This process, together with coal washing used to remove impurities from coal pre-combustion, requires large quantities of water. Thus, a second factor in the choice of location for coal-fired power plants is the proximity to a body of water.

Naturally, these general considerations were also relevant for the choice of location of the power plants in our sample. Chile has few coal deposits, which have mostly been depleted over the years. The majority of the coal used in electricity production has been imported, hence the usefulness of the proximity of coal plants to a port. The ports of Antofagasta and Huasco are close to local copper mines, that are heavy users of electricity. Valparaiso, also a port, is close to Santiago, a big demand center. Coronel is in the proximity of the main coal mines in Chile. These have been mostly depleted by now and the power-plants in this area are being phased out. In summary, while both access to inputs, such as coal and water, and transmission costs related to supplying electricity to demand centers are important, the location of coal-fired power plants in Chile appears to be mainly in order to minimize production costs, see, for example, Smith (1973). Coal-fired power plants are among the most polluting. While the amounts of pollutants released in the atmosphere depend on the grade and quality of the coal used, emitted pollutants always include significant amounts of nitrogen oxides (NOx), sulfur oxides (SOx), as well as particulate matter (PM2.5), in addition to greenhouse gases like carbon dioxide (CO2) and methane (CH4). We will concentrate on particulate matter (PM2.5) in what follows.

# **3.2 Coal-fired power plants as a valid instrument**

Our analysis focuses on city-level pollution and productivity data from Chile. As noted by Graff Zivin and Neidell (2012), several issues emerge when identifying the causal relationship between pollution and labor productivity. First, selection issues arise from how workers allocate their labor in the presence of high pollution levels. Given that most databases use annual frequency, workers who experience negative effects from local pollution may in the meantime decide to leave the area and work in a different region, or transition to a different sector that is less exposed to pollution. This labor mobility may occur within a year. Another potential source of concern is the presence of a confounder and the possibility of simultaneity bias. Increases in economic output lead to corresponding increases in energy demand. If the response of the energy supply is mainly through an increase in fossil fuel use, this could also lead to an increase in pollution. Arguably, this raises concerns about the orthogonality between pollution, PM2.5, and labor productivity. This, in turn, could affect the unbiased and consistency properties of any coefficient estimate. Several controls and instruments have been used in the literature to overcome the non-orthogonality issue. Given that we require one instrument for our explanatory variable, we can estimate the effect of pollution on labor productivity consistently using an IV-regression. In our case, the instrument needs to be strongly correlated with pollution (PM2.5) and uncorrelated with labor productivity.

We argue that the installation of fossil fuel power stations, specifically coal and diesel-fired power stations, can serve as such an instrument. Two arguments support this assertion. First, power stations plug into four regional grids, and are hence isolated from productivity developments that are specific to certain sectors and cities. Regional time fixed effects can control for regional specific effects related to productivity. Finally, as mentioned earlier, while both transportation costs for inputs and transmission costs related to proximity to demand centers are important determining factors, consistent with other countries, the location of coalfired power plants in Chile appears to have been mainly driven by supply-side considerations. While there is no formal exogeneity test, our analysis shows that coal-fired power-plants are not correlated with labor productivity. In summary, we employ coal-fired power-plants, as their operation is highly correlated with PM2.5 and largely uncorrelated with labor productivity. We note that while this study focuses on PM2.5 that causes respiratory problems, other pollutants that affect labor productivity also exist.

5