Does Environmental Regulation Help Mitigate Factor Misallocation?—Theoretical Simulations Based on A Dynamic General Equilibrium Model and the Perspective of TFP

Abstract

How environmental regulation affects factor allocation is becoming an emerging hot topic in academia. In this paper, we construct a dynamic general equilibrium model accommodating environmental regulatory shock based on the H-K framework to explain the impact of environmental regulation on factor misallocation from the perspective of aggregate total factor productivity loss changes, and numerical simulation results are provided for several representative scenarios. The results show that environmental regulation has a significant effect on factor market misallocation, but this effect is not simply positive or negative, and it mainly depends on the firms’ initial factor allocation status and the intensity of the shock. Reducing the intensity of environmental regulation for firms that face stronger distortion helps mitigate factor misallocation and, on the contrary, the same policy could exacerbate factor market misallocation. Under the environmental regulatory shock condition, firms’ overhead labor input has a moderating effect on the factor allocation mitigation of environmental regulation. Distorted firms’ higher overhead labor share inhibits the correction of factor misallocation by environmental regulation. And reducing firms’ overhead labor share amplifies the correcting effect of environmental regulation on factor misallocation.