Environmental regulation has become one of the most important driving forces underlying sustainable development and the transformation of the pattern of economic development. The water pollution incident in Lake Taihu(2007), called Lake Taihu Water Crisis, has provided a typical study case to reveal the relationship between environmental regulation and economic development. First, through the case study of Lake Taihu Water Crisis, this study compared the approaches and policies of environmental regulation before and after the Lake Taihu Water Crisis. Second, this study summarized the existing literature and developed a new theoretical framework focusing on the impacts of environmental regulation on the optimization and performance of manufacturing industries. Finally, such a new framework was validated based on a quantitative assessment of the relative strengths of environmental regulation policies and an analysis of factors affecting industrial performance. The quantitative assessment of the strengths of environmental regulation policies showed that, after Lake Taihu Water Crisis, during 2007 2009, the environmental regulation has been gradually stronger. The average strengths of government regulation, technological regulation, marketing regulation and social regulation during 2007 and 2009 increased by 2.2, 1.0, 2.6, 0.7 times than the average strengths during 2001 2006. The government not only used administrative commands(government regulation), but also tried to employ market-based regulation approaches on pollution control. However, the environmental regulation is still focused on the governmental regulation approach which has not been changed. Regression results showed that the environmental regulation manifested by the constrains of enterprises'entering in pollution sectors and the encouragement of high-efficiency technologies, has resulted in the optimization of manufacturing industries and the productivity improvement in Wuxi, which also countered the negative impact of rising production costs brought by regulation. However, innovation is still not the main driving forces of industrial performance enhancement. This paper contributes to our understanding of the theories concerning the pattern of sustainable economic and environment-friendly development and the applicability of different environmental regulation approaches.