Credit Constraints, Technology Upgrading, and the Environment

This paper develops a tractable general equilibrium model to analyze the effect of credit constraints on production-generated pollution emissions. The model demonstrates that reducing credit constraints increases the scale of production (scale effect) and increases the number of firms taking up production (market-size effect), while it also reduces emissions per unit of output (technique effect) and increases the share of firms investing in the technology upgrade (upgrading-composition effect). Because the former and latter effects are plausibly confounding in nature, the net effect of credit constraints on pollution emissions is an empirical question. This paper demonstrates, using variation in the timing of credit market reforms, that reducing credit constraints significantly improves air pollution. The results are robust using various approaches, including difference in differences (DID) with a rich set of controls, and an alternative DID approach, wherein the time series data are collapsed around credit reforms into a pre- and post-period.