How China will achieve carbon neutrality: The role of the emissions trading scheme and other reforms

[Editor’s Note: Below is a complete transcript of the Sinica Podcast episode with Michael Davidson, an assistant professor at the School of Global Policy and Strategy and the Jacobs School of Engineering at the UC San Diego. Davidson discusses a range of energy and emissions-related challenges in China, including implementing and improving the new emissions trading scheme, as Beijing works towards its goals of a carbon peak by 2030 and carbon neutrality by 2060.]

Kaiser Kuo: Welcome to the Sinica Podcast, a weekly discussion of current affairs in China produced in partnership with The China Project. Subscribe to The China Project’s daily Access newsletter to keep on top of all the latest news from China from hundreds of different news sources, or check out all the original writing on our site at supchina.com, including reported stories, editorials, regular columns, a growing library of videos, and of course, all of our podcasts. We cover everything from China’s fraught foreign relations, to its ingenious entrepreneurs, from the ongoing repression of Uyghurs and other Muslim people in China’s Xinjiang region, to China’s ambitious efforts to eliminate poverty. It’s a feast of business, political and cultural news about a nation that is reshaping the world. We cover China with neither fear nor favor.

I’m Kaiser Kuo coming to you today from my home in Chapel Hill, North Carolina.

There’s been a lot in the news in recent months about China, coal and climate change — not surprising, as recognition of the existential urgency of addressing global warming sinks in after another summer of extreme weather events, dire warnings out of the latest Intergovernmental Panel on Climate Change, the IPCC — the assessment report — and another well-deserved tongue-lashing of our so-called leaders from Greta Thunberg in Milan. China launched its new ETS, or emissions trading scheme in July. In September speaking remotely to the UN General Assembly, China’s president and general secretary, Xí Jìnpíng 習近平, announced that China was ending funding to all coal-fired projects — power projects, anyway — beyond China’s borders. With COP 26 in Glasgow right around the corner in November of this year, there’s obviously a lot of attention being paid to the environment.

Last year, Xi Jinping famously announced China’s ambitious goals of reaching peak carbon emissions by the year 2030 and attaining carbon neutrality by 2060. How realistic is that and what will need to happen for those goals to be met? How far will China’s new ETS, this emissions trading scheme, go toward reaching those goals? Are top down and coercive measures necessary to we China off its coal addiction, or should China abjure those in favor of more market instruments and bottom up approaches? How is — does the Xi Jinping announcement on coal-fired power plants on the Belt and Road actually matter? Is it going to be possible for us to keep the planet from warming beyond the 1.5 degree C mark from pre-industrial levels without extensive coordination and cooperation between the world’s two biggest emitters, China and the United States?

With me, to answer these and other questions, is Michael Davidson. Michael is assistant professor at UC San Diego’s School of Global Policy and Strategy, GPS and — this is really cool! — assistant professor in the mechanical and aerospace engineering department of the Jacobs School of Engineering at UCSD. Michael was previously the U.S.-China climate policy coordinator for the environmental nonprofit, Natural Resources Defense Council, NRDC. He’s written extensively on China and greenhouse gas emissions, and has really helped me to get my head around what China has accomplished and the challenges still ahead. Michael Davidson, welcome to Sinica.

Michael Davidson: Thanks so much for having me, Kaiser.

Kaiser: Yeah, it’s really my pleasure. Michael, let’s start with some of the items that I’ve mentioned in the news lately, and then maybe perhaps we can begin with Xi Jinping’s announcement at the UN General Assembly about coal-fired generators abroad. How significant is this announcement, and do we have a sense for how many projects it actually affects, and maybe what the net emissions impact is going to be?

Michael: Yeah. I mean, if you go back maybe two years, you were looking at Japan, South Korea and China as the main public financiers of coal overseas. Then we saw, starting in 2020, and then formalizing earlier this year, both Japan and South Korea had exited this finance. So, it was really just China as the last man standing in this arena. That meant there were quite a few projects that were dependent, at least in terms of public finance, on China support.

Now, there is a significant pipeline of finance from the private sector, but there’s no question that public financing in terms of export credit and insurance guarantees played a huge role in the build out of coal in a variety of countries. I don’t think it’s anything that we should laugh at. I think it’s quite a significant shift for China, just over the span of a few years, and it could cut off some significant pipelines of coal, though people are quick to note that there hasn’t been a lot of new coal plant development this year which is reflecting some development in the host countries themselves to fuel switch away from coal towards gas and renewables.

Kaiser: Right. Will it result in the cancellation of projects that are all already sort of on the books and are already planned, or maybe that had ground broken already?

Michael: We’re still parsing what Xi Jinping said, and it’s difficult to extract a whole policy out of a few words. But my sense is that we’re probably not gonna see cancellation of projects that have already received financial close. I think that projects that are very early in the pipeline that maybe haven’t even received permitting could definitely be canceled, and it certainly cuts off any future discussion and engagement from firms, whether they’re EPCs [engineering, procurement, and construction companies] or developers or manufacturers going to these other countries and trying to sell coal projects.

Kaiser: Now, I know it hasn’t been very long, but how so far has the announcement been received, both by developed countries and by developing countries, especially these belt and road countries who are hoping for coal fired power plants?

Michael: Well, I think it’s been widely lauded in the international community because of the movements over the last few years away from coal. Lots of international pressure has been mounting, both from environmental groups, nonprofits, up to shareholders and private financial institutions, and then through governments, through the U.S. and E.U., G7, a lot of other organizations have all taken stances on this. I think it was widely welcomed by those groups. I think that China’s shift here really does reflect some significant changes in host country energy development strategies.

I don’t think we can credit U.S. diplomatic engagement, or even E.U. diplomatic engagement alone for this success, this win. I think that we see already some significant shifts underway in countries where these coal plants were developing very rapidly. I’ve got a paper coming out soon, focused on Vietnam and Indonesia on that front. Really, what we see is that a lot of these coal plants were canceled domestically because of concerns around the availability of fuel, the desire to go clean, other environmental issues, maybe demand projections that were a little too rosy.

I think you’re seeing a constellation of events that resulted in China choosing this time to say, okay, we can step away from this area of economic activity and also make an important contribution to the climate discourse.

Kaiser:

Right. It helps when the host countries have already canceled their projects. But now, I’ve also seen a lot of takes, as you suggest, that this resulted from diplomatic efforts, in particular by the U.S. I mean, John Kerry had visited Shenzhen not long before the announcement. So, yeah, I had seen some takes that suggested that, that was the driver behind it. You seem not to think so. You don’t see a connection between the two.

Then, I guess, aside from, as you say, host countries themselves deciding to go another way, what else do you see as having really driven this decision?

Michael: I think John Kerry’s diplomatic efforts are certainly laudable, and he and Xiè Zhènhuá 解振华 , his counterpart in China, have made an enormous effort to maintain communication on this area, despite the fraught relationship, which maybe we can get to later in the program. So, I don’t want to discount those efforts. I just don’t think that those are the sole reason, or even the primary reason why China chose now to exit new coal overseas.

Kaiser: I guess, before we talk about this and some of the other commitments that have just come up recently, maybe we can look at a little bit of an overview of the timetable of different announcements that Beijing has made from, let’s say 2009 and well, or maybe, I mean, we can use a baseline of maybe 2014 when the U.S.-China deal was announced, the one that really ended up clearing the way for Paris. Where was China in terms of just a quick-and-dirty sketch of, what were they promising by 2014?

Michael: Yeah. So, we’re in the third round of commitments now. Maybe it’s useful to just say China made its first internationalized climate commitment, in advance of Copenhagen, in 2009. Prior to that, China had maintained a very hard stance that, as a developing country, it did not need to make any commitments whatsoever to reduce emissions on climate. So 2009 represents a step change. Then we have the U.S.-China agreement formalized in 2014 in advance of the Paris climate talks in 2015, at which China made its first commitment related to peaking carbon emissions. So, another step change. And that was its first contribution, its national determined contribution as, and yes, and the Paris-

Kaiser: Okay. That was an NDC.

Michael: That was an NDC. It was technically called an INDC at the time, because why give out an acronym of three letters when you could go with four.

Kaiser: Add another one. Sure. Yeah, why not?

Michael: Exactly. That was its first NDC. Then we saw, starting last year, China making a number of additional climate commitments, and really those are going to be formalized in an updated NDC in a few weeks time in Glasgow.

Kaiser: So in 2014, what had they committed to in terms of carbon peaking?

Michael: They committed to peaking carbon emissions around 2030 and to achieve non-fossil share in its primary energy mix of 20% by 2030, and a couple of other commitments as well.

Kaiser: Okay. So far, how have they done in terms of that? I mean, is that 2014 announcement different than what Xi Jinping said in 2020 when he talked about 2030 as peak carbon again? I mean the preposition changed, right? One said like “around 2030” and one said “by 2030,” is that the only difference or what?

Michael: Yeah, again, we’re parsing a few characters. I think the intent is the new commitment made in 2020 are one of the several new commitments made in 2020 was to peak emissions before 2030. I think prior to that, as you may know, a few years early, a few years later, I mean, zuǒyòu 左右 has a very general meaning in Chinese. This was before 2030. So the sense was that, by 2030 you would definitely have peaked emissions, but it was not saying we’re going to definitely peak emissions in 2028 or 2027. They didn’t pick that precise year.

That’s a subtle, but I guess important change for some folks that had thought, oh, China was going to maybe fudge the year a little bit. I think more significantly was the increase to non-fossil target from 20% to 25%, and they also put in place … Xi Jinping also announced a new target to build 1200 gigawatts of wind and solar by 2030. Those two would be going presumably into the NDC that it’s going to announce soon.

Kaiser: Yeah. At COP 2026.

Michael: Exactly.

Kaiser: Fantastic. Let’s look at one more thing that’s in the news recently. I know this is just in the last couple of days, so I don’t know how much you’ve looked at this, but there are these energy shortages that have hit, by counts that I’ve seen, some 20 provinces. I’m wondering whether this is at all comparable to what we saw in California and in Texas over the summer. I mean, is it related in some way to China’s push to reduce coal and change the energy mix to include more non-fossil energy? Or is this more just about coal prices, coal shortage, the inability of these power companies to pass on these higher costs to customers by raising rates? What’s your take on that?

Michael: I think the theme that’s running through each of these power shortage events, whether it’s China in recent weeks, California last year, Texas earlier this year, it’s weather induced, but institutionally exacerbated. In the case in Texas and California had extreme heat and extreme cold. In China, you’ve also had some heat in the south leading to higher AC loads. You also had some renewable energy availability concerns in the Northeast, but broadly speaking, these are exacerbated by the existing institutions in China’s power sector, which they’re desperately trying to reform, but it’s also a very difficult sector to reform. So in terms of the claims around whether or not policy targets to meet environmental goals, such as carbon directly contributed to these specific shortages, I think the evidence is pretty weak at the moment. Now, there are some, just to clarify, there are two types of targets or controls that are referred to as the “dual control” or the “dual targets.” There’s the dual targets related to energy intensity and energy caps which are referred to as the Néng hào shuāng kòng zhìdù 能耗双控制度. Then there’s the carbon peaking and carbon neutrality targets, which are the longer term targets of 2030 and 2060, which are sometimes shortened as the shuāng tàn mùbiaō 双碳目标.

I think the two controls, the two targets that folks have pointed to as potentially causing these shortages are the energy intensity and energy cap. Again, I think the evidence that those are directly contributing to this is a little weak, though there is some precedent for that. We do know that in 2009, as China was coming up to the end of the 11th Five-Year Plan, that some provinces were not on track to meet their energy intensity target, and so you saw some forced power outages by some very entrepreneurial local officials, I guess we’ll say, to … Then Wēn Jiābaǒ 温家宝 had to come out with an iron fist to tell these localities, “This is not the appropriate way to meet environmental targets.”

Kaiser: Well, this time what they’re saying, they’re coming out with an iron fist and saying these power companies are going to secure fuel irrespective of the costs and that they’re not going to tolerate any blackouts. Is that maybe evidence that there’s no intention to introduce more flexible market mechanisms, that this is just kind of tough love? What’s going on there?

Michael: Yeah. So, the other factor playing out in China’s power shortage debate right now is really the fact that the power market is not fully liberalized. So, you have some parts of the power market that have some pricing mechanisms in place, and you have other parts that are not, and local governments have an extraordinary amount of autonomy to restrict the way that these markets are designed and operated and they do so to protect certain interests. I think this reflects a broader phenomenon that markets are not just performative. They do serve purposes, but oftentimes those purposes may not be efficiency. When the markets are no longer achieving state goals, i.e., reliable and secure electricity, then the state’s going to intervene and they might intervene with a very heavy hand. So in the case of this example, you have coal prices that started to rise, but electricity prices — either you’re selling it at the plan, which is a benchmark rate changed infrequently by the NDRC, or you’re selling it in a market, but the market has a price cap at the benchmark set by the NDRC.

So, prices in both cases are effectively capped at that benchmark. So if coal prices, the input price rises by the electricity price where generators can sell at doesn’t, then they’re losing money. In that kind of situation, generators can fake outages. We know that this has happened in previous years, for example, 2011, when we saw a big similar situation happening and outages occurring in certain provinces. This is much more widespread than that year’s outages.

But nevertheless, I think that’s a huge determining factor. Then maybe the third institutional aspect here is the inter-provincial trading mechanisms, which are still very rigid. The market mechanisms that have been put in place in China since 2015 have not significantly broken down the walls between provinces. Protectionism is still a serious issue affecting both the efficiency and the environmental impacts of the power sector. And this could be an indication that provinces and the central government are finally realizing the difficulties of not tackling that really deep-seated inter-provincial protectionism issue.

Kaiser: If I’ve got a glut of coal in one province, in Shandong, I can’t just sort of ship it across the Bohai to Liaoning. Or I could, but there’s what? There’s like provincial tariffs or how does that work?

Michael: Yeah, I was referring more to the electricity system. Coal certainly ships across borders, but we have seen, and recently, because of the shortages, some provinces are restricting, coming out with policies saying, you’re not allowed to sell X amount of coal outside of the province. We need to maintain coal within our province. That’s a pretty stark protectionist, a barrier, but in electricity …

Kaiser: You’re talking about moving electricity on the grid.

Michael: That one was referring to coal, literally shipping up coal and moving it to another province. But electricity is quite different than that. All the provinces are interconnected, and you can ship electricity across provincial borders seamlessly. There’s no physical limitation on how you can do this. There’s just the institutional and the market limitations. What you’ve seen is that time after time, when provinces have the ability to choose markets, they always choose those that tend to preference their own generators, that tend to preference exports, and then to limit imports, except if they’re really, really dying for imports like some coastal cities and provinces.

Michael:

What this means is that, in the context of multiple provinces in the same region facing a shortage at the same time, they’re going to pull the plug on what they export to other provinces, or if some transactions that were approved by the central government are given priority, they’re kind of stuck and they’re tough love. I think it’s really important to recognize this is not unique to China. This is very similar to what happened in the West in California last fall, because every state was facing a heat wave at the same time. And some of the contracts that California had relied upon for its own assessment of supply security did not come through, because those states wanted to keep the power for themselves. So this is not a problem unique to China, but the fact that the inter-provincial trading mechanisms are so weak, really exacerbated the current situation.

Kaiser: So originally, when I approached you about doing the show, it was because the ETS had just launched and I wanted to get somebody on to explain that. Since then, so much has happened that this topic has kind of expanded, but I do want to turn now and focus on the new ETS for a bit here at the carbon market. Can you talk first about its inception and its origins, and maybe, what other systems did its designers draw from? I mean, were they looking at the United States or were they looking at Europe? Were there mistakes that were made, pitfalls that they knew to avoid or features that they openly copied, best practices that they imported?

Michael: China’s participation in a trading scheme like this was as an offset market for the Kyoto protocol called the Clean Development Mechanism, CDM, where they were essentially getting paid by European entities to reduce carbon locally. This was a big boon for, for example, the wind industry in China, which got a lot of money to help support early development. So, had some experience with carbon trading and the process of monitoring, reporting, [and] verification of carbon. Then, over the next few years, it started to put in place pilots in a handful of provinces in China, starting around 2013, and these were really to test out different mechanisms for making this work in the Chinese context, and they certainly had a lot of help, lot of experts from the EU, from California, from the EPA. Now, the U.S. doesn’t have a national carbon trading, but we do have experience with sulfur dioxide. There’s a lot of experts that will go into China and tell them how to make a cap and trade market. But as we know now, China did not build a standard cap and trade market and went its own way. So the extent to which those experts’ suggestions prevailed upon China decision makers, in the context of all of the other incumbent institutions in China, we need to examine a little more closely. But certainly they had a lot of examples and experts to draw from.

Kaiser: Without getting too into the weeds, can you walk us through how exactly the Chinese ETS works? You say that they deviated from your standard cap-and-trade. In what way? Maybe talk about that, and then also, I’m wondering why it seems to have taken so long. There seems to have been a lot of hold up along the way into actually deploying the thing and opening it for business.

Michael: Yeah. So I’ll try to not get too much into the weeds and you can feel free to draw on me back if I go a little too technical. A usual carbon trading system, a cap-and-trade, firms are allocated emissions or they might purchase or auction those emissions in an absolute amount. For example, you might have a firm, let’s say it admits 11,000 tons, and it gets 10,000 tons of permits for free. Now it means it needs to acquire a thousand more permits to meet its compliance obligation. Now let’s say permits are 50 renminbi a ton. So, that would cost 50,000 renminbi total. The marginal cost faced by the firm in that case is still 50 RMB per ton. That means that every additional ton of carbon that emits, it incurs a cost of 50. If it reduces it gains 50, because it can go out and sell those permits to someone else.

Now, in China, they have a performance benchmark system, sometimes called a tradable performance standard. This is an intensity based system that scales with production according to some benchmark emissions intensity. Some folks have called this resulting in an implicit output subsidy because what this means is that, if you are an efficient firm and you’re below your benchmark, every time that you produce more, you actually get more permits than you need to meet your own compliance obligation.

Kaiser: So, it could actually increase the absolute tonnage of greenhouse gas that’s emitted.

Michael: Well, before we get to the total carbon emissions ton, I think it’s important to just maybe put some numbers on here relative to the original, the typical cap and trade system. For example, if a firm has a benchmark of one ton per megawatt hour and that firm, that plant actually generates only three quarters of a ton of CO2 per megawatt hour. So, that’s kind of an average ultra supercritical plant in China. That means that if it generates a thousand megawatt hours, it gets a thousand permits, because its benchmark is one ton to one megawatt hour, but it has 250 left over that it can sell. That means that it’s actually got, for every additional megawatt hour of electricity, it generates one quarter permit and it can sell those at 50 RMB per ton. So, it actually has a negative carbon price — 12-and-a-half RMB per ton.

But if you go to a less efficient firm that’s above the benchmark, it phases a positive carbon price. Every times it produces more, it generates more emissions than the benchmark gives it. So, it has to go out on the market and buy that. That’s important to recognize there are two sides of this, which means that the incentives are still aligned so that the efficient firm always gets some kind of benefit relative to the inefficient firm. The system is not somehow distorting incentives and creating a perverse incentive for less efficient firms to generate more than efficient firms. That doesn’t happen except in the case where you get into the complicated nature of how there are multiple benchmarks in each one, but we won’t get into those details at the moment.

The point is that it does reduce emissions, but the interpretation of the price of the carbon permit for example, is markedly different than the interpretation of the carbon price and the EU ETS. It’s not gonna be as cost effective as if China put in place a traditional cap and trade system, but cost effectiveness isn’t the only name in the game. They want to create a system that creates some kind of incentives for firms to reduce emissions, and this does that.

Kaiser: Yeah. I mean, it’s an inducement to efficiency, which is not a bad thing. Are there ways that you see how this system might be abused? I mean, if you are an efficient producer, where you really face no penalties for increasing your output, could that produce distorting effects?

Michael: The distortions can come in a variety of context. One is you can have multiple benchmarks in the same class. For example, coal plants below 300 megawatts have a different benchmark than coal plants above 300 megawatts. That means that, and in general, the larger, the plant, the more efficient. That means that somehow, you could have a situation where less efficient, larger plants are somehow having to buy permits from more efficient, smaller plants, but their relative efficiency could go in the opposite direction.

Michael: That’s a situation where you could see a perverse incentive where less efficient firms and more efficient firms have the wrong directional signal from the carbon market. We don’t have exact numbers on how commonplace that is. I think that probably more generally, you’re gonna see the positive direction of inducement, but that is one area where you can see some distortion.

Kaiser: How common is an ETS that’s based on efficiency rather than just on sheer absolute output of carbon?

Michael: Well, in terms of a carbon system, China is relatively unique. Now, tradable performance standards, or just performance standards more generally, are very common in other aspects of energy and environmental regulation. So, the CAFE system in the U.S., which regulates automotive fuel economy standards is a performance standard. And you do see all certain kinds of trading and you also see gaming, the whole advent of crossover SUVs benefited from this gaming of what class of vehicle you put your — essentially, what benchmark, did you put your vehicle in and being able to get around an absolute emissions cap as a result of that. So this concept of performance standards is not new to China but the size of the market. I mean, we’re talking about four and a half billion tons of carbon that are regulated under this market, compared to the next largest system, which is around one and a half billion tons, the EU, and the fact that this is in carbon as opposed to — in covering these large electricity generators — as opposed to automotive efficiency standards or other sectors. is unique.

Kaiser: My other question was, what took it so long? What was the hold up in rolling the system out?

Michael: I mean, in terms of how long it takes to build up new institutions, I’m not sure that it was very long from international perspective. Certainly, China had been talking up about how national system is going to be deployed this year and later this year, next year, and the year after that, and there’s lots of delays. So, folks tend to think, oh, China took forever. But in fact, from the beginning of the pilots — so they started talking about pilots, maybe 2011, they put in place some in 2013, and then we saw the national system roll out after several years of piloting at the provincial level — we’re talking about eight years. That’s not unheard of in terms of how long that takes. Now, there was a delay for a couple of reasons. One, in 2018, there was a major government reorganization that shifted a lot of priorities and authorities among different central agencies and created a new Ministry of Ecology and Environment that took over these carbon responsibilities. And so transferring those folks from NDRC over to MEE, and then of course, all the local officials — that took some time and that certainly delayed things. The pandemic certainly did not help. You don’t want to put in place a dramatic new expensive system while you’re trying to jumpstart the economy. I think, if you put all those together, I’m not too concerned about how long it takes to put in place. I’m much more concerned about, now that it’s in place, let’s make it better.

Kaiser: So, your colleague Valerie Karplus at Carnegie Mellon wrote an excellent paper about the ETS, which I found to be really pretty easy to follow and really edifying, and I will try to remember to put a link to that in the show notes. She lists a bunch of benefits that the ETS brings, and I thought maybe we could talk about each of these. I think it’s — obviously, it’s a cost effective way for China to control CO2 emissions. That’s clear enough.But she also talks about how it builds government capacity really in, in monitoring and reporting and verification, which I guess is something I hadn’t thought of. It’s a very nice collateral effect. That also makes very basic sense. There’s a third, and I’ll come back to it in a bit, but there’s, because I specifically want to ask you about that, but there’s this fourth that I agree is really important, and that it’s this holding of managers of power plants accountable. I mean, that reminds me of say the River Chiefs system or how, when you kind of make the buck stop with a provincial official or with a manager or something like that, it seems to do very well, very much like the anti-pollution measures have, have done in China. I think that’s clear.

This third thing that she talks about though, it wasn’t something that I had understood well. She said that it would breathe life into, or breathe new life into China’s CO2 offset market. Is that what you were talking about earlier on when you were talking about the offset market? Where, to comply with Kyoto, they were receiving payments from the Europeans, and can you explain how the two are tied together?

Michael: Certainly I’ll do my best to try to summarize already a very good paper by Valerie, who’s a good friend, former advisor. In the offset market is the Kyoto protocol, where China had received payments or sold offsets. And those were drying up because the Kyoto protocol was phasing out. We were moving into the Paris agreement stage. In anyways, China was kind of moving out of the category of countries that were going to receive these clean development mechanisms because there was a lot of understandable criticism that China was receiving a bulk of these CDM when there were a lot of other poorer countries that weren’t receiving these benefits.

So China had all of this capacity built up around offsets and it had developed some expertise around MRV — monitoring, reporting, verification. This was a key sticking point in the lead up to the Paris agreement structure because the Paris agreement is built around determining commitments from a country by country basis, not a top-down system. Thus, there’s always going to be this question of, “Are countries living up to the commitments that they themselves set?” So, there was an emphasis on getting more MRV into the agreement and into the implementation.

So this really dovetails importantly with China’s existing environmental governance institutions, which have been historically very weak. The ministry of Environmental Protection, which became the MEE, was known for having very little teeth when it came to local enforcement. They were very low down the pecking order with respect to other local authorities, provincial governors, etc. There’s a great paper by Iza Ding, who called some of the activities of these local environmental agencies as “performative governance,” that they were not actually doing something meaningful. They were operating within their own constraints, where they had very little ability affected change, but also facing demands from the citizenry to take some actions. With the carbon standards and the additional emphasis on meeting climate policies, now these environmental agencies have much more authority — both institutional authority, as well as informal authority — through the credibility and the emphasis that Xi Jinping and other leaders have placed on it, to then go out and actually implement these environmental policies.

Kaiser: The enforcement mechanisms under this new system are ratcheted up pretty appreciably?

Michael: There’s a hope that they will be ratcheted up. Now, there’s still a gap here. We just still don’t know how effective, what the penalties or all those kinds of details, how that enforcement is going to work. I think there’s a substantial hope that the enforcement mechanisms, because this is so high profile relative to early environmental laws, is going to result in more environmental enforcement and the ability for local governments to actually follow through on some of these obligations.

Kaiser: So, how has the market performed since it launched last month? I mean, has the cost of a ton of carbon credit actually gone up appreciably? I guess it’s not measured by the ton, but [crosstalk 00:35:04].

Michael: Well, it is. They convert it to a ton, but then, recently, it’s been hovering around 40 to 50 RMB per ton. Again, we cannot directly compare that to other carbon prices like EU because of all of these strange aspects of the tradable performance standard. But I think that’s a reasonable starting point. I think over time, we want to see it go up and we expect it to go up. But we also recognize that, besides the ETS, there’s a whole host of other policies, which are driving carbon emissions reductions in the sector.

In general, when you have overlapping instruments, so multiple policies that are all pushing firms to do one thing, the prices that you reveal through an emissions trading system are going to be depressed. They’re going to be lower than what the total social cost of those emissions are. And we see evidence of this in the EU. In China, there are so many other policies, and some of them could be very, very strict that the eventual price that we see, once we effectively convert it to whatever the marginal cost of emissions is being faced by a plant could be much higher, significantly higher than the gap that we see in EU.

Kaiser: Michael, let’s talk about what some of those other policies are. You and several other colleagues recently published a paper looking at what Beijing will still need to do in order to achieve what’s been pledge, in order to see peak commissions before 2030 and carbon neutrality 30 years after that. Coming off this discussion of the ETS, first of all, gimme a sense of how much of a contribution to that are they expecting the ETS to make?

I mean, have they leaned really, really heavily on this? So, they place maybe too much faith in this one instrument. Let’s talk about that first and then look at some of the other ways that China’s pushing to decarbonize.

Michael: Yeah. China, historically, if you look at policies that, either directly reduced emissions or indirectly reduced emissions, relied upon, mostly planning targets, for example, in the Five Year Plan, and then command and control methods, for example, the top 1,000 or top 10,000 firms energy efficiency program, which basically mandated firms to improve their efficiency, in addition to other more draconian measures like factory shutdowns.

Then other standard industrial policies like investment strategies and investment targets. That’s the primary way that we’ve seen a lot of these emissions control and indirect emissions control approach is taking hold. More recently, we’re seeing some market instruments too. I think that we’ll see a transition, but we’re not going to see a full swing from planning all the way to markets. I think there’s gonna be a very strong and probably majority role for planning targets and command and control methods in order to achieve the 2030, 2060 targets.

Because it’s building on some of the same incentive structures that we’ve seen as a central feature of Chinese bureaucracy, which is you have performance metrics that affect promotion. Those incentive structures are felt in bureaucrats at the sub-national level, they’re felt in SOEs, and a lot of other agencies affiliated with the government. As a result of that, you’re using that existing set of institutions, and then on top of that, you’re gonna layer increasingly market mechanisms, mostly as a means of cost control

Kaiser: Yeah, let’s talk about that — the right mix of command-and-control and market measures. Because you have some people who will look at the kind of command-and-control, or even coercive measures that we’ve seen, and they’ll insist that, just like with the COVID-19 pandemic, there’s just a lot to be said for the heavy-handed state-led solutions. There are other people who raise real concerns over these top-down environmental policies. I’m thinking about conversations that I’ve had on this podcast with Judith Shapiro and Yifei Li, about their book, China Goes Green, which really, it’s quite skeptical about the long term efficacy of these coercive environmental policies.

Where do you come down on this question? I mean, I remember, I think it was in that paper that you wrote on, yeah, on hitting the 2060 goals, you talk about the approach as being sort of hybrid from the beginning, growing out of the plan, as you called it, and make an analogy to the early days of reform and opening. You see these kinds of similarities where we’ll maybe start with something more planned and central and kind of hybridized toward more market oriented solutions?

Michael: There’s so much to talk about in this. I love this question and I love getting into the details. I would give a couple plugs here. One is Ed Steinfeld wrote a paper in 2004 called “Market Vision,” which I think is the most under-cited paper on this topic that I can think of, which is basically dissecting the notion that there’s only one reason why countries engage in market reforms, right? He identified two reasons. I think there are more than two reasons, but those two, one is you want to increase the efficiency of the sector by pushing out the old fossils and bringing in new incumbents, like a Shumpeterian kind of a destruction.

But there’s also another reason where you want to preserve the ailing incumbents and increase their efficiency, and not necessarily push them out, but force them to become more efficient. I think that plays out to this day. I think you must recognize that markets can be built for a lot of other purposes, and maybe not even efficiency. Those two are two metrics of efficiency, but you can put in place markets where planning mechanisms are just too coarse. China has opened up the coal market, and as a result of that, its only measure to change the price in the coal market is to restrict supply, which is a very coarse and heavy-handed measure, and it results in huge coal price swings.

If you give up this idea of markets being solely for efficiency, but could be an alternative means for planners to control the outcomes of different sectors in ways that manage multiple priorities, you might come to see that a lot of what Chinese decision makers do around markets actually make a lot more sense than at first blush. The second plug is that I do not take credit at all for coming up with “growing out of the plan.” That’s my colleague, Barry Naughton’s book on the subject, and I think it still remains true to this day that, that’s the dominant method by which China implements markets in different circumstances, and certainly describes the initial efforts in electricity markets, where they have very much been adopting the growing out of the plan model.

In terms of the question around authoritarianism and command and control, and what is the relative importance of these compared to more market based mechanisms? I guess I would say, starting off by just disputing the premise that command-and-control is equivalent to authoritarianism. We have a lot of command-and-control environmental policies in this country. When we adopt them here, we don’t say we’re being authoritarian. In fact, we have lots of, for example, forced technology standards in a variety of sectors where we mandate certain technologies being used or technologies that meet the best available control technologies in certain sectors. So, we do these all the time. We don’t adopt the economist’s ideal measures for dealing with environmental problems most of the time, if not for the majority of the time. But I do think there’s a really important debate going on. In addition to Li and Shapiro’s book, you also have Huang Yanzhong’s book on toxic politics, which came out last year.

Both are, I think, making the argument that China can’t really accomplish its stated environmental goals without transitioning to either democratic governance or some kind of public participation, and exactly, to what extent how much participation is needed, how much democratic governance is needed, I think that varies by study. But also, I think the evidence for exactly how much you would need is not quite there because we don’t have a lot of examples, but certainly China has been engaging in more public participation on environmental local environmental issues increasingly, whereby people can send in anonymous tips around environmental issues and energy issues.

And that can raise the stature of environmental inspection team teams or cause them to look at particular issues when they’re coming in and doing the rounds on behalf of some kind of broader environmental governance campaign. I think there is some adoption of public participation. I do think that, both of those groups of authors, both of those books and others are pointing out that some environmental policy are used for, but maybe adopt methods that in the end are coercive in some ways because they require more information, they require more extraction of maybe private information from different parts of the system that is contrary to some democratic norms.

I think that there is an important balance here, and I think that it’s wrong to assume that China is not going to be able to achieve its environmental objectives unless it adopts a democratic system of government. I think that’s setting the bar way too high, but I think we can continue to push for public participation and other forms of participatory governance to improve China’s environmental reforms and to make them less coercive, more amenable to incentive based systems as opposed to top-down command control system.

Kaiser: Where would you classify something like, for example, feed in tariffs or electric vehicle subsidies? Which have been really effective, I mean, in creating a pretty robust EV industry in China. I mean, at least I’ve given to understand they’ve been pretty effective. Those certainly aren’t coercive. They aren’t market instruments exactly either. Where are these sorts of things? They are command-and-control, yeah.

Michael: Actually, it’s an interesting question because actually, I had a debate with some of my colleagues on this. Feed in tariffs change an incentive structure, right? They make it more profitable to choose renewables over coal. That’s an incentive based system. You’re not demanding generators go out and build a wind plant instead of a coal plant. You’re giving them more money to build a wind plant as opposed to a coal plant. That sounds like an incentive structure to me, that sounds like a monetary incentive structure, it’s a subsidy. On the other hand, you are not putting it in a market where generators will compete amongst themselves to find the lowest possible way of building a generator there. Now, that’s an auction, and China’s already moving in that direction. So, feed and tariffs are actually on their way out and are moving towards those more auction based systems.

Now, an EV subsidy, again, that’s changing incentives. It’s saying, I’m giving you a bunch of money to choose electric over gas. I’m not ordering you to do that. On top of the EV subsidies may not be the most important measure determining whether or not Chinese people choose an electric vehicle over a gas vehicle. Local license plate policies have a huge impact on this. If you have to get in line and wait 10 years to buy a gas vehicle, but you could get in line and buy an EV vehicle and next month, well, what are you going to choose? It doesn’t really matter what the price is. You’re always going to choose the EV. If you’re not subject to license plate restrictions, odd days, even days, those kinds of things, those are a bunch of other measures, you could call them coercive, but they’re incentives to choose EVs over gas vehicles.

Kaiser: Right. Maybe that whole binary isn’t a very useful way to approach this issue to begin with. Yeah. Michael, you’ve seen this argument being raised more and more that we might enjoy … I mean, as US China relations sort of spiral downward, we can’t really count on much proactive cooperation between these two states. A lot of people have started floating this idea that we’ll see a race to the top in competition as both try to sort of implement more green policies. I worry though, that we’re going to see like the trade spats, that there’s going to be a terrible suboptimal division of labor with lots of inefficient supply chain redundancies, and lots of other problems like that, where we’re all pursuing low carbon energy technologies but we’re in a completely decoupled scenario. What do you believe? Do you believe that there’s this optimistic scenario of a race to the top? In other words, how important is it that we still pursue actual formal cooperation and coordination?

Michael: This is a topic that has been coursing through the whole China and climate community for some time. I think folks are looking at what’s happening and saying, okay, how do we make the best of the current situation? And trying to come up with ways to make a competitive relationship work in terms of jointly increasing ambition and enhancing each other’s climate policies, and of course, enhancing deployment of clean tech. I think certainly, competition can be used full. I think a colleague, friend of mine, Alex Wang, had a really nice paper on this recently.

Kaiser: Yeah. I talked to him about that! Yeah.

Michael: Yeah. I think there’s another thread where some folks are arguing that there’s no longer a need for cooperation whatsoever in climate change. That climate change is no longer a global comments problem, it’s not a free writer problem, collective action problem. It’s in fact, a distributed politics problem. And the entire issue and crux of whether or not we reach climate goals is, can we manage who wins and loses in each individual domestic context along the way? I don’t really agree with that extreme viewpoint either.

There’s certainly a very significant free rider challenge in climate change because the marginal benefit from you taking on costly emissions reduction measures is always going to be distributed across the globe and it’s going to be distributed unevenly. So, the countries that are emitting the least are getting the hardest hit. I think that we’re definitely in a world where distributive politics matter, where it matters who wins and who loses.

I think that’s actually really key to whether or not China’s 2060 plan is going to be successful, is looking at who the beneficiaries are. But we also need to recognize that U.S. and China, as the two largest emitters, they played a fundamental role in getting the world together at Paris and establishing an agreement that was universal, that had everyone’s buy-in on how we’re going to make commitments, how we’re going to report on them, and how we’re going to jointly collectively increase ambition when we inevitably fail to reach our targets.

I think the U.S.-China relationship is absolutely critical. I feel like the climate change component of it was certainly sometimes felt as being, this is one area where the U.S. and China can finally cooperate on. We have all these contentious issues, let’s just choose climate change and use it as an excuse to cooperate. Now, it seems like the broader relationship is pulling us back and we’re trying really hard because we recognize climate is actually not an excuse, it is imperative. It’s one of the most important reasons why we need to work together. And we’re facing that against enormous headwinds in both countries that are pushing our countries apart.

Kaiser: It’s so unfortunate. I keep having this perverse thought that Trump’s decision to withdraw from Paris may actually have been a good thing in that it spurred Xi Jinping to fill the void and take on leadership, and it maybe induced him to make more aggressive pledges because he understood that it would look good in the world. I mean, that showing up as he did at Davos, the year after Trump’s election. It gave him a kind of a halo effect. What do you think? Does that make any sense to you?

Michael: I feel like, certainly US is not coming from a position of strength to the international arena, asking and demanding for more ambition from all parties, China and others, because we’re coming out of a four years of interregnum where we’ve been a climate pariah. Other countries are reasonably looking at the US and saying, you’re an unreliable partner on climate. China, when it makes targets, is not unreliable in commitments, right? Internationalized commitments are very important in the Chinese system, and because of their political institutions, they tend to meet them.

Now, ironically, I feel like Xi’s step onto the stage at Davos and at other ones has been perceived as China trying to subvert the liberal international order and to change international institutions in its own image. I feel like that has been perceived then now, in a good government that is pro climate, as being an existential threat to US’s own domestic interests. I think that’s an over-interpretation of what we’re seeing. There are certainly areas where we’re gonna be very contentious and competitive in how we shape rules of international organizations. But I think we’re well past the point where we can push out China and give it no decision making authority when it comes to how rules of a variety of international organizations on climate, on trade, on others are set. The same time, I think that China’s leadership and pressure on the US has really helped it to generate more solidarity with developing countries. It can always lean back and say, we’re on the side of developing countries. We want to give you the energy sources that you want. We’re not like those developed countries that are already historically the largest emitters and want to keep you from getting affordable and reliable electricity. We want to listen to you, our partners.

I think that’s a really powerful message and it also shows that China’s been listening to what those host countries and environmental groups in those host countries are doing, that it decided to exit from coal when it did. I think this kind of shifts some of the pressure back on to the US to demonstrate that it’s going to be a good partner potentially through this Development Finance Corporation, DFC, and others, that it’s going to be a good partner and listen to what these host countries and developing country partners want in their energy transition.

Kaiser: One of these areas where competition, interstate competition might actually be good. You did such a good job answering that half-baked hunch of mine that I’m going to throw another one at you. I have another sort of working hypothesis, admittedly, a very optimistic one and it’s not been rigorously tested. But I mean, I feel like these days, Beijing is convinced that now is the time to make some pretty big structural changes that may cause a lot of pain in the short-term, but really need to be done and will yield gain in the longer term.

I mean, this idea is that they’ve kind of stress-tested their capacity with the severity of the COVID-19 measures that they put in, and they’re convinced that the measures actually boosted rather than damaged regime support, and they made a swift recovery possible. Now they’re sort of broadly applying this. I mean, there’s no area of Chinese life that hasn’t been touched by some new regulatory action recently. I have this suspicion that we might see some radical steps in the coming years, maybe even in the coming months toward addressing climate change, addressing greenhouse gas emissions. Do you think that’s a possibility? I mean, it doesn’t seem that farfetched to me that we might wake up one morning and open the papers and see that there’s been some massive new pronouncement.

Michael: I would always welcome the opportunity to road test your hypotheses. It’s always going to be well-thought out. I think you’re onto something here, but we haven’t quite seen the same level of regulatory crackdown in the energy sectors as we’ve seen in other sectors. I think there’s a couple of reasons for that. One is that it’s predominantly state-owned. So, you don’t have this conflict between private and state actors. You’ve also already seen a lot of consolidation in these sectors, so that there’s a very large amount of powerful incumbents that restrict changes in this area.

But energy sectors are traditionally conservative. You go across the world, there’s lots of large incumbents that have all sorts of political and restrict changes and liberalization. But two aspects that I think could blossom into something much more significant on the energy sector reform is first, the 2015 energy electricity sector reform, which resulted in a lot of these markets for electricity, so growing out of the plan, were preceded by the removal, transfer, of the head of the State Grid Corporation of China, Liú Zhènyà 刘振亚, who is a powerful political figure over the 2000s, over the same period that China was struggling to stand up any kind of market in the energy sector.

And State Grid had its own ambitions in this arena, building large, long transmission networks. Markets could help that, but in general, they’d rather just control the flow of electricity itself rather than give it up to markets. So, preceding this 2015 reform, you got rid of this powerful political boss, and the success of heads of State Grid have not been nearly as politically powerful. They’ve cycled through three or four since that time. The second is that Xi Jinping has taken on a couple of priorities, but anti-monopoly, Fǎn lǒngduàn 反垄断 , has been a very prominent staple. It comes up in a lot of discussions, more recently in a comprehensive leading group discussion and another forum. The energy sector is, if anything, a monopoly. They’re just a handful of very large state-owned firms that control all these generation capacity. And you have these two large grid companies which have enormous control. Once the restrictions and the constraints in this system are felt more viscerally, like these interprovincial trading barriers, for example, I think we could see some more movement in this area where we would start opening up the energy sector.

And broad changes are possible. You can just, overnight, change, take two of the large SOEs in energy and form them, and combine them together, to form the largest energy coal and power company in the world. You can do that. Those kinds of shifts are huge, right? Those kinds of political shifts are enormous. So, if you can do that, you can do lots of other things. And I feel like another set of things to watch for in terms of the future evolution of China’s environmental and energy system is how these markets will evolve. I study quite a bit how electricity markets are governed at the local level and whether or not they’re efficiently giving the right signals for more renewables to come on the grid and to shift away from coal based production. And I think creating the right incentives for local officials to choose markets that actually align with national goals, environmental goals, energy security goals, is going to be another important litmus test.

Kaiser: Absolutely. Michael, this has just been a fascinating and really wide-ranging conversation. I am grateful that … I think the listeners are going to want to check in with you on the progress of China’s efforts every couple of months. So thanks for taking so much time out of your day to chat with me. You really do do such a marvelous job of making this stuff accessible to lay people. Michael, what is the URL of your personal website? It’s this great trove of papers that you’ve written or co-written. Can you share that with us?

Michael: Yeah. mdavidson.org.

Kaiser: Oh, okay. Just mdavidson.org. Yeah, check it out. It’s really fantastic. Michael, let’s move on to recommendations, but first, let me remind everyone that the Sinica Podcast is powered by The China Project, and if you want to help us out, the very best thing that you can do is to subscribe to our daily Access newsletter. It’s really just a fantastic resource. I think, if you are part of an organization, an NGO, or an embassy, a diplomatic mission somewhere, an academic organization, or even a company, and you’re looking for a group discount, we offer really great ones, check it out. Email alex@thechinaproject.com and he’ll set you up.

All right. Let’s move on to recommendations. Michael, what do you have for us?

Michael: I would recommend folks though, and maybe it’s not a new one, to check out The Chair. It’s a great series on Netflix. Have you seen it?

Kaiser: Yeah, I have. I really enjoyed it. I mean, it’s controversial, but you’re in academia, so you know it better. I tend to suspend disbelief and enjoy these things. I loved it. Sandra Oh was great. I thought it was hysterical.

Michael: Yeah. I thought it was hysterical too. I mean, I think it’s great to tackle some social issues in the context of an academic department, because that’s where I live. It’s very fun. I’m not a chair of a department yet, so I’m not privy to any of those administrative discussions, but it certainly is, it was fun to watch and see some of the interpretation exaggerations of how academic departments work. I thought it was really important. It had a strong lead female actor, and I thought it had brought in some really cool Korean culture references.

Kaiser: Yeah, exactly. I love that. The big point of — bone of contention with a lot of people is some people feel like there was just a kind of cruel caricature of “woke” campus culture. My feeling was that, well, it’s a comedy, first of all. Of course, there’s going to be a little bit of caricaturing, but I thought that it was fair. I thought that it actually was pretty empathetic to that point of view, that it wasn’t just mocking it as just ludicrous or ridiculous. There were other people who complained about centering it on this, kind of drunk white male guy. But yeah, in general, I thought it was … I enjoyed it. I binged it super, super fast. I just couldn’t stop it. I really enjoyed it.

But again, I am a sucker for these things. I don’t really watch stuff critically. I just read this gigantic piece on The Sopranos, because there’s this prequel coming out pretty soon. I can’t remember the name of the author right now off the top of my head, but it was in The New York Times Magazine, really good piece. I highly read recommend it. This is not my recommendation, by the way. But I sat there through the whole thing, recognizing every scene that was described in there. I mean, every scene that they talked about, but realized that I had failed to interpret it in what was apparently an obvious way that I guess Chase wanted us to think of it.

Anyway, I’m just kind of dumb that way, and hopefully not that bad when I read stuff on China.

But my recommendation is a new novel by Richard Powers, who is one of my very favorite writers, called Bewilderment. A lot of you guys are gonna know Richard Powers — I’ve recommended his stuff before, but from the novel, The Overstory, which won the Pulitzer. I say, hey, your new favorite author was this guy I’ve been reading since the mid-’90s. I’ve read like eight or nine of his novels. I mean, his very first one, Three Farmers on Their Way to a Dance. His probably most famous one before this was The Goldbug Variations, which I loved. Galatea 2.0, a great one, sort of about AI.

Anyway, he likes to write at the kind of intersection of really cutting edge science and high culture. This one is just beautiful. It’s really heartbreaking. Okay, he’s a show off. He’s a show off, and he’s a show off with his prose and with his knowledge, but it’s still great. This one is told in first person by a father in his late thirties, who’s this recently widowed astrobiologist. He looks at exoplanets and tries to figure out from their light signatures, whether they might have life. He’s great. Really interesting guy, and he’s got this non-neurotypical nine-year-old kid, who’s just really so sensitive, just feels things really deeply. The thing that he’s super into, I mean, his dead mother was an animal rights activist, and that’s his issue. He’s really freaked out about the mass extinction of the Anthropocene. It’s also about brain science and it’s about empathy and it’s about the overdiagnosis of ADHD and [overprescribing] of these crazy psychoactive drugs for these little kids. Anyway, I thought it was great. It’s heartbreaking and really compelling.

After you’ve read it, definitely until after you’ve read it, then listen to this interview that Richard Powers, the author, did with my favorite podcaster, Ezra Klein, who is just the best interviewer. It’s just an exemplary, exemplary podcast. It’s fantastic. Both of them are just … I’m going to listen to it again. Anyway, Michael, what a pleasure. Thank you so much.

Michael: Thanks for having me, Kaiser. This was great.

Kaiser: It was super edifying for me. Thanks. And we will have you back on again, I trust.

Michael: All right. I look forward to it.

Kaiser: The Sinica Podcast is powered by The China Project and is a proud part of the Sinica Network. Our show is produced and edited by me, Kaiser Kuo. I’d be delighted if you would drop us in email at sinica@thechinaproject.com. I really love getting emails from you guys. Just as good, give us a rating and a review on Apple Podcasts. This really does help people discover the show. Meanwhile, follow us on Twitter or on Facebook at @supchinanews, and make sure to check out all the shows in the Sinica Network. Thanks for listening, and we’ll see you next week, take care.