Can Environmental Regulation Promote Domestic Market Integration? Evidence From China

: While local protectionism and market segmentation owing to fiscal decentralization are 31 not conducive to broad economic development, they may be rational choices on a local scale. Based 32 on a spatial Durbin model, we analyzed the relationship between environmental regulations and 33 market segmentation in China using interprovincial panel data for 2004–2018. The results indicated 34 that the “beggar-thy-neighbor” phenomenon persists in China; environmental regulations have a U- 35 shaped impact on market segmentation, i.e., in most regions, environmental regulations strongly 36 promote local market integration. Regions with greater decentralization are better able to promote 37 local market integration through environmental regulation, suggesting that local governments are 38 better able to compensate for market failures when vested with greater power. Hence, we propose 39 that the central government should improve performance evaluation indicators for local 40 governments and grant them greater autonomy; additionally, local governments should increase the 41 intensity of environmental regulations as appropriate, thereby promoting both environmental 42 protection and the unification of domestic markets. 43

Abstract: While local protectionism and market segmentation owing to fiscal decentralization are 31 not conducive to broad economic development, they may be rational choices on a local scale. Based 32 on a spatial Durbin model, we analyzed the relationship between environmental regulations and 33 market segmentation in China using interprovincial panel data for 2004-2018. The results indicated 34 that the "beggar-thy-neighbor" phenomenon persists in China; environmental regulations have a U-35 shaped impact on market segmentation, i.e., in most regions, environmental regulations strongly 36 promote local market integration. Regions with greater decentralization are better able to promote 37 local market integration through environmental regulation, suggesting that local governments are 38 better able to compensate for market failures when vested with greater power. Hence, we propose 39 that the central government should improve performance evaluation indicators for local 40 governments and grant them greater autonomy; additionally, local governments should increase the 41 intensity of environmental regulations as appropriate, thereby promoting both environmental 42 protection and the unification of domestic markets. 43 Keywords: environmental regulation; market segmentation; fiscal decentralization; spatial effect 44 45

Introduction 46
Since the reform and opening up, China has achieved tremendous economic growth owing to 47 its market-oriented reforms, particularly that of permitting the market to play a critical role in 48 allocating resources (Cui et al. 2019; Duan et al. 2019). History has indicated that rapid economic 49 development depends on efficient free markets, which thrive under integrated rather than 50 fragmented or isolated conditions (Jin et al. 2008; Lai et al. 2021). The unification of the domestic 51 market promotes competition, the development and application of new technologies, and the gradual 52 standardization of market rules, thus realizing the optimal allocation of resources. Therefore, 53 reducing market segmentation in favor of domestic integration, accelerating the establishment of a 54 competitive, orderly, unified, and open free-market system, and allowing the market mechanism to 55 play the decisive role in resource allocation have become important practical issues for the 56 development of China's market economy. 57 Since fiscal decentralization, the Chinese market has existed in a fragmented state. Market 58 segmentation can be measured via production (Young 2000), trade law (Poncet 2003), and relative 59 price (Parsley and Wei 1996) methods, which scholars have applied to conduct preliminary 60 assessments of market segmentation in China. Although some controversy exists regarding the trend 61 of market segmentation in China, economists generally agree that market segmentation is a major 62 problem. Segmentation reduces market efficiency and slows technological progress, which is 63 detrimental to both economic development and environmental protection ( in China has focused on local protectionism, which is generally considered a primary cause of 66 market fragmentation and is motivated by strong profit-based motives. Fiscal decentralization is 67 also a manifestation of local protectionism (Fan and Zhang 2010;Song et al. 2020). Fiscal 68 decentralization enables local governments to obtain a more reasonable distribution of financial and 69 administrative power; however, it can lead to self-promotion by local officials and the 70 implementation of "catch-up" strategies to more rapidly secure economic benefits, thereby leading 71 to over-intervention by the government and preventing market integration.

72
Domestic market integration is typically a gradual process, and market segmentation is not 73 unique to periods of economic transition. While the factors that lead to market segmentation are 74 diverse, they can be broadly categorized into institutional (Li et  increasing labor productivity. Li and Du (2020) showed that environmental regulation has a 97 significant spatial spillover effect on green innovation efficiency. Zhou et al. (2020) asserted that 98 spatial spillover and industrial structure effects are the main pathways through which environmental 99 regulations affect innovation, and Hu and Wang (2020) reported that environmental regulations have 100 significant spillover effects on interprovincial carbon productivity in China. In these contexts, 101 "spillover effects" represent the indirect effect of environmental regulations on reducing pollution 102 and increasing productivity; therefore, they can compensate for certain environmental market 103 failures, improve market efficiency, increase environmental welfare, and thus promote economic 104 specialization (often referred to as "division of labor" by Chinese policymakers), thereby facilitating 105 green economic development and technological progress by reducing domestic market 106 segmentation. 107 Considering these benefits, local governments have emphasized environmental regulation after 108 fiscal decentralization. However, when environmental regulations are extremely stringent, this can 109 negatively impact market effectiveness and ultimately exacerbate market fragmentation. Therefore, 110 research on the impact of environmental regulations on market segmentation, such as the present 111 study, has clear theoretical and practical significance. This study aimed to demonstrate that fiscal 112 decentralization leads to regional market segmentation by constructing an intertemporal decision-113 making model based on environmental welfare effects and to elucidate the theoretical mechanisms 114 by which environmental regulations affect market segmentation. Based on spatial econometric 115 methods, we also empirically analyzed the impact of environmental regulations on market 116 segmentation and examined spatial spillover effects. Finally, we comprehensively discussed the role 117 of fiscal decentralization in mediating the impact of environmental regulations on market 118 segmentation, thereby further testing the reliability of the model. welfare. Here, we first considered the environmental welfare effect ( 1 ), the microscopic effect on 125 human welfare attributable to ecological improvements (Welsch 2007). The conditional valuation 126 approach suggests that environmental welfare effect can be measured as the maximum cost that 127 people are willing to pay for environmental improvements (Costanza et al. 1998). For example, the 128 private costs of pollution are lower than the social costs, resulting in negative pollution externalities. 129 This social cost can be considered as the cost that society is willing to pay to secure environmental 130 improvements; therefore, the reduction in the environmental welfare effect caused by pollution is 131 equivalent to its total social cost ( ). Studies have indicated that the higher a society's level of 132 economic development ( ), the greater its preference for a good environment and therefore, greater 133 the loss in social welfare owing to pollution (Givens and Jorgenson 2011;Stern 2004). Thus, the 134 environmental welfare effect can be expressed as follows: 135 where ( ) denotes the total marginal social cost of pollution, which increases with ; 137 represents the amount of pollution. We assume that the private marginal cost of pollution ( ) and 138 the total marginal social cost ( ) do not vary with the amount of pollution. In a perfectly 139 competitive market, the private marginal cost of pollution is the price of pollution ( ) , i.e., the 140 economic cost that the public is willing to pay for a unit of pollution (goods). Thus, we can obtain 141 the socio-economic effect ( 2 ) of pollution as follows: 142 Since the social marginal cost of pollution is greater than the private marginal cost, the total 144 social effect must decline when pollution occurs, as shown in Eq. (3). 145 Negative externalities lead to an inconsistency between the private and social costs of pollution, 147 contributing to price-signaling failures and a certain degree of environmental market inefficiency 148 ( ), in which increases as the gap between the marginal social and private costs of pollution 149 becomes larger. Therefore: 150 where ( ) represents the increase in private marginal costs due to environmental regulations. 158 Our simple inter-period division of labor decision-making model based on environmental welfare 159 considers two regions (regions and ), two sectors (sectors ℎ and ), and two periods ( 1 and 160 2 ). Region has a higher degree of economic development; it has a comparative advantage in its 161 ℎ sector, which has achieved a high level of technological development and is largely based on 162 high-tech industries. Region has a comparative advantage in sector , which has a low level of 163 economic development and technology and is dominated by high-polluting and high-energy-164 consuming industries. Considering the objective existence of negative externalities due to 165 environmental pollution, environmental markets usually suffer from severe market failures. Thus, 166 we posit that such markets are characterized by severe inefficiency. In general, high-technology 167 sectors, due to the nature of their products, have weaker connections with and are less affected by 168 environmental markets, whereas low-technology sectors, which are often engaged in the production 169 of highly polluting products, are typically more affected by environmental markets. Therefore, for 170 model simplicity, we assumed that environmental market failures only exist in sector and region 171 .

172
The technological progress rate is faster in sector ℎ than in sector ; hence, we assumed a 173 "learning by doing" effect in sector ℎ and no technological progress in sector . To facilitate the 174 model solution, we combined Eq.
(3) and (4) based on the Cobb-Douglas effect function, an 175 integrated effect function was constructed to account for environmental welfare effects: 176 where ℎ and denote the consumption of products in sectors ℎ and , respectively, and 178 denotes the production in sector . We assumed that labor is the only input to the production process, 179 and it was standardized as 1. For model simplicity, we only considered the integration of product 180 markets, while market factors were assumed to be completely segmented and labor was assumed to 181 not be freely mobile across regions. Thus, the initial endowment of local labor is the labor input in 182 production. The relative initial technology attainment and rate of technological advancement in 183 sector ℎ in region are and , respectively, while regions and have no technological 184 advancement in sector , and the initial technology is set as 1. 185 186

Intertemporal division of labor decision-making assuming no cross-zone commodity flow 187
To consider the benefits of not dividing labor and assuming no time preference, regions and 188 must maximize the sum of the effects of two periods: 189 1 , 2 = 1 ℎ * 1 + 2 ℎ * 2 − ( 1 + 2 ) (7) 190 where 1 and 2 are the workforce assigned to sector ℎ in both periods; for region , = 0. In 191 this model, we could not accurately calculate the value of using Eq. (4). Therefore, we referred 192 to the calculation results of Wang et al. (2010) and let = 0.2. We assumed that there is no return 193 to scale in the production of sector, output is a linear function of time, and consumption is equal 194 to output. To distinguish between regions and , we used lowercase letters to indicate the effect 195 and output of region . Region has an initial technology and a rate of technological 196 advancement of 1 regarding product ℎ; its output in both phases is: 197 Through simple linear projection, we determined that the resource allocation and effect in 200 undeveloped region (without division of labor) are as follows: 201 Similarly, the output of developed region in the two sectors is: 203 Therefore, the resource allocation and effects in the two periods are: 206 Here, we used the condition of undivided labor (no economic specialization) to represent 208 extreme market segmentation, where production equals consumption in both regions and the 209 commodity market is completely separate. If this model represents the rational choice for lagging 210 region , then the implementation of environmental regulation would improve market efficiency 211 and allow the region to participate in the division of labor, it implies that the effect is larger than the 212 above-mentioned part of the effect (without division of labor). 213 214 2.2 Intertemporal division of labor decision-making model assuming inter-regional 215 commodity flow 216 We assumed that market integration entails a perfect division of labor (complete economic 217 specialization), wherein the lagging region allocates all its resources to the production of product 218 , with an output of 1 in each period. The developed region is responsible for the production of 219 product ℎ; the output in the first phase is , and that in the second phase is . Complete market 220 integration indicates that products and ℎ can be freely exchanged; it is assumed that the price of 221 product is 1, and the price of product ℎ is ( > 1). The transportation cost between regions 222 is represented as an "iceberg" cost. Assuming 1 unit of product is transported from one region to 223 another, only 1⁄ units ( > 1 ) of products can reach the destination ( represents the 224 transportation conditions between the two regions). Thus, the maximum two-period sum of effects 225 in region is: 226 Solving the linear programming problem yields: 229 Similarly, the effect in developed region is: 231 Under static division of labor conditions, the effect in lagging region is impaired, and the 233 following condition must be met: Because > 1 and > 1, Eq. (17) will be satisfied under normal conditions. At this time, 236 if region implements environmental regulations, it can be concluded from Eqs.
(3) and (5) that 237 the overall environmental welfare effect will increase (we also address special circumstances when 238 environmental regulations can cause the overall welfare effect to decline). 239 When environmental regulation is implemented in region , through Eqs. (4), (5), and (7), we 240 obtain: where * represents the effect of implementing environmental regulations in region , and ( ) 243 represents the improvement in market efficiency due to environmental regulations. When ( ) = 244 0.2, environmental regulations completely compensate for environmental market failures. 245 By contrasting Eqs. (10) and (13) with Eqs. (15) and (16), we can determine that the 246 environmental welfare effect actually decreases in region under divided labor and completely 247 free trade. This suggests that under both decentralization and a free market, the lagging region would 248 rationally choose not to divide labor and to adopt the strategy of market segmentation to achieve 249 greater economic gains. However, developed region would receive the entire benefit of the 250 "learning by doing" effect of the division of labor, and higher the relative price of product ℎ, the 251 higher the initial skill level, and faster the technological progress, more the benefit to region 252 stands; thus, the division of labor is more beneficial to region . For environmental regulations to 253 ensure that both regions are willing to integrate into a specialized economic system, the benefits of 254 the specialization must exceed the associated threats, thus satisfying the following formula: 255 Since > 1, Eq. (19) also indicates that the greater the technological gap between regions, 257 the greater the transportation costs and the greater the intensity of environmental regulations needed 258 to make region willing to integrate into the division of labor system.

259
To simplify the model, we assumed that production factors cannot flow freely. If we relax this 260 assumption, then under the conditions of division of labor, when environmental regulations are 261 implemented in region , according to the "pollution haven" theory (Candau and Dienesch 2017; 262 Shao et al. 2019a), the production factors of sector will be transferred to region , thus increase 263 pollution in region and reduce the environmental welfare effect. In this scenario, region will 264 often adopt a non-division of labor strategy; therefore, the implementation of local environmental 265 regulations may lead to aggravated market segmentation in neighboring regions. 266 267

Evolution of environmental regulation and market segmentation 268
We used the "relative price method" to measure the degree of market segmentation in China, 269 For specific calculation methods, please refer to Lu and Chen (2009). The "price method" measures 270 the degree of market integration using data on the differences in the relative price of various 271 commodities between regions. Then, trends in these relative prices are considered over time. If the 272 price trends converge, it indicates that the transaction costs between regions have decreased, a sign 273 of market integration. We note that the western region's market segmentation index declined the fastest and to a greater 296 extent than the national average, whereas that in the east declined the slowest.  1 was used as a measure 304 of environmental regulatory intensity and 2 as a stability test. Fig. 3 and 4 present temporal  305 trends in the intensity of environmental regulations in China and its three major regions, and 306 represents the total investment in industrial pollution control. Fig. 3 indicates that the intensity of The implementation of environmental regulations directly compensates for some 328 environmental market failures, resulting in increased inter-regional market efficiency and changes 329 in regional economic strategies. To accelerate the process of market integration between different 330 regions, the establishment of different environmental regulatory policies could be a primary strategy 331 adopted by local governments. When we compare temporal trends in market segmentation and 332 environmental regulation, we see that market segmentation reached a local minimum in 2014 and 333 environmental regulation reached a local maximum in 2014, the first official year of the "new 334 normal" economic plan. This shows that macroeconomic policies have a great impact on national 335 market integration and environmental protection. We also note that market fragmentation declines 336 more rapidly in the West when a higher intensity of environmental regulations is adopted in this 337 region. This is because the implementation of environmental regulatory policies in the West makes 338 the region more willing to cooperate with the East in the division of labor and promotes market 339 integration. Although in the second part of this study, the specific impact mechanism of 340 environmental regulation on market segmentation is modeled and analyzed, there is no empirical 341 evidence that environmental regulations break down domestic market segmentation; hence, the 342 effect of environmental regulations on market segmentation needs to be further verified through 343 empirical analysis. In the empirical analysis described in Section 4, to avoid underestimating the 344 regression coefficients, we multiplied the environmental regulation coefficient by 1000.  Year

Model construction and data sources 386
From Section 2.3, we can see that Chinese provincial market segmentation has significant 387 spatial autocorrelation, and the impact of environmental regulations on market segmentation may 388 also have spatial spillover effects, that is, foreign environmental regulations may affect local market 389 segmentation. Therefore, we adopted a specific-to-general approach and selected a spatial Durbin In Eq. (21), , −1 denotes the explanatory variable, is the spatial autoregressive 395 coefficient of market segmentation, denotes the coefficient of the explanatory variable, 396 denotes the coefficient of the spatially lagged term of the explanatory variable, and , is the error 397 term. To mitigate the endogeneity problem, we lagged all explanatory variables by one period. Since 398 a nonlinear relationship may exist between environmental regulation and market segmentation, we 399 introduced the squared term of environmental regulation, 2 , into the equation. Regarding the 400 explanatory variables, we first focused on their coefficients and significance of the environmental 401 regulation 1 and its squared term 1 2 . For the control variables, we used the ratio of the main 402 business income of state-controlled industrial enterprises to the main business income of industrial 403 enterprises above a designated size to depict the degree of enterprise ownership ( ). The degree 404 of regional economic development ( ) is expressed in terms of GDP per capita (million yuan); 405 the degree of fiscal decentralization ( ) is expressed in terms of the ratio of the regional budget 406 per capita to the national budget per capita, and the level of regional logistics (LL) is measured in 407 terms of freight turnover (trillion tonne-kilometers). 408 All data were obtained from the

432
From column (1) of Table 3, we note that the coefficient of environmental regulation is positive, 433 and the coefficient of its squared term is negative. Both coefficients are significant at the 1% level. enterprises (SOEs), the more likely that local governments will adopt local protection strategies to 444 protect the interests of SOEs and thereby exacerbate market fragmentation. The coefficient of GDP 445 per capita was negative at the 5% significance level, suggesting that increased economic 446 development can promote market integration. The level of economic development often reflects the 447 technological advancement in a region, as in our model-the higher the level of local technology, 448 the greater the local incentive to adopt division of labor. The coefficient of the level of logistics was 449 not significant (likely because this variable does not fully reflect transportation costs); however, in 450 our model, reducing transportation costs between two locations can mitigate market segmentation. 451 In terms of spatial effects, Table 3 shows that environmental regulations have a significant 452 spatial spillover effect on market segmentation, and environmental regulations in neighboring 453 regions have a significant nonlinear effect on the level of market segmentation in a region. 454 Specifically, when the intensity of environmental regulations in surrounding areas is less than 3.431, 455 environmental regulations in these neighboring areas can significantly increase market 456 segmentation in the region; more than 86.43% of the 450 observations presented environmental 457 regulatory intensity less than this threshold. Therefore, under the scenario, market segmentation can 458 be exacerbated by environmental regulations in neighboring regions. When a neighboring region 459 implements environmental regulations, on the one hand, the neighboring region increases its market 460 efficiency, relatively lowering the local market efficiency. Local production factors will be attracted 461 to the neighboring region; thus, to retain production factors locally, the rational strategy is to pursue 462 market segmentation. On the other hand, according to the "polluting paradise" theory, when 463 polluting firms from neighboring areas move to a local area, the local area may adopt a market 464 segmentation strategy to avoid a decrease in the overall environmental welfare effect. 465 Regarding the other control variables, greater fiscal decentralization in neighboring regions 466 reduced the degree of market segmentation locally, mainly because when neighboring regions 467 intervened more heavily in the market, it resulted in a decrease in the efficiency of resource 468 allocation to the market; the losses from such decreases in market efficiency far outweigh the gains. 469 Therefore, a local region can benefit more from economic specialization and thus will be more 470 inclined to pursue this strategy. An increased GDP per capita in a neighboring region significantly 471 increased the degree of local market segmentation because as the neighboring region's level of 472 economic development rose, its technological advancement increased as well; therefore, the local 473 region was more disadvantaged by specialization and would rationally choose to pursue 474 segmentation instead. The spatial effects of the other control variables were not significant. Notably, 475 the coefficient of W*dep.var was significantly positive, confirming the strong spatial autocorrelation 476 of market segmentation. 477 Having demonstrated the U-shaped effect of environmental regulations on market 478 segmentation, we explored whether this effect changed in regions with different degrees of fiscal 479 decentralization. To do so, we introduced an interaction term between environmental regulation and 480 fiscal decentralization into the model. To eliminate the effects of multicollinearity, we deaveraged 481 the interaction terms, and as shown in column (3) of Table 3, we found that the interaction term was 482 positive at the 1% significance level. This suggests that when the intensity of environmental 483 regulation is low, increasing the intensity of environmental regulation can significantly promote 484 domestic market integration and that increasing the degree of fiscal decentralization enhances this 485 effect. When the degree of environmental regulation is high, increasing the intensity of 486 environmental regulation can significantly dampen domestic market consolidation, while fiscal 487 decentralization can mitigate this negative effect. 488 489 Table 4 Effects of environmental regulation (ER2) on market segmentation 490

493
To verify the stability of the empirical results, we selected 2 as a proxy for environmental 494 regulatory intensity while continuing to use the fixed-effects SDM for a regression analysis; the 495 empirical results are shown in Table 4. We found that environmental regulations still had a U-shaped 496 effect on market segmentation, and the interaction term between environmental regulations and 497 fiscal decentralization remained significantly positive. The estimated coefficients of the control 498 variables were similar to the results shown in Table 3, indicating that the estimates of 1 and 499 2 were generally consistent. Therefore, the regression results obtained in this study are robust. 500 to a certain degree of market failure in environmental markets, where the private costs of discharging 506 pollution are smaller than the social costs; thus, the pollution emissions of enterprises tend to be 507 much larger than the optimal social carrying capacity (Reinhardt 1999), thereby decreasing the total 508 social environmental welfare effect. Environmental regulation directly affects polluting firms, 509 increasing their private emissions costs, internalizing external costs, reducing pollution emissions, 510 increasing the overall environmental welfare effect, and partially compensating for environmental 511 market failures. However, pollution tends to be upstream in the supply chain, and environmental 512 market failures can result in pollution being sold to downstream firms at lower prices; therefore, the 513 prices of goods produced via pollution are necessarily lower than is optimal for downstream firms, 514 causing price failures and triggering more significant failures in the commodity market. Thus, 515 environmental regulation can also compensate for broader commodity market failures. 516 Market failures inevitably lead to decreased market efficiency, such as resource mismatches; 517 better resource allocation could increase the overall social environmental welfare effect (Clinch and 518 Healy 2000; Izquierdo and Izquierdo 2007). Thus, as the degree of market failure decreases, the 519 total social effect must increase (Bator 1958). In this context, more developed regions experience 520 more significant benefits from labor division, as they usually have relatively efficient markets and 521 comparative advantages in technologically advanced sectors. In lagging regions, industries with 522 comparative advantages are usually high-polluting, high-energy-consuming industries with greater 523 links to environmental markets; increased division of labor would indicate that lagging regions 524 would have to increase commodity production in these industries. Owing to the objective existence 525 of environmental market failures, lagging regions must produce more at prices lower than the social 526 environmental welfare cost. Therefore, the rational choice for these regions is to pursue market 527 segmentation. However, when a certain degree of environmental regulation is implemented, the 528 economic effect decreases to some extent, but the environmental welfare effect increases; if the 529 latter is greater than the former, it can indirectly cause lagging regions to abandon the segmented 530 market strategy, and economic specialization can be promoted at the national level, thereby 531 improving overall market efficiency. 532 Fiscal decentralization allows for increased individual rights and a more rational distribution 533 of authority between the central and local governments, without forcing each region to wholly fend 534 for itself. Decentralization also indicates that local governments can implement more appropriate 535 regulatory policies based on their own levels of development (Chen and Chang 2020; Mao 2018; 536 Treisman 2006). Our results suggest that local governments could better use environmental 537 regulations to promote market integration in more decentralized areas. On the one hand, local 538 governments better understand market failures in their regions than the central government. Thus, 539 with the same intensity of environmental regulation, local governments with a higher degree of 540 decentralization can develop environmental regulatory policies that are well-suited to their market 541 conditions. Further, under increased environmental regulation, the overall effect of labor division in 542 lagging regions becomes greater, making market integration a more rational choice for such regions. 543 Thus, the role of environmental regulation in promoting market integration is more pronounced in 544 regions with greater decentralization. 545 Environmental regulation can improve market efficiency and increase the overall 546 environmental welfare effect, which typically leads local governments to move away from local 547 protectionism and toward market integration. However, some countries and regions continue to 548 voluntarily reduce the intensity of environmental regulations for three main reasons. First, local 549 governments usually consider the overall environmental welfare effect and formulate appropriate 550 environmental regulatory policies. For example, under China's "new normal" economy, its people, 551 in addition to their growing material and cultural needs, have become increasingly interested in 552 maintaining a good ecological environment. Therefore, the Chinese government, while actively 553 pursuing economic development, is also paying more attention to environmental protection. 554 However, "rent-seeking" on the part of local governments can cause them to discount overall 555 environmental welfare effects and lead to governmental regulatory failures. Second, in extremely 556 poor countries or regions, the fulfillment of basic needs supersedes environmental welfare. The 557 effects of basic necessities tend toward the infinite, leading to a decrease in the overall effects of 558 environmental regulations, which we do not discuss in detail here. Finally, when the present value 559 of expected returns on invested capital in year t is greater than the current environmental welfare 560 effect, that is: 561 where is the discount rate, and is the expected return on capital investment. In an 563 environmental welfare effect-based intertemporal decision-making model, the right side of the 564 equation represents the total social cost (i.e., the environmental welfare effect), and the left side of 565 the equation represents the present value of the expected return on capital investment. When the 566 above equation holds, the implementation of environmental regulations leads to a decrease in the 567 overall regional effect, and the rational choice of local governments is to sacrifice the environment 568 for economic gains. It is worth noting that the above equation is valid when > and → +∞. 569 In this case, local governments usually make comprehensive decisions that account for temporal 570 costs. Therefore, countries with higher rates of return on investment (i.e., developing countries) may 571 pursue the strategy of relaxing environmental regulations. As economically developed countries are 572 likely to have diminished marginal returns on capital investment, the above conditions are less likely 573 to occur; thus, these countries tend to have a greater preference for environmental welfare (which 574 implies a higher social cost related to pollution). 575 576

Conclusions 577
In the context of fiscal decentralization in China, the mitigation of market segmentation and 578 the development of an efficient free-market mechanism while protecting the environment is an 579 important goal. Therefore, based on spatial econometric theory, we employed an SDM to 580 empirically study the relationship between the intensity of environmental regulations and market 581 segmentation in China using interprovincial panel data from 2004-2018. Based on the empirical 582 findings and the above discussion, we present the following conclusions and recommendations. 583 First, the spatial agglomeration effect of market segmentation is evident, and the "beggar-thy-584 neighbor" phenomenon persists in China. The main reason for the increased market fragmentation 585 between regions is the pursuit of greater local economic benefits (partial for the personal gain of 586 local officials). However, current research suggests that way local protectionism may be the 587 dominant approach, it is always not the best strategy (Ke 2015; Lu and Chen 2009). Therefore, 588 accounting for the economic development of each region, the central government should guide local 589 governments at the policy level, actively promote regional integration strategies and strengthen 590 cross-provincial cooperation to realize complementary advantages. Local governments should work 591 to accurately assess their own positions, accept the guidance of the central government, and avoid 592 excessive artificial intervention in the market, allowing market forces to play a decisive role in the 593 allocation of resources. 594 Second, environmental regulations have a U-shaped effect on market segmentation. When the 595 intensity of environmental regulations is not too high, increasing their intensity promotes market 596 integration. However, if the intensity of environmental regulations exceeds a certain threshold, 597 increasing them discourages market integration. Our results suggest, however, that in the vast 598 majority of cases in China (specifically, more than 97.86% of the observation points), environmental 599 regulation would facilitate market consolidation while reducing environmental pollution and 600 promoting increased productivity through "innovation compensation" mechanisms. This is because 601 environmental regulations reduce the negative externalities of pollution, partially compensate for 602 market failures, enhance the overall efficiency of the economy, and allow lagging regions to benefit 603 through economic specialization. Therefore, local governments should generally increase the 604 intensity of environmental regulations and more vigorously regulate market failures, not only to 605 improve environmental quality and labor productivity but also to promote market integration in 606 China. 607 Third, we also noted that provinces with a higher degree of decentralization are better equipped 608 to employ environmental regulation to promote domestic market integration. When local 609 governments are granted more power, they can better fulfill their regulatory role and effectively 610 compensate for market failures. However, fiscal decentralization is also an important cause of 611 market fragmentation in China and has stimulated local protectionism (Lin and Liu 2000). Therefore, 612 the central government should reform the existing fiscal decentralization model in favor of a more 613 reasonable and scientific system and grant more economic and administrative powers to local 614 governments. Further, the central government should also improve its GDP-based performance 615 evaluation system for local governments by including more "soft indicators," such as environmental 616 protection, social security, and citizen wellbeing. 617 Despite this study' contributions, there were some limitations in its analysis. First, although we 618 noted that environmental regulations clearly facilitated market integration in China, our 619 intertemporal decision-making model may not be applicable to extremely economically backward 620 countries or have higher expected returns on capital. Second, while we discussed whether 621 environmental regulations promote domestic market integration, we did not fully delve into the role 622 of economic development level in this process due to model limitations. However, our results 623 suggest that the level of economic development can indirectly affect market efficiency by 624 influencing environmental welfare effects, which may ultimately affect regional economic 625 specialization decisions. Therefore, the development of more refined models to overcome these 626 limitations should be the focus of future research.