The decoupling the world is waiting for: China’s green growth breakthrough

Employees check solar panels, as they work on a grid-connected photovoltaic power generation project, at a power plant in Changxing County, Zhejiang Province, China June 13, 2017. REUTERS/Stringer ATTENTION EDITORS - THIS IMAGE WAS PROVIDED BY A THIRD PARTY. CHINA OUT.

After a disappointing COP25 in Madrid, the hopes for decisive climate action now reside on a better outcome in Glasgow this year, where countries will be expected to raise their commitments to emission reductions. As the world’s largest emitter of greenhouse gases, China is in a unique position to decelerate the pace of global emissions. If China succeeds, it will not only play an enormous role in combatting global climate change, but also solidify improvements in pollution control and air quality, with direct benefits to millions of its own people. In the process it could also unlock new drivers of innovation, growth, and job creation at home and help alleviate potential tensions and loss of market access abroad.

China is on track to meet its current commitments under the Paris Agreement. Having cut carbon intensity—the amount produced per unit of output—by more than 40 percent from 2005 levels, it achieved a key target two years earlier than promised. Emissions growth in recent years has decelerated sharply, underpinned by tighter environmental regulations and massive green investments, including in renewable energy and electric vehicle infrastructure. This in turn is driving green innovation.

China’s economic growth and growth in emissions are linked

Despite this important improvement, China remains the world’s largest emitter of greenhouse gases, accounting for about a quarter of total CO2 emissions—more than the U.S. and EU combined and larger than its share in global population and GDP. China’s rapid economic ascendance was associated with an equally rapid increase in emission levels (Figure 1). On a per capita basis, emissions have already reached the levels of some high-income economies. Much of this increase is due to the heavy reliance on coal to meet the country’s growing energy demand. While the share of coal in China’s energy mix fell below 60 percent last year, China still consumes half the world’s coal. Moreover, China’s carbon intensity remains much higher than in high-income and even other upper middle-income economies, indicating a large potential for further efficiency gains.

Raising ambition

According to the U.N., the global pace of emission reduction would need to increase fivefold over the next decade to get on track toward the 1.5°C temperature goal of the Paris Agreement. While reductions in high-income economies—notably the U.S. and the EU—need to accelerate, it will be impossible to achieve this target unless China decouples growth from carbon emissions even more. Such a path is clearly within China’s reach. Recent projections indicate that China could reach peak emissions well ahead of 2030, its Paris target. To anchor a higher level of ambition and drive policies for a deeper decarbonization across all major emitting sectors, China could set an absolute economy-wide emissions target for carbon in the upcoming 14th Five Year Plan.

Unlocking the power of (power) markets

While targets and environmental redlines, including provincial coal-consumption caps and renewable-energy targets, have been effective policy tools in China, the use of more market-based mechanisms could be expanded. This would create powerful market incentives to innovate, adopt greener technologies and processes, and drive down the cost of emissions reductions. In this regard, China’s national emissions trading system (ETS)—which will be rolled out to the power sector this year—could help facilitate the shift to cleaner energy. However, broader reforms to create more competitive power markets are even more important for the transition to a more sustainable energy system. For price signals—including those expected from the ETS—to be effective, power producers need to compete, allowing less polluting and more efficient ones to trade freely and expand their market share. This is currently not the case in China, where the power market remains heavily controlled. Interprovincial trade is limited, and the dispatch system allocates the same minimum operating hours to all power plants regardless of their operating costs. China’s increasingly competitive renewable capacity would be utilized more effectively and expand even faster if these barriers were effectively addressed.

In the meantime, China’s ETS could also be expanded beyond the energy power sector to include steel, cement, and other heavy industries, turning it into a true cap-and-trade regime. This would create incentives for end users of energy to increase efficiency while power-sector reform is still unfolding.

Ensuring a just transition

The transition to a greener growth path offers great potential to tap into new technologies as sources of growth and job creation. But the transition also means a faster exit from polluting industries with asymmetric impacts across China’s regions. The country’s most developed coastal regions and leading cities—Beijing and Shanghai—have already decoupled, while emissions in China’s more resource-dependent interior provinces—such as Shanxi and Inner Mongolia—continue to grow (Figure 2).

Asymmetric transitions

Since their economic fortunes are tied to coal and coal-related heavy industries, these regions face significant transition costs. Retrofitting of some existing assets may be economically profitable if power markets are reformed, inefficient coal-fired power plants are retired, and no new coal capacity is built. To make this feasible, however, some losses from stranded assets may need to be absorbed by power producers or compensated from other sources. In addition, mitigating asymmetric impacts and social risks calls for a combination of increased labor mobility, including reforms of China’s household registration system, efforts to diversify local economies away from coal, and strengthened social safety nets to protect households from adverse shocks associated with economic restructuring. While the costs associated with China’s energy transition are concentrated, there are significant national and global benefits. There is thus a strong case for transition support to help exposed regions mitigate these risks and ensure China’s transition to a low-carbon economy is not only fast, but also fair.