Environmental Regulation, Heterogeneous Firms, and Resource Reallocation

We develop and estimate a structural framework for production with heterogeneous firms, endogenous emissions, costly abatement, and firm-specific regulatory stringency. The unified framework accommodates several popular regulatory forms and can be estimated using firm-level production and emissions data without observing abatement expenditures. Applied to China’s non-metallic mineral products industry under an emissions-intensity standard, the model recovers firm-level productivity, the shadow price of emissions, and the implicit output subsidy rate. We show that ignoring abatement understates productivity by an average of 10.8 log points, with larger biases among less productive firms. Counterfactuals show that tighter regulation generates increasingly large industry-surplus losses and reallocates market shares toward less productive firms. An emissions-trading benchmark substantially reduces these losses by reallocating emissions toward firms with higher marginal values of emissions, allowing aggregate emissions to fall by about 44% while preserving industry surplus.