The Size Distribution of Firms and Industrial Water Pollution : A Quantitative Analysis of China

We show that misallocation across firms amplifies industrial pollution by distorting the firm size distribution in China. The empirical evidence suggests that larger firms tend to use clean technology but face higher distortions. In a heterogeneous firm model with an endogenous choice of pollution treatment technology, we show that size-dependent distortions lower the adoption rate of clean technology, amplify pollution intensity, and lower output. The quantitative results show that, on average, eliminating size-dependent distortions would increase output by 30% and decrease pollution by 20%, while environmental regulations that decrease pollution by similar magnitude have a limited effect on output