| Abstract: |
This paper develops a general equilibrium model with heterogeneous firms to
analyze the effect of default risk on production-generated pollution
emissions. The model analytically divides the effect of default risk into
three distinct effects: the market-size, technology-upgrading, and selection
effect. Conceptually, an increase in default risk raises equilibrium borrowing
costs, thereby precluding investment in a technology upgrade among a subset of
firms (technology-upgrading effect). As a consequence, the economy consists of
more numerous (market-size effect) but less productive and more
pollution-intensive firms (selection effect). Because the effects are
confounding in nature, the effect of default risk on aggregate pollution
emissions and emissions intensity is an empirical question. To answer this
question, this paper estimates the model’s key parameters using a unique
dataset with establishment-level credit scores and a composite measure of
pollution emissions for a panel of manufacturing firms in the United States.
Using a two-step procedure where default risk is estimated in the first stage,
the results indicate that the estimated elasticity of emissions intensity and
productivity with respect to default risk is 0.89 and -0.16, respectively.
Next, I use the theoretical model to leverage the coefficient estimates to
estimate the effect of economy wide default risk on aggregate pollution
emissions, demonstrating that default risk increases aggregate emissions and
emissions intensity, primarily as a consequence of the technology-upgrading
effect. Finally, this paper demonstrates that historical changes in
economy-wide default risk can generate economically significant changes in
pollution emissions. |