Impacts of Market‐based Environmental Regulation on Green Total Factor Energy Efficiency in China

• Published date: 01 May 2023
• Author: Ge Li,Da Gao,Yi Li
• Date: 01 May 2023
• DOI: http://doi.org/10.1111/cwe.12485

©2023 Institute of World Economics and Politics, Chinese Academy of Social Sciences

China & World Economy / 92–114, Vol. 31, No. 3, 2023

92

Impacts of Market-based Environmental Regulation

on Green Total Factor Energy Effi ciency in China

Ge Li, Da Gao, Yi Li*

Abstract

This study employed a difference-in-differences design to assess the effect of market-

based environmental regulation on green total factor energy effi ciency (GTFEE) in a

quasi-natural experiment that investigated China’s carbon emissions trading scheme

(ETS). The empirical results show that ETS had a positive eff ect on GTFEE. A series

of robustness tests revealed that the results were robust. Potential mechanisms through

which ETS can improve GTFEE include the promotion of technological innovation and

the upgrading of industrial structure. The positive eff ects varied in diff erent cities and

different regions – the result was pronounced in eastern China and developed cities,

but it was insignifi cant in central and western areas and developing cities. This study

confi rms the satisfactory performance of China’s ETS in improving GTFEE, and this is

relevant for other emerging countries.

Keywords: carbon emissions trading schemes, difference-in-differences, green total

factor energy effi ciency, market-based environmental regulation

JEL codes: O44, Q56, Q58

I. Introduction

Energy consumption, including consumption of coal, oil, and natural gas, has increased

considerably with economic development. However, the use of these fossil fuels has

caused severe environmental pollution (Gao et al., 2022). China ranks first in energy

consumption among all countries. Its energy consumption accounted for 26.5 percent

of the world’s total in 2021, with up to 5.24 billion tons of standard coal utilized (BP,

2022). As fossil fuels are nonrenewable, uncontrolled consumption will lead to resource

exhaustion (Shi et al., 2021; Perkins, 2023), whereas increasing the green total factor

*Ge Li, Lecturer, Glorious Sun School of Business and Management, Donghua University, China. Email: lige@

dhu.edu.cn; Da Gao (corresponding author), Associate Professor, School of Law and Business, Wuhan Institute

of Technology, China. Email: gaoda@hust.edu.cn; Yi Li, PhD Candidate, Food and Resource Economics,

University of Florida, US. Email: yi.li1@ufl .edu. This work is supported by the Fundamental Research Funds for

the Central Universities in Donghua University and Shanghai Soft Science Research Project (No. 23692120100).

©2023 Institute of World Economics and Politics, Chinese Academy of Social Sciences

Environmental Regulation and Green Total Factor Energy Effi ciency 93

energy efficiency (GTFEE) can guarantee economic growth and reduce energy input

(Choi et al., 2012). Ineffi cient energy usage is harmful to the environment. Increasing

the GTFEE, which includes both energy input and pollution emissions, is the best way

to address the dual issues of energy shortage and environmental pollution; it helps to

decrease pollutant emissions and meet economic targets. Improving energy effi ciency

eff ectively is therefore essential for China’s sustainable economic development.

Faced with severe energy and environmental problems, the Chinese government

has adopted a series of environmental regulation instruments. These mainly include

command-and-control environmental regulation and market-based environmental

regulation. Implementing the carbon emissions trading scheme (ETS) appears to be

the primary method to combat the climate crisis. The ETS is a typical use of the Coase

theorem, which postulates that under the premise of clear property rights and zero or low

transaction costs, externalities can be eliminated through market transactions, to solve

environmental externalities. The government allocates a certain number of “emission

permits” to enterprises and allows them to trade freely like commodities. Hence, under

the market mechanism, the government can realize the emission of the same amount of

pollution at a lower economic cost. As a market-based form of environmental regulation,

the ETS has been adopted widely in developed countries, and a growing body of

literature has emerged studying the design and eff ectiveness of the ETS (Choi and Chao,

2019; Makridou et al., 2019). However, due to countries’ varying political, economic,

and cultural backgrounds, the research on ETS in developed countries has limited

relevance to China. A considerable amount of the current literature on China’s ETS also

specifi cally considers its role in carbon emissions and technological change (Hu et al.,

2020), and, therefore, the eff ect of China’s ETS consequently needs further discussion.

Closely related to this is the issue of how China’s ETS affects GTFEE. What is the

role of ETS in GTFEE? What are the underlying mechanisms? Does the impact of ETS

on GTFEE vary from region to region? These are the critical issues discussed in our study.

Using a dataset of 273 cities in China from 2003 to 2018, we introduced a difference-

in-diff erences (DID) design to study whether and how ETS aff ected GTFEE. This study

explored two plausible mechanisms through which ETS could aff ect GTFEE: technological

innovation and industrial structure upgrading. We also conducted a series of robustness

checks, including a placebo test and a variable substitution test, and excluded the eff ects of

other policies. The heterogeneity of the impact in diff erent regions is discussed. The above

studies provide a valuable resource for further improving China’s ETS.

This paper contributes to the fi eld in the following ways. First, it enriches the current

body of literature on the evaluation of the effectiveness of ETS from the perspective

of GTFEE. Earlier literature concentrated mainly on the impact of ETS on carbon