1. Applicability of market-based instruments in developing countries
A case study on the SO2 emission trading system in China and lessons-learnt for a China-wide CO2 emissions trading system
Miriam Schroeder
University of Potsdam

2. Content Starting point
The transferability of economic instruments to developing countries
Case Study: Analysis of China’s SO2 ETS pilot projects
Lessons-learnt from the SO2 pilot projects
Prospects for a possible CO2 emission trading system

3. Starting point
Challenge: CO2 emissions of developing countries with no international reduction targets

4. Starting point Choice of instruments at national level
Command-and-control:
Carbon tax
Market-based:
Scaled up version of CDM
Emission trading
Feasibility of a permit trading system for GHGs in developing countries

5. Starting point Research Question
“Which preconditions does the instrument of emission trading require for its successful implementation in developing countries?”

6. Permit trading in developing countries
Assumption
The transferability of ETS to developing countries depends on the match between preconditions necessary for the functioning of this economic instrument and the existing framework conditions in the country under consideration.
ETS ?
Developed countries
Developing Countries

7. Permit trading in developing countries
IVs DV
Property rights
Liberalised market
Successful
SO2 / CO2
ETS
Rule-setting capacity of state
Environmental
Effectiveness =
Reduction of
SO2 / CO2 ??
Rule-enforcement capacity of state
Monitoring capacities of institutions
Equity of cost distribution

8. Legal precondition
Argument: Monetary value needs to be attached to a natural resource via the assignment of a property right to the user
Hypothesis: Property rights on natural resources need to be properly defined.
Indicators:
strictness and legal embeddedness of emission cap
eligible installations for emissison permits
time frame of ETS
spatial scope of ETS

9. 2. Economic precondition
Argument: In an ETS, market signals determine the most cost-efficient way of emission reduction. Market signals functions only if private (or state-owned) enterprises have incentives to follow the market signal.
Hypothesis: The market in the power and energy-intensive sector needs to be liberalised and companies need to be managed independently.
Indicators:
ownership ratio of companies
number of companies in the market

10. 3. Political precondition
Argument: State has to set rules of the game:
Constitutive rules in terms of types of emissions to be reduced and business actors to participate;
Regulative rules in terms of the mode of measuring, trading and accounting of emission permits.
Hypothesis: The state needs to have an adequate rule-setting capacity.
Indicators:
- the state’s method for allocating emission permits
- the interference of the emission trading system with already existing regulations for emission control

11. 4. Political precondition
Argument: Compliance with ETS needs to be credibly enforced.
Hypothesis: The state needs to have an adequate rule-enforcement capacity.
Indicators:
the legal back-up of the emission trading system
the power relations of the state institutions responsible for emission trading
the state’s enforcement strategy and its imposed penalties for noncompliance

12. 5. Political precondition
Argument: Monitoring of companies’ emissions, a registration and follow-up of the tradable permits and verification of emission data of installations demand a qualified and well-equipped staff in state institutions.
Hypothesis: State institutions need to have good administrative and monitoring capacities.
Indicators:
- the institutions’ measurement abilities for the emissions of the affected installations

13. 6. Political precondition
Argument: Distributional implications of policy instruments matter especially for developing countries. Who pays and how benefits most by emission reduction measures is a question of equity.
Hypothesis: Costs and benefits of any emission trading system need to be distributed in a socially and environmentally beneficial mode among participants and affected citizens in order to ensure its acceptability.
Indicators:
- usage of revenues by the state
- evaluation of the ETS’s distributional effects by companies and affected citizens

14. Case study - SO2 ETS in China
Benxi City
Taiyuan City
Jiangsu Province
Hongkong – Guangdong Province

15. Preliminary results of case study - 1. Definition of property rights
The SO2 emission reduction target is derived from the national target, but local governemnts have relative freedom in choosing the means of how to achieve it.
In pilot ETS, the eligible installations (mainly from power sector) and the scope and timeframe of the ETS is limited.
-> incentives for trading or investment in abatement technology is low.

16. Preliminary results of case study - 2
Preliminary results of case study Existence of a liberalised market
At the national level most energy companies are still state-owned enterprises (SOEs), because this sector is regarded as being sensitive in terms of national energy security. For the local level, a similar dominance of SOEs can be assumed.
-> State-owned enterprises are an obstacles to any ETS implemented in China

17. Preliminary results of case study - 3. Rule-setting ability of state
Allocation method so far only fixed in one case: Principle of grandfathering and free allocation of permits.
->In general, distributing the cost burden of the required emission reduction among companies and sectors of one jurisdiction is highly political, and thus prey to the power and interest of local actors.

18. Preliminary results of case study - 4
Preliminary results of case study Rule-enforcment capacity of state
In most cases, the local government has initiated or at least supported the emission trading system, but operation and administration of the system are in the hands of the local Environmental Protection Bureau (EPB).
-> EPB has not the authority to impose penalties and is dependent on local government for finance. Not very likely to enforce penalties against powerful interests of their local community.
-> The penalty itself is seen as too low to motivate companies to comply with the reduction limits.

19. Preliminary results of case study - 5
Preliminary results of case study Monitoring capacities of institutions
technical equipment for measuring emission is often lacking in installations
data quality varies according to
the data collection experience and authority of the responsible state institution
no experience with allowance tracking systems for the follow up of issuance and trading operations
-> low monitoring capacities

20. Preliminary results of case study - 6
Preliminary results of case study Equitable distribution of revenues
No data on costs and benefits available from secondary literature.
Chinese researchers doubt that costs for state-owned enterprises are „real costs as money is handed back to companies through back door“.

21. Preliminary results of case study - SO2 ETS in China
Dependent variable „successful ETS“ measured in numbers of accomplished trades between companies
Benxi City
Taiyuan City
Jiangsu Province
Hong Kong – Guandong
Trading situation
None so far
4 trades
1 trade

22. Lessons-learnt from the SO2 pilot projects
Some preconditions deemed necessary for a successful ETS are not yet given in China.
1. Design flaws in ETS
limited spatial and time dimension,
penalties for polluters are weak,
interfere with the levy system on SO2 emissions.
low price of non-compliance penalties has not provided incentive for trading,

23. Lessons-learnt from the SO2 pilot projects
2. Problem of governance capacities at local level
weak power position of implementing institution,
lack of monitoring equipment and experiences.
3. Transformative state of the Chinese economic system
state ownership of power companies,
market dominance by a small number of large companies.

24. Prospects for a possible CO2 ETS
No national cap on CO2 emission reductions, but goal of
1) improving energy efficiency by 20% up to 2010,
2) increasing usage of renewable energies to 16% of power production.
Means of achieving these targets are not further specified
-> option for establishment of a trading system for CO2 emissions/ energy intensity/ green energy certificates
-> introduction of coal – energy – carbon tax

25. Prospects for a possible CO2 ETS
If Chinese government opts for a CO2 ETS, it will probably be first tested on a local scale.
Fundamental problem remains:
State owned enterprises are not the right addressees of a policy instrument that has its merits in reducing the costs of emission abatement.

26. Thank you for your attention and thank you for the workshop!
Miriam Schroeder