Abstract

Designing a reasonable regional CO2 emission permit allocation mechanism has great meanings for China to achieve its peak emission goal as well as to optimize total emission abatement costs. Chinese government officially launched the construction of national emission trading scheme (ETS) at the end of 2017. The national ETS will first cover electricity generation sector and gradually cover other industrial sectors in the future. The emission permits will be freely allocated using benchmark method. The key questions of constructing the national ETS are threefold. First, how to realize the effectiveness that the overall emission control target is achieved? Second, how to improve the efficiency of carbon market to minimize total emission abatement costs? Third, how to seek the balance between social equity and efficiency of environmental policy? As a result, it is necessary to conduct studies on designing the optimal permit allocation mechanism of China’s national ETS.

In this paper, we start from analyzing the marginal abatement cost curve (MACC) which will be separated into two parts by carbon emission efficiency. One region’s potential carbon reduction amount is determined by the part which is not related to low-carbon technology. When social planner allocates emission permits by maximizing national total output, the economic efficiency will be achieved. The marginal abatement cost of each region would be equalized under the first-order condition of this optimization problem. At the meantime, the corresponding permit allocation mechanism is a multi-criteria mechanism which includes total emission reduction target, total emission amount, emission intensity and carbon emission efficiency. This paper proves that a region with higher carbon emission efficiency would be allocated more emission allowances. By introducing the criterion of carbon emission efficiency, we can fully take into account the early emission reduction technology investment in different regions, thus avoiding the phenomenon of 'spurring a willing horse'.

In the empirical part, the patent data related to environmentally sound technologies are used to measure low-carbon technology development level in each region. Besides, effects of introduction of seven pilot carbon emission trading markets which are considered to improve regions’ emission performance are also investigated in empirical analysis. Both consumption-based and production-based carbon emission efficiencies of 30 provinces in 2006-2015 are estimated by using stochastic frontier model and are applied in a numerical simulation. From the perspective of carbon emission efficiency changing trend in different provinces, most regions show a downward drift during the 11th Five-Year Plan period. While during the 12th Five-Year Plan period most regions have a turning point in carbon emission efficiency and show a gradual upward trend because of the compulsory carbon emission intensity constraints. Different from other regions, regions that introduced pilot carbon emission trading market show a significant improvement in their carbon emission efficiencies.

For consumption-based efficiency, output based allocation (OBA) and emission based allocation (EBA) will surfer 1.61 percent and 0.47 percent more aggregate output losses than multi-criteria allocation mechanism. While for production-based efficiency, OBA and EBA will surfer 0.68 percent and 0.21 percent more aggregate output losses. Moreover, simulated allocation results are different between consumption-based and production-based allocations. Energy production provinces undertake more emission reduction responsibilities using production-based allocation. For example, Inner Mongolia will reduce around 65 percent more emissions using consumption-based efficiency. Comparatively, electricity inflow provinces undertake more emission reduction responsibilities using consumption-based allocations. For example, Hebei will reduce around 83 percent more emissions using production-based efficiency.

Based on our theoretical analysis and empirical results, following policy suggestions are given in this paper. Firstly, when considering the allocation of carbon emission allowances, China should take multi criteria such as output, historical emissions and technological efficiency into account to avoid the “Spurring a Willing Horse” phenomenon. Secondly, under the optimal multi-criteria allocation framework, firms will invers more on low-carbon technology to obtain more emission permits. Thus, endogenous low-carbon technological progress can be realized in the long term. Thirdly, permit allocation results are quite different between consumption-based and production-based allocations for some provinces. Therefore, the impacts of different allocation results on regional equity must be fully considered in practice. Fourthly, the multi-criteria allocation mechanism proposed in this paper can also be applied to firm-level permit allocation in the future.

Citation

Qian, H., Wu, L. and Ren, F. (2019). From 'Spurring a Willing Horse' to Efficiency Driven: A Study of China's Regional CO2 Emission Permit Allocation. Economic Research Journal, 3, 86-102.