Environmental regulation, endowment characteristics and income inequality: A general equilibrium analysis

Abstract

Environmental regulations such as the “dual carbon” target directly act on the restriction of the total amount of dirty capital to reduce carbon emissions. The change in factor endowment will have a range of effects on production and income distribution. To examine the effects of environmental regulations restricting dirty capital endowment on income distribution, this paper presents a general equilibrium model with two sectors and three factors. The unregulated clean capital-intensive sector is imperfectly competitive and features firm dynamics, using labor and clean capital as factors of production, while the regulated dirty capital-intensive sector is perfectly competitive using labor and dirty capital. We show that a decrease in the dirty capital endowment will reduce the output of the dirty capital-intensive sector and expand the clean capital-intensive sector in the long run, making society transition to green production. The tighter the restriction on the use of the dirty capital endowment is, the more firms will enter the clean capital-intensive sector, while the business-stealing effect will reduce the output of individual clean firms. We further show that the rents of both dirty and clean capital will rise while the wage of labor will fall due to the regulation. Changes in factor prices do not necessarily lead to inequality in income distributions. When the factor substitution effect in the regulated sector is large enough, clean production regulation will increase the share of labor income and decrease the share of capital income.