Factor distortions and carbon efficiency: the case of energy misallocation

The enhancement of carbon productivity necessitates the deployment of cleaner technologies, the establishment of robust policy frameworks, and the optimization of production factor allocation. This study examines the effect of energy misallocation on total factor carbon productivity (TFCP) using stochastic frontier analysis across 73 countries. Employing panel data from 1991 to 2023, we construct country-level relative misallocation indices for energy, capital, and labour, based on deviations between observed and theoretically efficient factor input shares. Our methodology involves fixed-effects models and several robustness checks, including dynamic panel analysis and policy-heterogeneity tests. The results reveal a strong negative correlation between energy misallocation and TFCP, whereas the impacts of capital and labour misallocation are comparatively weaker and less consistent. Energy over-allocation imposes a greater productivity cost than under-allocation, indicating that excessive energy consumption significantly impedes carbon-adjusted efficiency. This deleterious effect intensifies in later periods, coinciding with increases in economic scale, energy demand, and carbon constraints. Nevertheless, policy-heterogeneity tests, utilizing Environmental Policy Stringency indicators, demonstrate that environmental policies, particularly market-based instruments, partially attenuate this effect by strengthening price signals and incentivizing structural adjustments. These findings highlight energy allocation efficiency as a critical mechanism through which low-carbon transition policies can advance carbon productivity.