September 10, 2014, by editor
How institutions will constrain China’s efforts to build a low-carbon energy sector
Written by Philip Andrews-Speed.
Moving to a low-carbon economy is not just a technological issue, but necessarily involves changes across the whole of a society. This realisation has led to the application of concepts such as ‘socio-technical regime’, ‘regime transition’ and ‘adaptive capacity’ in order to examine the nature of the challenges facing any society seeking to promote a transition to a low-carbon economy. Many of the obstacles and constraints to this transition have been referred to as ‘institutional’ in nature. But few attempts have been made to bring an understanding of institutions into carbon scenarios or to apply institutionalism to the low-carbon transition.
A ‘socio-technical regime’ comprises an assemblage of institutions which develop around a particular set of technologies and which support the development and use of these technologies. The move to a low-carbon economy requires a transition from one regime to another and involves societal change spanning the economy, technology, organisations, rules, systems, values and behaviours. Many aspects of major societal change can be captured through new institutional economics and historical institutionalism.
Institutions can be regarded as the formal and informal rules and expectations of a society. The higher levels of institutions, known as the embedded institutions (or culture) and the institutional environment, play a key role in determining the degree of path-dependency in different societies, their relative openness to change and the likely processes of such change. China’s embedded institutions and institutional environment have their roots in the distant imperial past as well as in the more recent Communist regime. These institutions create a high degree of path-dependency in the governance of energy in China, in policy-making and policy implementation, as well as determining the nature of institutional change.
The lowest level of institution comprises the specific policies, laws, rules and contracts which govern individual economic transactions. One of the problems in China, and in other transition economies, is that the various rules that government introduces at this lowest level of institution are inconsistent with the higher level embedded institutions and institutional environment. As a result, new policy instruments either fail to meet their objectives or trigger unintended consequences.
China’s government has recently launched experimental carbon markets and has raised the possibility of introducing a carbon tax. Whilst the ambition to introduce such economic instruments is to be applauded, effective implementation will face a number of serious obstacles. First, the major energy users are large state-owned enterprises which have significant political and market power, soft budgetary constraints and a low cost of capital. In addition, they are not open to hostile take-overs or bankruptcy without government approval.
Second, the limited capacity and authority of the governing agencies may constrain their ability to monitor actors, administer the scheme effectively and impose penalties on offenders. Local governments are also likely to find ways to undermine central government initiatives, for example by compensating local enterprises for financial losses arising from these schemes or by issuing too many permits. Finally, most energy prices are still subject to direct or indirect government control and the government continues to be reluctant to allow the prices of energy and industrial products to rise too rapidly.
In the terms of new institutional economics, a profound mismatch exists between these proposed policy instruments (emissions trading and carbon tax), on the one hand, and both the prevailing institutional environment and many of the institutions which govern transactions in the energy and heavy industry sectors, on the other hand. In everyday terms, economic instruments are unlikely to work in sectors where the state dominates both ownership and price. Emissions trading and carbon tax are unlikely to bring about significant emission reductions until the major energy producers and energy consumers are further freed from state ownership and control, and until the government loosens its control over energy prices. Until that time, the government’s aim of constraining carbon emissions may best be served by combining traditional administrative instruments with the continued steady rise of energy prices for all users.
China’s efforts to support the manufacture and deployment of wind and solar energy have met with a high degree of success. The country now ranks top or near the top on the world in terms of both manufacturing capacity and installed capacity for both wind and solar energy, and is a dominant force in international markets for these products. This success was achieved through the traditional means of providing direct subsidies and tax breaks to manufacturers and feed-in-tariffs for energy suppliers. Despite this generous and expensive support, problems with coordination and incentives have constrained the actual despatch of wind power and the installation of small-scale solar PV. In addition, the solar PV manufacturing industry now has massive over-capacity and bad debts.
China’s path to a low-carbon economy under the prevailing institutions of governance will probably be characterised by the continued construction of infrastructure to produce and deliver low-carbon energy. However, this may be almost matched by ongoing growth of high-carbon energy sources such as coal, oil and natural gas, unless economic growth stays at a low level. The switch from coal to gas will be sustained, but the pace of substitution will be constrained by the availability of gas supplies as well as by the low price of coal relative to that of gas. If the economy picks up again, coal will remain the fuel of choice to meet short-term supply deficiencies. In a booming economy, efforts to constrain the total consumption of primary energy are likely to encounter resistance from local governments and industries. Radical institutional change across the polity, economy and society in China will be required in order to accelerate the transition to a low-carbon economy. In the energy sector such changes would include the ownership of the energy industry and of the energy-intensive industries, the pricing of energy, and the role of the state-owned banks. But it is difficult to identify such profound institutional changes taking place today.
Philip Andrews-Speed is Principal Fellow in the Energy Studies Institute, National University of Singapore.