Credit Constraints, Technology Upgrading, and the Environment

Access to credit is indispensable to financing firm investment and therefore bears on technology decisions and in turn environmental performance. 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 (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 that, using variation in the timing of credit market reforms, reducing credit constraints significantly improves air pollution (sulphur dioxide and lead concentrations) in both developing and developed countries. The results are robust using various approaches, including two-way fixed effects, lagged dependent variables, and difference-in-differences.