Factor substitution and decomposition of carbon intensity in China's heavy industry

The heavy industry, which accounts for over 60% of China's total primary energy and electricity consumption, has contributed largely to the worsening environmental pollution and CO2 emissions. This study adopts two-stage estimation based on translog cost function to decompose changes in energy related carbon intensity into substitution effect, technological progress effect, output effect and budget effect. The empirical results show that all the inputs (capital, labor and energy) are substitutes, and the substitution between labor and energy have the highest degree of responsiveness. This is a clear indication that increasing labor inputs in the production process will reduce energy consumption and CO2 emission while improving the worsening environmental problems in China. Also, the empirical results show that about 45.77% change in carbon intensity is attributable to capital-energy and labor-energy substitutions, which affirms the success of any policy by the government to increase labor and capital inputs at the expense of energy use towards CO2 mitigation agenda.