With economic development and the change of industrial structure, industrial relocation is an inevitable trend. In the process of industrial relocation, environmental externality and social cost could occur due to market failure and government failure. Little attention has been paid to this issue. In this paper, we address it with a theoretical analysis and an empirical investigation on the relationship between China's industrial relocation in the early 1990s and energy consumption which is the primary source of CO2 emission, an environmental externality that causes increasing concerns. The macro-policy analysis suggests that there would be a positive link between China's industrial relocation in the early 1990s and energy saving (and environmental externalities reduction). Using fixed-effect regression model and simulation method, we provide an empirical support to this argument. In order to further reduce environmental externalities and social cost in the process of industrial relocation, we provide policy suggestions as follows: First, strengthen the evaluation of environmental benefits/costs; Second, pay more attention to the coordinated social-economic development; Third, avoid long-lived investment in high-carbon infrastructure in areas with industries moved in; Fourth, address employment issue in the areas with industries moved out. (C) 2011 Elsevier Ltd. All rights reserved.