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Carbon pricing can boost Chinese growth

Green investment is mainland China’s new growth driver, and carbon pricing can mobilise private finance.

Mainland China’s economic growth is facing strong headwinds and measures such as interest-rate cuts have only marginally buffered the slowdown. Green investment will provide growth, but a carbon pricing policy would enhance the boost.

In the short term, public-led green investment is supplementing traditional infrastructure investment. But longer term, the green transition requires private participation. It could cost almost 500 trillion renminbi – about USD80 billion – over 30 years and that cannot be sourced solely from public finance.

Mainland China’s plan includes incentives – renewable-energy subsidies, tax rebates – and penalties such as fines or sanctions for missing energy or emission-standard benchmarks.

It involves private capital, but carbon pricing can allow even more to be done. The costs of emissions – higher healthcare costs, weather damage to crops, property damage from rising sea levels or flooding – cannot easily be linked to their sources. Firms may have little incentive to reduce emissions if bearing the costs is less than the investment needed to ‘green’ their production. It is a problem a free market alone cannot solve.

Governments thus need to establish a regulatory framework to internalise emission costs. Carbon pricing does that by making emitters decide whether to pay to transform or pay to emit.

Mainland China has a national emission trading system that should be a key policy instrument for realising its climate ambition. Currently quota is allocated without charge, only the power sector is covered, emission verification is imperfect, and fines are minimal. However, coverage will be expanded gradually, trading types and means diversified, and the allocation and management of allowances improved.

Governments elsewhere have tried to put a price on emissions with varying success. The European Union’s system, launched in 2005, is a cornerstone of its climate policy and a key mechanism for reducing greenhouse gases.

But it has got off the ground slowly and gone through several reforms. Now the EU proposes accelerating the reduction of emission allowances, phasing-out their free allocation, including shipping, and creating a separate system for the road transport and buildings sectors. And a cross-border adjustment mechanism would prevent ‘carbon leakage’ – EU businesses moving operations to jurisdictions with less-strict emissions requirements.

We believe implementing this package could accelerate multilateral decarbonisation and initiate the international race on climate ambitions through the carbon tariff.

The EU system sets an example that Beijing could follow. But it would mean enhancing mainland China’s allocation allowances and its carbon price levels, plus wider coverage – possibly starting with steel and cement – and gradual migration from free allocation to an auction-based system.

And there should also be a change from a rate-based system to ‘cap and trade’ – a cap on emissions (ideally, declining) with trade through emission permits. Transition to emission controls is a must for mainland China to achieve its climate ambition, we believe, but successful implementation not only hinges on regulations, but also on technology development.

However, the changes should be introduced sooner than later. Otherwise a hefty amount of tariff will be surrendered to the EU once its cross-border adjustment mechanism is in place.


First published 28th January 2022.
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