased air pollution, but the influence of this policy on the regional industrial upgrade and its mechanism of action have rarely been investigated. This study uses the opportunity provided by the TCZ policy to test whether and how environmental regulation affects regional industrial upgrading. To overcome the possible endogenous problems of the influence of environmental regulation on the industrial upgrade, the research selects TCZ as quasi-natural experiment. Compared with previous studies, this paper provides a new perspective for evaluating the effects of environmental regulation and confirms that stringent environmental regulation benefits regional industrial upgrade mainly through technological innovations over time.
    Given the above theoretical and reality background, this paper applies a panel data of 282 cities in China from 1994 to 2010, and the data resources are from China Statistical Yearbook, China City Statistical Yearbook, and China Patent Office Patent Statistics Database. This paper focuses on whether China′s environmental regulations can promote industrial upgrade while controlling environmental pollution. The research process is conducted through the following procedures. Firstly, this paper selects policy as the quasi-natural experiment and uses the difference-in-differences models to discuss the influence of environmental regulation on regional industrial upgrade. Secondly, this paper divides all observations of China′s city data into three subgroups data of such region as east, middle, and west, and empirically analyzes the regional heterogeneity of the transformation and upgrading. Finally, this paper tests three possible mechanisms of TCZ policy on regional industrial upgrade.
    We find that compared with non-control areas, environmental regulation has markedly boosted regional industrial upgrade since TCZ policy is implemented in 1998. Moreover, the marginal effect of the policy on the whole is decreasing over time. Meanwhile, the effect of the policy varies across such regions as eastern, middle and western areas, namely, the effect is more pronounced in central areas than the other areas. Further study confirms that environmental regulation promotes regional industrial upgrade not through capital-deepening (proxy by total fixed assets), FDI spillover but through technological innovation (measured by the patent application number). After a series of robustness tests, the conclusions of this paper still hold.
   Based on the above conclusions, this paper draws the following policy implications on how to effectively implement environmental regulation policies to incentive innovation-driven regional industrial upgrade. Firstly, further perfect improve environmental regulation system in China, namely, it is necessary to further strengthen environmental regulation based on institutionalized and normalized environmental protection system and mechanism to facilitate the regional industries transformation and upgrading. Secondly, carrying out differentiated environmental regulation policies. Our research confirms that environmental regulation does not significantly promote the transformation and upgrading of the eastern region, which doesn′t exclude the possibility of the transfer of pollution industries in the eastern region to other regions, especially the western region. Therefore, in the process of undertaking the industrial transfer in the eastern region, the central and western regions should pay attention to the "zoning policy" in the layout of pollution industries. Finally, further launch the strategy of innovation-driven development, and come to establish a long-term mechanism to promote sustainable economic development relying on technological progress. Meanwhile, we should effectively activate other paths such as FDI that affect the transformation and upgrading of regional industries to push our economy forward high-quality development and build "beautiful China" in the future.