The spatial effect of fiscal decentralization and factor market segmentation on environmental pollution

Externality is a form of market failure, and also a starting point for government intervention. Environmental quality, as local public goods, has a characteristic of regional spillover, thus the intervention of government is crucial. Fiscal policy is widely seen as an effective tool for environmental management. The existing literature about fiscal decentralization's effect on environmental pollution did not consider about spatial correlation in factor market segmentation. To explore such decentralized effect through factor distortions, we develop a two-sector model on the constraint of pollution emissions and market segmentations, and conduct an empirical estimation using Chinese provincial panel data from 15 years. The results show that there is a big difference between expenditure and revenue decentralization on pollution, furthermore, market segmentation exacerbated the environmental effects of fiscal decentralization and its positive role on environmental pollution is statistically more significant. Therefore, a better way out of pollution for policy making viewpoint is to adjust the decentralization structure and to break the productive factor market segmentation.