Market-Based Instruments with Chinese Characteristics: The Feasibility of Cap-and-Trade Implementation to Reduce SO 2 Emissions in China and the Role of the EPA June 20, 2007 The La Follette School of Public Affairs MIPA Workshop Project Aditya Chandraghatgi * Brandon Lamson * Leah Larson-Rabin Raul Leon * William Lipske * Allison Quatrini * Marta Skwarczek

Project Motivation   China and the U.S.: Can markets deliver ecological results?   Policy Report for Jeff Smoller, President of the Multi-State Working Group   June 15, 2006 Trilateral Agreement between the EPA, ADB and SEPA

Why SO 2 for Cap-and-Trade?   China has the world’s highest sulfur dioxide emissions.   SO 2 emissions in China are mostly generated from burning coal for electricity production.   SO 2 causes severe health problems and environmental damage.

Problem Statement Chinese leaders face the challenge of controlling SO 2 emissions without derailing economic growth.

Analytical Approach   Assess the feasibility of implementing cap- and-trade mechanisms in China   Evaluate feasibility in the current Chinese context based on three categories of criteria: political/regulatory, administrative, and economic   Identify the changes necessary for a successful cap-and-trade mechanisms and the potential role of the EPA

Political/Regulatory Feasibility  Political will – –Why it matters – –Economic development vs. environmental protection  Political control – –Nomenklatura and Green GDP – –Directional flow of political power  Regulatory clarity – –Accountability and predictability  A role for social pressure – –Where governments cannot or will not act – –NGOs/GONGOs as extension of the State – –The Fire-Alarm System

Political/Regulatory Feasibility Political and Regulatory Criterion Status Quo in China Political will Low: Low: Economic development continues to be primary concern Political control Moderate: Moderate: Nomenklatura system potentially useful, but ambiguous political organization creates complications Regulatory clarity Low: Low: Environmental regulation currently opaque A role for social pressure Low-Moderate: Low-Moderate: Very little political and regulatory space for non-governmental entities

Administrative Feasibility   A relationship exists between institutional capacity and compliance in emission control   Capacity and commitment necessary for environmental policy to be effective   Administrative challenges: accurate measurement of emissions, monitoring of emission sources, and enforcement of policy present

Provincial Capacity Li, Wanxin. “A Survey of Institutional Capacity of Local EPBs in China.” Paper presented at 2005 Urban China Research Network Annual Conference: Chinese Cities in Transition, 2 May 2005, in Shanghai, China.

Administrative Feasibility Status Quo, by Local Capacity AdministrativeCriterion Low Capacity Area High Capacity Area Accurate measurement of SO 2 emissions from all sources Accurate measurement of SO 2 emissions from all sources Low: Low: Material balance calculations not accurate enough for measuring SO 2 emissions Moderate: Moderate: With increased funding, continuous emissions monitors would better estimate emission levels Monitoring of SO 2 emission sources and permits Monitoring of SO 2 emission sources and permits Low: Low: Continuous emissions monitors are needed but costly Moderate: Moderate: State monitors inspect more often and more accurately Consistent, effective enforcement Consistent, effective enforcement Low: Low: Provincial compliance varies Moderate-High: Moderate-High: Provinces have ability to increase fines for noncompliance

Economic Feasibility   Focused on Guangdong, a single high capacity province   Selected power and cement industries   Both industries are large emitters of SO 2

Economic Feasibility Status Quo in Selected Industries Economic Criterion Power Industry Cement Industry Area of targeted emissions that is regional or global in scope Area of targeted emissions that is regional or global in scope High: High: SO 2 emissions travel considerable distances High: High: SO 2 emissions are regional. High concentration of plants across province Multiple firms facing different marginal abatement costs Multiple firms facing different marginal abatement costs Moderate: Moderate: Varying ranges of technology, emissions levels, and different management efficiencies High: High: Firms have different technology and efficiency levels Ability of firms to transfer burden of pollution abatement onto consumers Ability of firms to transfer burden of pollution abatement onto consumers Low: Low: Prices still highly regulated High: High: Cement prices generally set by the market Existence of competitive market Existence of competitive market Low: Low: Power plants not fully independent in decision making Moderate: Moderate: Wide variety of ownership structure and many firms

The EPA’s Role in Cap-and-Trade Implementation in China Feasibility Area Change by Chinese Central Government Feasibility of EPA’s Potential Impact Feasibility of EPA’s Potential Impact Political and Regulatory Feasibility Political and Regulatory Feasibility Reprioritize environmental protection on par with economic development Low-Moderate: Low-Moderate: The EPA must use whatever leverage available through its role as a U.S. government agency Administrati ve Feasibility Administrati ve Feasibility Build human capital Moderate-High: Moderate-High: EPA should assist with training, seminars, and hosting conferences to help build human capital Increase incentives to break ties between SEPA and industry Economic Feasibility Economic Feasibility Create an industry sector made up of multiple, independent firms Low: Low: The EPA will have a limited role; technical assistance may increase deregulation

Summary of Findings   Cap-and-trade would not be successful in China under current conditions.   Significant changes would be necessary; it is unlikely that they will be implemented in the near future.   The EPA has little power to induce change in China to make cap-and-trade successful.

Final Recommendation and Conclusion   The EPA should focus on helping SEPA strengthen existing environmental command-and-control regulation.   A strong command-and-control foundation supports progression towards market-based instruments, and will provide immediate results in SO 2 reduction.

Question & Answer Session