The impact of environmental regulation on productivity with co-production of goods and bads

Governments have implemented various environmental regulation policies to improve environmental performance by reducing undesirable economic outcomes. These policies may shock productivity as they change the input allocation, economic outputs, and pollutant emissions. One widely ignored fact in related literature is that goods and bads are co-produced, in which the latter is jointly generated as the byproduct. However, ignoring the co-production of goods and bads may bias the estimation, especially tend to conclude that environmental regulation and productivity are inversely related. In this paper, by incorporating the co-production of goods and bads into the empirical framework to measure productivity, we estimate the productivity shocks from environmental regulation, especially explore how these shocks take place. Using an exogenous instrumental variable to overcome endogeneity, we found that a country increasing environmental regulation from 25th to 50th quantiles improves its productivity by 28%, yet the magnitude of the effect would be 44% by catching up with the technology frontiers worldwide. The results suggest that environmental regulation improves productivity but depresses technology progress. Using innovation data, we provide further evidence of the finding. Furthermore, productivity shocks from market-based measures are estimated to be more substantial than those from non-market-based measures. We anticipate this paper to provide empirical evidence for a better understanding of the economic implications associated with policy interventions in the context of sustainable development. •Co-production of goods and bads is used to measure productivity.•Using instrumental variables to solve endogeneity of environmental regulation.•Exploring mechanisms of how environmental regulation affects productivity.•Heterogeneous effects from different regulating measures are identified.•Providing empirical evidence on the policy outcomes for sustainable development.