The market won't stop China's polluting state industries

With state control over China's major energy producers, energy consumers and energy prices, the power of a market instrument – like an ETS – is blunted.

The Conversation

When officials in the northern Chinese province of Hubei recently declared their dedication to cleaning up air pollution by giving up smoking, few were impressed by their grasp of the problem. But China has demonstrated it is taking steps to tackle air and wider climate change-related pollution, most recently by rolling out an emissions trading scheme in its industrial heartlands.

China accounts for more than 20 per cent of the world’s emissions of carbon dioxide generated by energy use, just ahead of the US at 18 per cent. Its carbon intensity – the quantity of carbon dioxide emission per unit of GDP in purchasing power parity – is more than twice that of both the US or India, and 80 per cent higher than that of South Korea.

China’s high carbon intensity arises from a combination of an economy dependent on heavy industry, the predominance of coal, which accounts for 70 per cent of primary energy consumption, and the inefficient nature of much of the industrial plant. Nevertheless, it must be recognised that some 30 per cent of the country’s carbon emissions derives from the manufacture of goods which are exported.

China’s government has pledged to reduce carbon emission intensity by 40-45 per cent between 2005 and 2020. This will require an equivalent reduction in energy intensity. Between 2005 and 2010 the government achieved considerable success in reducing energy intensity by 19 per cent against a target of 20 per cent. The intensity of carbon emissions from energy fell by a similar amount. This was accomplished principally through greater regulation of the mainly state-owned heavy industries such as steel, cement and chemicals.

But what works for a limited number of energy-intensive enterprises is unlikely to be effective across the whole economy, not least because of the sheer number of enterprises, many of which are privately-owned. So the Chinese government has had to introduce economic carrots and sticks tackle the problem.

Emissions trading and carbon tax

The Draft Law on Addressing Climate Change, published in March 2012, includes both cap-and-trade-style emissions trading schemes and a carbon tax. In April this year the National Development and Reform Commission (NDRC) announced that seven pilot emission trading schemes would be launched this year, with a focus on energy intensive industries such as petrochemicals and power generation. The even more energy-intensive and polluting industries such as steel and cement do not appear to have been included, probably because they are critical for the construction sector and employ so many people. The pilot schemes are to be held in seven industrial cities and the first was launched in Shenzhen in June.

The Xinhua Press announcement of the government’s plan to introduce a carbon tax in February referred to an earlier Ministry of Finance suggested rate of 10 Yuan ($US1.6) per tonne of carbon dioxide rising to 50 Yuan (US$ 8.0) per tonne by 2020. The proposed carbon tax was to be only one component of a package of tax measures aimed at energy and resource consumption and environmental damage.

This proposed tax package implies the direct involvement of the Ministry of Finance, apparently in opposition to the National Development and Reform Commission’s proposed emissions trading scheme. Running both tax and trading scheme together for the same emitters would be unnecessarily complex, but nothing more has been said on the matter since February.

Institutional constraints

Whilst China’s ambition to introduce such economic instruments is to be applauded, implementing them in such a way that they are effective will face a number of serious obstacles. First, the major energy users are large state-owned enterprises which have significant political and market power, soft budgetary constraints and a low cost of capital. Additionally they are protected from hostile take-overs or bankruptcy, which would require government approval.

Second, the limited capacity and authority of the governing agencies may restrict their ability to monitor and administer the scheme, or impose penalties on offenders. Antagonistic local governments are likely to find ways to undermine central government initiatives, for example by compensating local enterprises for financial losses arising from these schemes, removing any economic impetus to change.

Finally, most energy prices are still subject to direct or indirect government control, and Beijing is reluctant to allow the price of energy and industrial products to rise too rapidly.

In the terms of institutional economics, there’s a profound mismatch between the emissions trading scheme and carbon tax on the one hand, and the prevailing institutional inertia and the manner of governing the heavy industry sectors on the other. Essentially, this means that where the state dominates ownership and price controls, such instruments based on market forces are unlikely to have any significant effect.

Until the state releases its grip on major energy producers, energy consumers and energy prices, the aim of reducing carbon emissions may best be achieved by further regulation and by allowing energy prices, for everyone, to rise.

Philip Andrews-Speed is Principal Fellow, Energy Studies Institute at National University of Singapore.

The ConversationThis article was originally published at The Conversation.

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