Opening the Brown Box: Production Responses to Environmental Regulation

Abstract

We study manufacturing firms' production responses to an emission capping regulation. Firms lower emissions by improving energy efficiency, substituting towards cleaner fuels, and moving from producing electricity to purchasing it from the grid. They move away from coal-intensive products and increase their abatement expenditures. These changes improve firm productivity, supporting theories that regulation prompts technology adoption. In the aggregate, we document lower product variety and an altered firm-size distribution, driven by a reduced likelihood of business formation. Our findings highlight the mechanisms behind how mandated pollution reduction can be effective and the costs it imposes, suggesting a loss of agglomeration externalities.

Keywords: Abatement, Firm Production, Profitability, Environmental Regulation

JEL Classification: G18, G31, G38, Q50, Q58