Greening China: tackling bad industrial policies should be a policy priority

(This article in a slight different version was first published in the website of Institution of Developmental Studies, UK, as an opinion piece on 16 March 2015)

The Chinese government's industrial policies have played a big role in pushing

the green transformation of China. But it has also allowed less visible policies to

counteract this transformation.

Recent increases to domestic petrol consumption taxes by the Ministry of Finance and the State Administration of Taxation have triggered a strong public backlash. At first, taking advantage of the drop in global oil prices to push the energy reform agenda seems like a good idea. However, the Chinese government would do well to also address the removal of existing ‘bad’ industrial policies which, for example, subsidise existing fossil fuel interests and ultimately jeopardise the energy transition China is trying to bring about. Indeed, this should be a policy priority.

The debate between experts over a free market vs government intervention

In the Government’s 12th Five Year Plan (FYP), seven industries have been identified as Strategic Emerging Industries (SEIs) They include those that supply products associated with energy-saving and environmental protection technologies, new energy sources such as solar and wind power, and new energy-powered cars such as electric vehicles, amongst others. China has since utilised a variety of policy instruments to promote these industries, including direct or indirect investments by the state, tax breaks, and price controls.

Some Chinese economists who strongly believe in a ‘free market’ approach argue that such industrial policies will not work because there is no reason to believe that government officials are more capable of identifying future trends in technological changes than anyone else, nor is the government likely to effectively execute the policies in the manner in which they have been designed. Others argue that officials either simply have a poor understanding of how economies work, or are seeking greater power and opportunities for rent-seeking. For example, some economists have attributed the Chinese solar PV industry’s difficulties over the past two years (up to 2014) to overcapacity, which, in turn, was regarded as the outcome of various support programmes provided by central and local governments.

For these critics, China’s energy transition cannot be achieved through publicly-funded investments, the provision of land at discounted prices, or cheap loans from state-owned banks. Rather, they see the best policy for driving the energy transition as the creation of a fairer market environment, and then letting it operate.

However, there are also scholars and industry experts who argue that state intervention is an essential element for the success of an energy transition, especially in a country like China. In a recent book, Greening of Capitalism: How Asia is Driving the Next Great Transformation, the Australian Professor John A. Mathews provides an in-depth discussion of this argument.[5]

In his view, “China has both motive and means” to transition, and lead others to do the same.

The ‘motive’, because it is facing unprecedented pressures on its environment and energy supply brought about by its emergence as a global power. The ‘means’, because, unlike the governments of democratic nations, the Chinese government is powerful and resourceful in the management of its economic affairs and is prepared to use that power.

While it is both practically necessary and theoretically correct to introduce a carbon tax and/or carbon emission trading mechanisms to facilitate the energy transition, these are not sufficient, given the urgency and scale of the problem.

Mathews argues that such market-based instruments can be expected to work once a new trajectory has been set by state intervention; but without such state intervention their use and effects are limited. It is difficult to establish the right prices for the externalities of energy use and pollution, as well as slow for the market signals to take effect. Well-designed industrial policies are therefore necessary to accelerate the process of the energy transition.

Removing ‘bad’ industrial policies as a priority

As the designer and implementer of industrial policies, the Chinese government is being increasingly challenged over its judgement, fairness and efficiency. For example, it has come under a lot of scrutiny over its declaration that the recent increases in domestic petrol consumption tax were to "improve the environment and promote energy conservation”, and the legal procedure has been questioned.

In such an environment, the government might consider shifting its focus. One way to off-set ongoing controversies over the introduction of new, ‘good’ industrial policies, would be a consensus and drive to eliminate existing, ‘bad’ industrial policies that are currently jeopardising the energy transition.

Take subsidies for example. There are still explicit and implicit subsidies to the traditional fossil fuel-based industries (coal, oil, natural gas and thermal power) in China. According to the International Energy Agency (IEA), the Chinese fossil fuel industries received in the region of US$21 billion in subsidies in 2013. Taking into account the external, environmental costs of fossil fuels, the International Monetary Fund (IMF) estimates that the total amount of subsidies awarded to China’s fossil fuel industry in 2011 reached nearly US$280 billion. The scale of these subsidies paid to fossil fuels dwarfs any support provided to renewables.

Some companies from energy-intensive industries, such as steelmaking, metallurgy and cement production, also ranked high on the list of publicly listed companies according to the amount of subsidies they received. In order to attract investments and grow the local GDP, it is known that some local governments use public funds to subsidise the use of electricity and coal by local manufacturers.

In addition to direct provision from public funds, many Chinese energy companies continue to enjoy low-interest loans from the policy banks. According to a recent report by the Overseas Development Institute (ODI), the China Development Bank alone had outstanding loans valued at US$766 billion in 2013 credited to Chinese petroleum, petrochemical and coal companies.

As a social security measure, China also provides fuel subsidies to certain industries and user groups, such as farmers, fishermen, bus companies, taxi drivers, and people with disabilities. While fuel subsidies to people with disabilities for their transport needs may be justified, those provided to taxi drivers are not. The government needs to rethink whether it is more effective for such subsidies to be targeted at fuel consumption needs or whether they should be included as a general social security payment. To compound the issue, there have been numerous cases where the granting of fuel subsidies has been subject to corruption.

Conclusion

At the G20 Pittsburgh summit in 2009, China together with other countries made a joint commitment to “phase out and rationalise over the medium term inefficient fossil fuel subsidies […]”. It should be noted that China's policy reform in this area is necessary not only to fulfil the commitment it has made to the international community, but more importantly, to help accelerate its own energy transition.